The oil and gas majors would have us believe that they are transitioning into lower-carbon energy companies. How credible is this?
Right now, there is no doubt we need the industry’s products (oil and gas). But climate change constraints, technological advances, and changing consumer preferences mean we won’t need as much in the not-too-distant future.
Lower demand begets lower prices, which favours the lowest cost producers – the national oil companies. For the international oil majors the strategic options include business-as-usual, a managed decline, or morphing into a broader lower-carbon energy business. The industry has never faced such change and, as BP said at a recent investor meeting, “everything is on the table”. The price of the last barrel of oil that the world will ever produce is quickly moving from infinity to zero.
Right now, it looks like business-as-usual for most oil majors. With limited exceptions, current business models still rely heavily on finding and proving oil and gas reserves. Traditionally, more proven reserves equals more oil, which equals more value.
Despite a lot of talk about alternative energy investments, the reality is that capital expenditure on low-carbon energy is dwarfed by spend on traditional upstream ventures. CDP estimates that low-carbon investment is on average 1.5% of total capital expenditure for the majors.
For the managed decline of fossil fuel production read returning capital to shareholders. This means becoming smaller and leaner, neither of which is a strategy that the oil majors (or their CEO’s) are familiar with.
Currently, there are limited incentives to adopting a managed decline approach. Generally speaking, the bigger an oil company, the more its senior executives get paid.
Transitioning into low-carbon energy businesses
Dong Energy, which we hold in several of our portfolios, is already well down this road. The company is running down its oil and gas business with a view to a complete exit and is investing heavily in offshore wind.
In contrast, remember ‘Beyond Petroleum’? Not quite so successful. BP is six times the size of Dong, while Exxon is 18 times as big. Oil tankers are slow to turn.
At Exxon’s recent AGM, shareholders demanded ‘more disclosure on climate change risks’ and they got it. The oil majors invariably produce the most bullish scenarios for fossil fuel use, but we are sceptical. Don’t expect anything too telling, especially from the US players. Compared to their European counterparts, there is a clear transatlantic divide on climate governance and strategy and their exposure to gas.
To transition successfully, as Dong Energy is doing, will require support from investors. In May Repsol issued a green bond, but it was shunned by many responsible investors. Meanwhile, Drax has faced similar problems winning support for its investment in biomass conversion.
This is a shame. The energy transition will be a challenge for the oil majors, but what could be more responsible than supporting companies which genuinely want to change for the better?
By Ryan Smith, Head of ESG Research, Kames Capital
Picture; aboutpixel.de—YandinaQLD Don Espresso