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.
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.
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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