By now, we’ve all tired of sanctimonious, box -checking ESG (environmental-social-governance) investors who talk the talk but own clearly unsustainable (to use another favorite word) stocks. And of big fossil-fuel producers who profess their desire to decarbonize—but not for a while, and not if it will cost too much money, or decrease profits. The same folks who want to take “responsible” steps to decarbonize but not until 2050 when all present managers will have retired. So, with our long experience in banking, security valuation, investing and even venture capital, we’d like to offer a few gratuitous words of advice to those investors who want to find a real decarbonization opportunity rather than an oil company covered by greenwash and to those managers who want to advance their careers in the decarbonization field rather than get sidetracked into a greenwashed token operation that will kill their careers.
Step #1. Talk to the top brass and listen to them carefully. Are they mouthing the PR line or do they really mean it? You can tell. When they talk about the need to take a long time to achieve something, about “responsible” environmentalists who counsel slow motion, taking gradual actions so not to disturb existing investment, dipping the toe into the water, and then inform you that there still is not a scientific consensus about climate change, make a fast exit. Understand, this is a paradigm shift, as described by Thomas Kuhn in his seminal work, The Structure of Scientific Revolutions. Which means that somebody opines that we should look at things differently, the idea gains adherents, but does not convince the nonbelievers, who never switch to the new idea, although they may mouth the words without really meaning them. Eventually the non-believers in the new paradigm retire or die and the new paradigm prevails. That's why there are always some doubters out there, long after most people in the field have accepted the new idea. Is the CEO an advocate for new environmental ideas or just mouthing the words? If the latter, don’t expect much to happen or much financial support (think capital allocation) for the new idea. Related: “Mystery Middlemen” Make Billions From Sanctioned Russian Crude
Step #2. Determine where within the corporate structure the new business is situated. Any relatively small operation alien to the corporation’s total business culture and aims is at risk of losing financial and managerial support because it is too small to matter, not as profitable as other uses for capital or annoyingly attempting to take business from other branches of the company. There is an exception to this rule, however, when the corporation’s objective is to transform itself into an entity primarily providing the new products and services. That’s a lot easier to do when the new services help to expand the corporation’s sales rather than take business away from existing lines of business.
Step #3. Beware the hedge-our-bets or dip-a-toe in-the-water approaches. Managers who are dubious about the new direction but figure that if everyone else is doing it they should at least show some interest and protect themselves from being blamed for missing the boat, will make a weak commitment. This may look good in the PR release but probably won’t matter commercially. As we see it, investors want real commitments and employees will not further their careers by getting involved in operations that nobody at the top really cares about.
Step #4. Determine whether the management might separate the new business into an identifiable entity and possibly float shares in it to outsiders. Investment bankers argue that the market often misvalues or ignores relatively small lines of business buried within a large corporation. Making the new business a separate entity, visible and partially owned by outside shareholders, helps set a more accurate market value for the company. And if the new line of business is more attractive than the old one, a higher market value. Creating a publicly owned affiliated company, however, has other advantages. Selling stock in the new entity can provide it with funds to develop its business if the parent does not have the money to do it. And, a company with outside shareholders can operate independently of the parent and can finance its own needs going forward.
Now for some examples. SSE, the Scottish utility, is an example of a company that sees its future in renewables and decarbonization, has sold off assets to reach that goal, and has resisted efforts to separate the parts. Iberdrola, the giant Spanish utility, previously spun off its renewables unit, bought it back when the market put a low value on the unit, and now is considering a sale of stock in its North American renewable operation in order to finance its expansion. ThyssenKrupp, the German steel company, wants to sell stock in its electrolyzer (hydrogen) subsidiary, probably because it does not have the funds to develop the new business and a share sale will raise the cash. On the other hand, French auto manufacturer Renault, which sees its future as electric, and has a big wad of cash to execute its goals, wants to spin off its electric vehicle operation, which leaves observers puzzled.
If we are correct in our analysis, the giant oil companies do not seem the right entities to own and operate new, decarbonization and renewable ventures. The legacy oil and gas companies are so big that most new ventures would get lost in the rounding. In addition, many new ventures would hasten the drop in oil sales. And return on capital would be greater in the oil sector, so why divert capital to less profitable ‘green” ventures over the short term? The oil companies, however, do have capital, and they do have engineering and geological expertise. They could build relatively large (compared to competitors but not relative to the oil company) ventures in such fields as lithium production, carbon capture and sequestration, or hydrogen production. But to capture the value creation they might have to spin off the new companies and investors and managers assigned to the new ventures might want that assurance before plunging in. No point investing in a venture that might be worth 5 times earnings if buried in a big oil major but worth 10 times if on its own.
So, back to the beginning. Don’t buy the PR and don’t buy the ESG hype. Watch the words carefully and pay most attention to structure and size.
By Leonard Hyman and William Tilles for Oilprice.com
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Dr Mamdouh G Salameh
International Oil Economist
Global Energy Expert