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Leonard Hyman & William Tilles

Leonard Hyman & William Tilles

Leonard S. Hyman is an economist and financial analyst specializing in the energy sector. He headed utility equity research at a major brokerage house and…

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Can Renewables Become As Profitable As Oil And Gas?

Here’s the question for oil industry investors. Can oil companies scale up clean energy enterprises to replace business lost from a decline in fossil fuel revenues? Some of the oil companies put up a brave front as they boast of their decarbonization plans. Others ignore the question. But at the end of the day— and this is the takeaway— we don’t think they will replace lost fossil related income by massively investing in windmills and solar power. Here’s why. It’s a simple matter of risk and return. Investors accept lower returns when they make low risk investments (regulated utilities for example). Except for nuclear power, non-fossil fuel investments are lower in risk than fossil fuel investments. Energy exploration by its nature entails risk of financial loss. There is no such thing as a dry hole in the wind or solar industries. That is why renewable industries can attract new capital while offering investors steady but lower returns.

If oil managements do decide to enter the renewables business in a big way, as opposed to mere greenwashing, they may have to accept a lower rate of profitability. If they don’t, they will have a hard time obtaining business.

The inherently lower business risk of renewables distinguishes it from the oil business. Renewables do not require massive investments taking decades to fully develop in inhospitable and unfriendly places like the ocean floor. Their projects are bankable as soon as they have contracts signed. They do not compete against state controlled entities with few capital or environmental constraints. They can contract for a steady flow of revenues and pay regular dividends. Environmental accidents do not have multi-billion dollar consequences. Okay, weather can affect performance, but on balance performance averages out. In brief, renewable energy projects can be characterized as relatively small, or modular, with short duration of construction (planning takes longer), predictable revenues with limited foreign exposure. Low risk, low return. This profile doesn’t have the investment attributes of the oil business at all. Related: Should Oil Markets Brace for A U.S. Shale Comeback?

Maybe, though, the oil industry could find a suitable new opportunity in nuclear energy. From our perspective some of its investment attributes are similar: projects with long lead times, large concentration of capital in one project, relatively low risk of catastrophic accident but high risk that any accident will be really bad, ongoing need for negotiation with and cooperation from the government authorities. Big oil’s scale gives it an edge. New nuclear projects are too big nowadays for most energy companies.

And unlike renewables, if the nuclear builder negotiates aggressively it can extract an appropriately high return that reflects the risk. New nuclear construction is one business that most resembles the oil industry in terms of risk, possible return and scale. The obvious catch is that not many for-profit businesses want to get involved with new nuclear construction and operation for good reasons, all of which are well known to our readers. 

But with better construction management, research to develop a new generation of reactors and permanent waste storage, who knows? A new generation of nuclear power plants might emerge just when the oil companies need to find big replacements for lost income. This is still a possibility. But if we assume that commercialization of new nuclear technology is at least a decade away that still leaves a big hole in prospective capital budgets. What to do in the meantime other than drill for oil?

In short, we don’t expect the oil industry to grow in any meaningful way with wind turbines and large solar arrays. The demand for capital in the renewable industry is high but the returns may not be high enough for oil investors.

Maybe the oil industry has confused its end market with its business strengths. It seems to see itself as purveyor of energy on a mass scale. Okay, but that market will become crowded with purveyors of new energy products who work for less. Perhaps, instead, the oil industry’s strength is not its customer base but rather its skill as a financier, developer and operator of risky resources on a massive scale, akin to the giant mining and trading combines, but with more technological skill. 

Oil and electricity are both commodities but with very different margin structures. Perhaps the oil industry would be better served by investing in potentially high margin commodity businesses like cobalt or rare earth metals, for example, without which no batteries can be made. Or, it could invest in resources or capital intensive processes that will be required for decarbonization. 

In short, replace oil profits with windmill and solar profits? Other people can do it as well. Oil companies will need to do something big, and maybe as daring as drilling for oil in the old days. How about, for instance, a process to remove carbon dioxide from the air and turning it into chemicals and fuels on a vast scale? They need to start thinking on a bigger scale. Otherwise, why bother?

By Leonard Hyman and William Tilles for Oilprice.com

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Leave a comment
  • Ahmed Bakhaled on January 05 2021 said:
    I don’t think that, coz Renewable energy is very expensive and still in developing and need more,
  • Mamdouh Salameh on January 05 2021 said:
    In the global oil and gas business risk and high return on capital go hand in hand. Renewables aren’t in the same category of oil as investing in them doesn’t carry the same risk as exploring for oil and gas and therefore they generate far less return on capital.

    That is why Big Oil has neither the intention whatsoever to transform itself into an energy industry nor the ability to achieve the lofty goal of zero emissions by 2050. It will be doing itself, the global economy and climate change a great service by maintaining the core business that has sustained it for decades, namely oil and gas while sensibly reducing its emission footprint.

    If Big oil does, however, decide to truly greenwash itself and become an energy industry, it may never survive the price it has to pay with catastrophic implications for the global economy and humankind as a whole.

    Dr Mamdouh G Salameh
    International Oil Economist
    Visiting Professor of Energy Economics at ESCP Europe Business School, London
  • James Hilden-Minton on January 05 2021 said:
    Hey, if you what to amp up both risk and reward, just use more leverage. ROE can be as high as shareholders want.

    I would recommend oil companies look into offshore wind or geothermal wells to make use of some core competences. Battery minerals are good too, though you might want to learn enough to know that rare earth minerals are not used in li-ion batteries.
  • Henry Hewitt on January 06 2021 said:
    Thanks Leonard and William,

    Who knows about nuclear's future? Seriously. Still wondering about how many Miracle Occurs Here slides you get to keep in the Business Plan before people give up? The market gave up decades ago. Who will insure these things? Who will dismantle them? What will that cost? Who will pay? Need we still address the waste problem? A monopolist's delusion at best. A DNA altering nightmare at worst.

    But to your question about profitability, sun and wind are fundamentally different than oil, gas and coal. The latter are capital; once gone they are gone for good (and ill). Renewables are income, and they go on forever. So far, the sun hasn't missed a day in 4 billion years. The Phaethon wipeout a few thousand years ago was a problem, but the sun rose the next day, even if in a different place.

    Sun and wind are going to become a problem not just for utilities (who needs 'em? The utilities, not the sun and wind), but for investors generally because finally the fusion reactor in the sky will be providing power that is 'too cheap to meter'. The nuclear crowd was right about this, they just got the source code wrong. (Celestrial Hydrogen, not terrestrial, Lads; that's the ticket.)

    So, that means rooftop, either yours or your neighbors, even perhaps a collection of neighbors, for PV which will provide miles to your EV for a penny or so. "Get a roof." It's not just the 10 moving parts v 1,000 or so that make this game checkmate already. It's just a matter of time and I'm sticking to the mantra 0 to 60 in 15 Years, where 60 is percent market share, and we are now five years in.

    Norway, with its free hydro, is already there. Resistance is feudal, but profitability may become so as well. Too bad for the investing class -- a dream for the rest of us. The good news is that the money we've wasted for 100 years that feeds your car and the oil producers can now go to buying things that matter, delivered by drones (100x more efficiently), like Dr. Pepper or cigarettes.

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