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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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How Feasible Is BP’s Zero-Emissions Goal?

When Lord Browne ran BP (formerly British Petroleum) from 1995 to 2007, those initials also stood, aspirational, for “Beyond Petroleum”. The company made renewable energy investments that complemented its green and yellow flowery trademark. But Browne’s corporate investments in renewables were early. His successor Tony Hayward abandoned renewables and resumed the corporate focus on drilling oil wells. But he did keep the seemingly pro-environment trademark. BP’s current CEO, Bernard Looney, is returning to the environmental theme and recently announced BP’s new corporate goal of zero carbon emissions by 2050. His blueprint for doing so has not yet been revealed but his actions follow those of oil majors Royal Dutch Shell and Madrid based Repsol. 

We are not sure how to assess this new commitment or strategy. These oil companies, as well as others, declared and began exploratory efforts in green energy previously and yet still commit the bulk of their capital expenditures to drilling for oil.

When a parent instructs a young teenager to clean up the room and the response is “Yeah, Yeah, Yeah”, we would characterize this as sullen compliance. Similarly, when a large energy corporation suggests a radical strategic shift with no accompanying plans to accomplish same, we sense a similar tone. Corporations express themselves to investors and the public in three and five year capital plans. When we see a major environmental commitment expressed in these terms then we will take it seriously. Otherwise, as we say in NYC, we’re touched but not moved.

One would think the best way for oil companies to achieve a low carbon footprint is to stop investing in oil exploration and development. But instead their current efforts seem more focused on business as usual with some “back end” retrofits. By this we mean carbon capture and other offsets that attempt to negate the adverse carbon impact of what they have already produced.

Will oil companies explore investments in renewable resources, agricultural offsets or nuclear power? Or will they follow the lead of some electricity providers and assist fossil fuel consumers in reducing energy consumption and thereby decarbonizing? Separately, do oil companies even have expertise in these areas to the degree it conveys a competitive advantage? The interesting thing here is it suggests more aggressive M&A activity as these companies seek to acquire other skills and businesses for their greener futures. Or perhaps some will take the plunge into production and distribution of electric vehicles although it reduces their existing sales base. 

Related: Goldman Sachs: Oil Demand Could Exceed Supply By End-May

Thinking about the best but most ruthless aspect of modern capitalism, twentieth century economist Joseph Schumpeter probably would have urged these companies embrace “creative destruction”. Abandon the old lines of business and plunge into the new full speed ahead before the newer technology eventually renders their legacy business irrelevant.

But major corporate reorganizations imply two basic strategic elements: 1) future capital expenditures will be deployed differently and 2) methods of rewarding or compensating equity investors may also have to change. While this sounds reasonable and is pretty standard analytical stuff, it implies an enormous dislocation for yield hungry investors. The oil majors have offered equity investors supposedly safe dividend yields far above almost anything else of comparable risk—at least until the present.

But as oilprice.com readers know, these dividends are now at risk. Royal Dutch Shell reduced its common stock dividend by two-thirds last week. Other managements will probably follow suit but to us there is a broader point here. The dividend, among other things, anchors or supports the price of a company’s common stock. Once the yield begins to exceed certain levels. like Exxon’s 8%+ yield for example (or BP’s even more egregious 11% yield), investors have already begun to price in a significant dividend reduction. Hence the company gets no credit in its stock price since yield and stock price move inversely. More bluntly, management is shelling out enormous amounts of cash to equity investors but receiving little benefit in terms of share price—a key metric for management evaluation and ultimately compensation. It would be a better use of that capital to reinvest in new businesses or growth opportunities rather than pay out vast sums that the market already perceives to be unsustainable.

Bottom line? High yields in this industry should be viewed the way a motorist views a flashing yellow signal at an intersection. It means proceed with caution.

Related: U.S. Oil Companies Are Cutting Production Much Faster Than Expected

An energy analyst speaking to the Financial Times offered an observation that may explain the new found interest in “greenness”. He asserted that profits on renewable contracts, when adjusted for volatility, were not much different from returns on new oil investments. So why not go big for the green investments?

