The foundations of the oil and gas industry are under assault from all quarters. The most immediate cause is the coronavirus, of course: Global lockdowns have eviscerated demand for transportation fuel, and a global recession is applying even more pressure.
But long-term trends have been undermining the business model for years. Fracking, a method of extracting oil by injecting chemicals and liquids into underground shale formations, has essentially capped the price of oil—and profits—leaving the industry with billions of dollars in unprofitable investments. The oil and gas sector, once worth a combined $3 trillion, is now worth less than Apple.
It’s a stunning fall. Companies that once sailed on a sea of expensive oil now face an uncertain future in a diminished market for petrochemicals, plastic bags, and niche energy applications. Today, the question may not be what the future looks like for oil and gas firms. It’s if a future exists at all.
If there is a future, it’s increasingly likely it will ride on the back of the energy transition. The rise of renewables and electric vehicles means the defection of Big Oil’s biggest customers: utilities and motorists. Both are leaving the fold far faster than expected. With most governments pledging to zero-out net greenhouse gas emissions by 2050, the arrival of peak oil (and gas) consumption is closer than ever—within 15 years, according to Vitol, the world’s largest independent energy trader.
The challenge now is: Can oil majors become energy companies? Saudi Aramco economist Matthias Pickl says five out of eight oil majors have begun putting money behind a clear renewable energy strategy. “Oil firms are essentially attempting to figure out how the best presently available cash cow in the world can be replaced for the benefit of their own sustainable future,” he writes in the peer-reviewed journal Energy Strategy Reviews.
But critics point out the money the industry has put behind this effort is a relative pittance—less than 10% of capital expenditures, compared to oil and gas investments. A real survival strategy would seek to retire fossil fuel assets early as a bet on the future of clean energy.
Two risky paths forward are emerging for today’s oil and gas industry. But Big Oil may not like either.
The first strategy, known as managed decline, would extract as much money as possible out of the assets that already exist—oil fields, offshore drilling platforms, pipelines, proven reserves—and stop investing in new or unprofitable ones. If the fossil fuel industry still has decades to run, smart money might be to capitalize on that and return the earnings to investors.
But this carries its own risk. As per-barrel oil prices fall below $55, says Philip Verleger, an energy economist and consultant, “much of the private industry must shrink or vanish.” Indeed, the last few months have seen unprofitable wells corked, assets auctioned, staff reduced, and dividends slashed. Oil supermajors are laying off staff for the first time in years: 10,000 at BP and 6,700 at Chevron with more to come. Small fracking operators, already overleveraged and underwater after nearly a decade without profits, are filing for bankruptcy in droves.
If this scenario continues, production could decline to meet shrinking demand from energy and transportation. Without new investment, BP’s oil chief notes oil production would naturally fall by about 3% per year. Plenty of money will be made, but there will be little growth.
If you ask financial markets, this obituary has already been written. Investors, Verleger notes, no longer expect growth from oil company stocks, just cash and dividends. Over the last seven years, oil majors have dispensed $380 billion in dividends while generating only $173 billion in free cash flow, mostly by issuing debt and selling assets.
“What they’re essentially saying is that the best thing they can do with the money is to give it back to shareholders because they’ve run out of good places to put it,” says Clark Williams-Derry, of the Institute for Energy Economics and Financial Analysis (IEEFA). “They would rather give the money away than invest in the future.”
Now even those dividends are being slashed. Royal Dutch Shell riled investors by cutting its dividend by 66% this April, for the first time in 80 years. Other majors are mulling the same despite calling those dividends untouchable just a few months ago. That’s raising questions about the industry’s long-term prospects: Oil companies are now even shortening the maturity of corporate bonds. BP no longer issues 30-year bonds, the standard among many multinational firms.
All this implies a world in which oil prices never recover. Demand will continue to languish, and US frackers will keep prices low once they resume pumping. “No one really believes oil prices can stay high very long anymore,” says Per Nysveen, head of analysis for Rystad Energy. “Oil companies cannot maintain high enough investments at these lower prices. Peak oil is coming.”
The different bet—and perhaps a smarter one—would be on a renewable future. Oil companies would redirect cash from shareholder payouts to developing new carbon-free energy sources. In this scenario, oil and gas giants refashion themselves as “energy” companies for a post-oil world.
Many, in fact, are now claiming to follow this strategy.
Led by Europe’s majors, they’re snapping up companies and investing in solar, wind, and biofuels. France’s Total now refers to itself as “an energy company,” while Shell’s CEO Ben van Beurden has told investors it’s now an “energy transition company,” predicting electricity will provide a third of its revenue by the mid-2030s.
That’s a sharp break with recent rhetoric. For decades, oil majors avoided investing heavily in renewable energy (a lone exception, BP, largely abandoned its efforts after marking down its investments in the 1990s), and even funded disinformation campaigns to cast doubt on the threat of climate change, a crisis the industry first identified in the 1970s.
Until recently, there was virtually no discussion of an “energy transition” in oil and gas boardrooms, according to corporate documents and transcripts from the private equity research firm Sentieo. Documents show the term was used less than a dozen times—mostly by a single company, Total—until 2017. Only in the most recent quarter did “energy transition” surge into the conversation.
