Big Oil warms to climate challenge

But lower returns will set pace of companies’ growth in renewables

16 January 2020 Gordon Gray, Global Head of Oil and Gas Research

    Carbon emissions and managing the energy transition are increasingly important priorities for the oil and gas industry, with pressure coming from shareholders, politicians and the public. Some companies have announced long-term ambitions to cut the carbon intensity of their energy supply mix drastically, or even to become net CO2 neutral – but it could entail significant investment in non-oil and gas activities and move Big Oil away from its historical core competency.

    Non-oil and gas sources currently average less than 1 per cent of large oil and gas companies’ total energy supply, but this may need to increase to up to 20 per cent for their long-term carbon-intensity ambitions to be met. However, the oil majors have huge flexibility to redeploy capital – we estimate that their oil portfolios could generate USD600 billion of investible capital over the next 20 years.

    How quickly can oil companies realistically change and how much could it cost? The proportion of low-carbon investment for large oil companies is set to rise from 5-7 per cent currently to 8-10 per cent in the medium term. On current company targets, the oil majors could account for up to 5 per cent of global renewable energy additions out to 2025.

    The main challenge for the oil majors investing in new energies is that returns on renewable power projects – under 10 per cent – are much lower than the mid-teens or higher returns from conventional oil and gas. Costs are falling, but power prices and investment returns over recent years have deteriorated too as markets have matured.

    Oil companies will not be willing to compromise profits and shareholder value, and could therefore struggle to find enough investment opportunities that meet their criteria.

    The market has yet to grapple with how to value non-oil and gas businesses within the oil companies: reasons include poor disclosure, small size and the free-cash-negative nature of current businesses. Those factors are unlikely to change in the near future.

    Meanwhile, some market concerns over the oil companies’ ‘stranded asset’ risks look overdone. Even on the most progressive scenarios for the energy transition, oil and gas demand will remain substantial on a 20-30 year view and we calculate that only around 5 per cent of the value of the companies’ current reserves base will be unproduced by 2040.

    First published 13 January 2020.

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