And this brings us to the problem of scale. At present, looked on as a percent of the S&P 500, the oil stocks comprise a mere 3% or so versus 10% of the broad US market index not too long ago. However, despite their battered share prices, they are still very large companies with very large capital programs. And their assets deplete quickly. We are not sure there are enough green investments in the pipeline to absorb oil company cash flow assuming every major decided tomorrow to transition rapidly from oil to renewables.

Some critics would dismiss the oil company announcements as “greenwash”. But we don’t agree. Oil companies devote considerable corporate efforts to strategic planning and they don’t have far to look to see what happens when energy producers take the ostrich approach. In short they don’t want to become the coal industry—a dead industry walking, so to speak. The problem, as we see it is that the oil industry hasn’t fully focused on remedies that would generate new business opportunities but rather on imitating weak environmental compliance strategies of their principal competitors.

In the fall, the newspapers report, BP’s strategy will emerge. We have the feeling that CEO Looney may have announced his destination without knowing precisely how to get there. There are a lot of clever people working at BP, so let’s see how they propose to position BP as a carbon free oil company. It won’t be easy.

By Leonard Hyman and William Tilles for Oilprice.com

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  • Mamdouh Salameh on May 09 2020 said:
    BP’s zero-emissions vision by 2050 is very ambitious and a trailblazer but is it realistic and achievable? I don’t think so.

    If anything, the coronavirus outbreak with its destructive power of both the global economy and the global oil market has proven irrevocably how inseparable oil and the global economy are by demonstrating that destroying one automatically destroys the other and vice versa.

    Furthermore, there could neither be a global economy nor a modern civilization as we know and enjoy without oil and vice versa. The global economy operates on oil and will continue to do so throughout the 21st century and probably far beyond.

    Still, Big Oil does invest in clean energy solutions and has accelerated such investments in recent years partly to be genuinely involved in the clean energy solutions and partly to burnish its environmental credentials but the general mood, at least for now, is as Shell put it last year—we’ll move away from oil when this makes commercial sense.

    The global energy scene will continue to be governed by three pivotal realities. The first is that there will be no post-oil era throughout the 21st century and probably far beyond. Oil will continue to reign supreme all through.

    The second reality is that there will be no peak oil demand either. While an increasing number of electric vehicles (EVs) on the roads coupled with government environmental legislations could decelerate the demand for oil, EVs could never replace oil in global transport throughout the 21st century and far beyond.

    The third reality is that an imminent global energy transition from oil and gas to renewables is a myth. The slower pace of oil majors toward alternative energies is due to two key reasons. First, they all say that oil and gas will continue to be needed well into the foreseeable future. And second, and probably much more important, is that financial returns from renewables are nothing compared to that from oil and gas.

    The fourth reality is that oil and gas will continue to be the core business of Big Oil well onto the future. BP is no exception.

    Still, Big Oil will emerge from the coronavirus outbreak leaner and fitter. But it has to choose between continuing to pay huge dividends or sink under the weight of huge debts. I think it will opt for cutting the dividends and Shell has led the way by doing exactly that for the first time since the end of world war two.

    Dr Mamdouh G Salameh
    International Oil Economist
    Visiting Professor of Energy Economics at ESCP Europe Business School, London
  • Tony Zamora on May 11 2020 said:
    The authors equate BP to a teenager forced to cleanup their room in “sullen compliance” and note that they see no significant shift in BP’s capital expenditures yet.

    But BP announced this commitment in February and it plans to roll out detailed plans in September when it releases its capital expenditure budget for 2021. Seems reasonable to me.

    Also, the authors suggest that the only conceivable way that BP can reach its net zero goal is to invest in renewable and/or nuclear energy. But they are underestimating the enormous potential in carbon capture, methane emission reductions, and “nature-based solutions” such as reforestation to reduce atmospheric carbon.

    BP's not stupid. BP wouldn’t make this Net Zero commitment if they didn’t see a profitable path to get there. I will wait to see their plan before I criticize it.

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