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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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Why Decarbonization Could Make Strategic Sense For Oil Majors


Can oil companies profitably transform themselves into low carbon, green enterprises? That is a big question for investors. We have already noted that green investments because of their lower risk profile earn lower returns than those to which oil investors and managements have become accustomed. Also oil companies bring no particular edge in renewable investment with the possible exception of geothermal which could utilize the industry’s considerable drilling expertise. In order to make a long term positive financial oil industry managers need to look beyond the standard menu of renewable investments. Plus the market is not likely to ascribe much value to oil industry owned renewables due to a conglomerate discount by investors. Green investing opportunities will not matter unless large enough to absorb the presently huge cash flows of the petroleum majors. If oil companies simply stopped capital spending on exploration and production, could they find enough renewable projects to replace what they spend now on oil and gas? The doubters sneer, “There aren’t enough windmills out there. “ Without enough green projects, oil companies would have no way to replace oil -derived revenues with something greener but still in the energy business. Isn’t that the argument of those who want the oil companies to stick to their knitting? 

We can’t speak for the windmill count, but decarbonization requires more than windmills, and some of those alternative needs, such as energy storage or nuclear power (if someone can manage to get nuclear construction under fiscal control) require huge capital outlays. The combined annual capital expenditure program of the top five oil companies could fund completion of fewer than ten nuclear power plants accounting for maybe 0.5% of world electric generating capacity. Or, more practically, they could finance maybe 1% of the world’s energy storage needs. Those are rough numbers, but you get the idea. There is no shortage of places to put the money.

Related: Was Saudi Arabia's Surprise Production Cut A Good Idea?

The capital expenditures of all oil companies bounce around, depending on the price of oil, and $500-$1,000 billion a year seems a reasonable range to use. That is a lot of money to spend. However, the worldwide capital expenditure required to decarbonize the electricity sector may be close to $1,000 billion per year. And electricity providers are nowhere close to spending that amount, especially in the US where electricity producers are on a slow motion transition to decarbonization. We would venture that the annual shortfall in the spending needed to decarbonize electricity worldwide (spent over 20 years) is at least $300 billion. These numbers, however, do not include additional expenditures to electrify more of the economy (electric vehicles, chemical processes and heating) which would raise electric industry spending by at least one third. Taking into account that additional spending, the gap between present spending and that required to furnish carbon-free power to present and new users rises to around $600 billion per year.

So, if the oil industry were serious about decarbonizing it could shift its capital program into electricity decarbonization. And the electric industry could absorb it although perhaps unwillingly because many U.S. electric companies have their own reasons for slow walking their decarbonization transitions. However as noted previously, the oil companies may earn a lower return from green investment and really piling in now would not only reduce their profitability faster, but also reduce sale of petroleum products. Go slow and lose market share or go fast and replace high margin sales with low margin sales but keep the market share? Not an easy decision. 

Right now, oil companies would love to be viewed as progressive, making strides to reduce or eliminate their carbon emissions, while still pleading for patience because it takes a long time to change strategic investment policy in very large corporations. And if despite the doomsayers they surprise and continue to do well financially they will have the resources to help the world end its reliance on fossil fuels. In analyzing oil industry strategies, keep in mind that there is a difference between making a contribution to decarbonization as opposed to mere greenwashing. Financing a windmill that would have gone up anyway shouldn’t really count as an offset to corporate carbon emissions.

So, to sum up, the oil industry could make enormous and meaningful investments in decarbonization. That would accelerate or enable the process of global environmental remediation but with likely far lower oil profits. Or the oil industry can continue a business as usual strategy by continuing to invest capital in a still very large, important legacy business in secular decline. Their hope in this case is simply that the industry’s seemingly inevitable decline takes place more slowly than expected. That seems to be the issue the industry is grappling with right now. And there is a lot at stake.

By Leonard Hyman and William Tilles for Oilprice.com

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  • Mamdouh Salameh on January 23 2021 said:
    This article is virtually a rehash of two previous articles by the authors on the same topic but under slightly different titles.

    In their analysis of the topic in their last two articles and my comments, we seem to have established a broad agreement on the following issues.

    1- 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.

    2- Oil and gas will continue to be the core business of the global oil industry well into the future because they are very profitable and there will always be strong demand for them as long as the global economy continues to run on oil and gas.

    3- Therefore, it isn’t in the interest of the global oil and gas industry to reinvent itself as an energy industry nor will it be able to achieve zero emissions by 2050 or even 2100.

    4- To the above, I will add a fourth important point, namely that global electricity decarbonisation is the duty of utilities not the global oil and gas industry. The industry can efficiently and handsomely contribute to global decarbonisation by reducing sensibly the emission footprint in its production of oil and gas and refining whilst maintaining the core business that has sustained it for decades.

    Dr Mamdouh G Salameh
    International Oil Economist
    Visiting Professor of Energy Economics at ESCP Europe Business School, London
  • James Hilden-Minton on January 23 2021 said:
    From a macro view, the progressive cost decline of renewable energy and storage tech, implies that aggregate investment inbthe total energy sector will decline over time. Deal flow will shrink. So while oil companies bring no specific advantages to competing in green energy, there would not be enough aggregate green deal flow to replace oil and gas deal flow, even if oil companies were the only players in green energy.

    The inescapable conclusion is assets owned by the entire oil industry will decline over time, even if they go 100% into green energy assets. When oil majors struggle to find replacement deal flow, they should give substantial consideration to buying back shares. Assets per share, EPS and dividend per share can all keep growing indefinitely, if surplus cash buys back shares. Market cap will decline, but shareholder will be delighted if per share value continues to grow.

    Responsible divestment from fossil energy may be the best contribution oil companies are uniquely positioned to global decarbonization. Investors can amply rewarded if this end of the story is embraced.

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