But oil companies’ balance sheets tell a different story. Investments in renewables by private oil and gas companies account for less than 10% of capital expenditures. The majority of that will come from just one firm, Norway’s state oil company Equinor. The industry as a whole still has $166 billion slated for new oil and gas projects in the next three years, according to an analysis by Rystad Energy.
Duane Dickson of Deloitte calls the industry’s commitment a “formidable investment in renewables,” given the early stages of the solar and wind that still only supplies about 10% of global electricity. The pace will accelerate as new technologies scale up. But others, such as IEEFA’s Williams-Derry, calls this new direction a facade.
“My read of the numbers is that they are not pivoting,” says Williams-Derry. “Some are making good noises, but when you look at the [capital expenditure] budgets, at best you could say they are planning to pivot.”
Yet a shift to electricity now appears inevitable. In a world ostensibly committed to zeroing-out net emissions by 2050, “any piece of energy demand that can be electrified, needs to be electrified,” said Maarten Wetselaar, who leads Shell’s “new energy” strategy, in the Financial Times.
Oil majors want to buy their way into this transition. Shell and Total have begun acquiring companies suggesting they intend to build an integrated supply chain for electricity, much like they did for oil in the 20th century. That would include EV charging, retail sales, battery manufacturing, solar developers, and energy trading. Shell has bought two clean energy utilities in the UK since 2017; this June, Total bought a 51% stake in Scotland’s largest offshore wind farm for £70 million ($88 million).
Like their renewable energy budgets, oil and gas companies’ acquisitions are still heavily slanted toward fossil fuels on the whole. Data from private equity research firm PitchBook shows less than 2% of oil majors’ mergers and acquisitions since 2007 have gone into clean tech. Most doubled down on fossil fuel infrastructure, such as Total’s natural gas power plants in Myanmar, which will lock the company into decades of new greenhouse gas emissions.
A few companies, though, are willing to take the leap. One is Ørsted, formerly the Danish Oil and Natural Gas company. In 2009, the state-owned firm was one of Europe’s leading coal utilities, with 85% of its energy came from fossil fuels. Yet the looming threat of climate change change and a European carbon tax threatened the business.
So the company did what few else have: It pledged to give up fossil fuels. Its original goal in 2009 was to reduce its share of energy produced using fossil fuels from 85% to 15% by around 2040. The company sold off all its oil and gas assets in 2017. Today, Ørsted is on track to eliminate fossil fuels entirely by 2025. Coal and gas now make up just 13% of its power mix, and the company commands about a quarter of the world’s fast-growing offshore wind market.
That was a lucrative bet. The company has roughly tripled in value since its 2016 IPO, far outperforming every major oil company. Ørsted says sustainable energy systems were “the key to our growth over the past decade.”
Now, Ørsted is crossing the Atlantic. It has secured about half of the capacity awarded for offshore wind leases in the US so far. Three gigawatts of projects are due to come online from Virginia to Massachusetts. Even with delays due to Covid19, Ørsted claims it will have 10 times that ready by 2030.
Yet the Danish firm may be the exception. Ørsted was uniquely positioned. By 2000, it already possessed a deep understanding of offshore oil and gas exploration along with a willingness to bet on new sources of energy. By 2010, it was acquiring companies to design and build offshore wind farms. Fortuitously, the financial winds blew in the same direction. Ørsted’s main shareholders, the Danish government, urged the company to reduce its reliance on fossil fuels, and the collapse of natural gas prices forced it to move even faster.
It might not be too late for supermajors to catch up. The renewable energy market remains small, with decades of growth ahead. Supermajors could try turning their fossil fuel assets into cash machines, reinventing themselves as electric utilities that extract energy from the wind and sun and deliver it to your car battery and LED light bulbs
That seems unlikely, says Verleger. It’s true a few companies have managed to reinvent themselves over the centuries: Nintendo started off selling playing cards in Japan and cell-phone giant Nokia began life as a Finnish pulp mill in the 1800s. But it’s exceedingly rare.
“They’re going to fail,” he says, comparing oil firms’ efforts to Kodak’s failed leap to digital in its own industry. “Very few companies have transformed from being really good at one business to really good at another. It’s hard to see how [a company like] Shell will be really good at electricity.”
Oil companies are left scrambling to argue why they are best positioned to lead the charge into the next phase of the energy transition. They don’t appear to have many natural advantages.
Few companies are better-equipped to stand up enormous projects around the world, but renewables can typically be built more quickly and for less money than traditional oil platforms. Fossil fuel giants already employ an army of petroleum engineers, geologists, welders, and financiers, but just how applicable those skills will be to the next phase of wind, solar, and energy storage development is unclear. Nor has the industry proven particularly good at forecasting the energy future, even on its own turf.
The supermajors do have money. Their balance sheets allow oil and gas firms to invest in research and development, or acquire the companies they need in the new energy supply chain. But investors have raised a related question: If you want to invest in an all-electric future, why do it through a struggling oil company? Plenty of successful clean energy companies already exist. And they’d love to take investors’ money.