by Stephen Lacey
December 20, 2016

We're now offering Squares transcripts to our two podcasts, The Interchange and the Energy Gang. Below is an edited version of our latest episode of The Interchange.

Stephen Lacey: This is The Interchange, a weekly conversation about the changing business of energy and cleantech from GTM Squared. I'm Stephen Lacey. Welcome.

For our last episode of the year, we're going macro. After a lot of fits and starts, we're finally seeing the biggest conventional energy companies in the world get serious about making a play in cleantech, renewables and distributed energy.

This week we're looking at what is behind that trend. Why now? Is it different from past spurts? How will it continue in 2017? GTM is now a part of this trend too. Earlier this year we were acquired by Wood Mackenzie, a global research, modeling and consulting company that focuses on global energy markets, mining and metals. Their reasons for acquiring us echo the reasons why big energy companies are investing in and acquiring cleantech companies, and that feeds into the broader discussion that we're going to have today.

Here with me as usual is Shayle Kann. He's our senior VP of GTM Research. Shayle, a lot could be said about this year, good and bad, but it was a good one for GTM.

Shayle Kann: Yeah. Great year for GTM. Next step in our journey.

Stephen Lacey: That brings me to a man who's going to be instrumental in that step in our journey. Our guest is William Durbin. He's the executive vice president for global research at Wood Mackenzie. He's been in this sector for nearly two decades. He's acutely aware of how the ground is shifting underneath the worlds top energy companies. Bill, welcome.

Bill Durbin: Hey, thank you very much. Appreciate being here.

Stephen Lacey: I want to start off by asking both of you the same questions, because I think you come at this from different perspectives, with Shayle obviously coming from the cleantech side, and Bill, you coming from the conventional energy side. I would make the argument that 2016 was a turning point in interests from super majors and global utilities in cleantech. Continued low oil prices are putting pressure on the super majors. Distributed energy is actually putting pressure on global utilities, and investment strategies have evolved as a result. In 2016, I want to list off a couple of important deals.

Total invested $1.1 billion in the French battery maker Saft. Shell created a new renewable energy division mostly focused on wind. We saw a bunch of project-related investments from smaller oil and gas companies. In addition, the biggest power providers in the world, both in Europe and in the U.S., scaled up their energy services arms to focus on distributed energy.

Shayle, I'll start with you first. Do you think that 2016 was a turning point in this respect, and I'm not necessarily saying a tipping point, but a turning point?

Shayle Kann: Well, I think it's important to separate out those two groups that you were talking about. First, you're talking about the super majors. The large upstream oil and gas producers. Within that group, I do think that you've seen more meaningful investment in renewables generally, than you've seen, at least in the past few years. There was this wave of it a decade ago or so. BP was the biggest solar manufacturer in the world for a little while. Chevron had Chevron Energy Solutions in the U.S. They were developing commercial solar projects. This isn't a totally new thing, but a lot of them stepped back for a few years and we're seeing a resurgence there I think.

Stephen Lacey: Not just step back once. Some of these companies have tried a couple of times to make strategic investments.

Shayle Kann: Right. Like you said, fits and starts a little bit. It does feel like there's something meaningful turning there though, I think you have to look at this if you're trying to figure [it out] in a historical context. You have to look at this as the beginnings of a longer term trend if it's going to be true. WoodMac put out a report, a really great report actually, on the decarbonization strategy's of these majors a couple months ago, and among the more eye popping stats was that some of them, you mentioned a few, but I would add Statoil to that list as well, are making real investments. Despite the fact that they're doing that, it's still in total comprises less than 2 percent of their total upstream capital expenditures. It's a small portion of their spending, albeit a new one.

The other thing that I think is interesting is, if you look at their own projections -- and Bill can probably speak to this better than I can -- BP's statistical review every year seems to get more and more bullish on renewables in the long term. It's actually a pretty bullish outlook on renewables in the long term, so they clearly believe it themselves and are just now starting to figure out exactly where they fit in that world. Again, I would separate that out from the power companies.

I think power companies are much further down this road. In Europe, they're further down this road completely out of necessity. Their standard businesses are getting eviscerated. They're looking at distributed energy, and in many cases, clean energy and are out there and investing heavily in that. At GTM, we're actually trying to pull together a comprehensive list of all utility investments in distributed energy resource companies and assets globally. We're still working on the list. We're at around 130 separate investments and counting. It's actually a staggeringly large number when you add it all up. [Investments] are definitely happening, and 2016 was a big year there.

Bill, I'm curious from your perspective, especially on the super majors. Do you see this as being the continuation of a trend that's been in place for a while or was something different about 2016?

Bill Durbin: Well, I think it's definitely something different. The energy around carbon emissions and COP21, there's just a lot of political drivers that I think have reached the point where conventional energy companies cannot ignore this trend any further. They have to report to shareholders, and they have to find ways to create value. I think looking at the trends that we see in the renewable sector from cost-competitiveness and increasing penetration across the spectrum, they need to see how to play a role in that process, and can they play that role properly because, as I said earlier, they report to shareholders. They have to get a clear understanding of where value is going to be created and how they can participate in the creation of that value without compromising their existing businesses.

Shayle Kann: You know, that's one thing I've always wondered about, with these companies, in terms of thinking about profitability, because I know that one of the reasons that BP and some of these other companies pulled back from their early investments in solar and wind, was that they didn't find it to be a particularly profitable enterprise, particularly when compared to their core business, which is highly profitable, which makes sense. It's not as profitable today.

On the other hand, these companies more than almost any others have really long time horizons, right? They'll make investments in a pipeline that will yield fruit a decade later and they see the profit down the line, so I've always wondered why, when they look at renewables, it seems like they're taking a shorter-term view compared to when they look at big, expensive upstream assets. Do you feel like there's a disconnect there or is it that they really need to show profit in the short term in order to get into a new technology?

Bill Durbin: No. I think all these companies will make heavy investments into R&D. I don't think renewables and moving into the renewables space is an R&D effort. It's business-segment development for them at this point, so it is a matter of having a line of sight on when and the scale of that profitability will occur. When you reference [the fact that] they take long-term horizon views on projects, a deepwater Gulf of Mexico project can take 10 years from the spend of the first dollar until they make the first dollar of revenue off of a barrel of oil. When they do the full NPV calculation, it's very attractive for them to make that long-term investment.

For them, getting into a whole new business line, like renewables, I think they have less experience and less line of sight. And you have to remember, I don't think it's unfair to say that there have been a lot of government policies across the globe that have supported the development of renewables over the last decade. Those are giving way to market capitalism driving renewables' development because of the cost reductions, but it's still relatively new business in terms of understanding what that long-term profitability is going to look like.

Stephen Lacey: That's actually a good question that gets us to the root of some of these drivers. I wonder if you can break down why 2016 was different when you actually look at the drivers. Is it a defensive move because of low oil prices? We've had a couple years of serious pressure on many of these oil majors. You also see a lot of public policy around the world that's making these investments more favorable, and you also potentially have long-term concerns about carbon taxing and, potentially, limitations about how much fossil fuels you can take out of the ground. Where did those play into current strategies?

Bill Durbin: I think first and foremost, as I said earlier, COP21 has probably pushed a number of these companies to take actions sooner rather than later. I think that's one of the reasons why there are so many questions around what the impact of the Trump presidency is going to have on the U.S. role in the participation of COP21 or any global climate initiatives going forward. There's also rising questions both at home with the SEC and New York Attorney General or how U.S. companies are accounting for the risk of carbon and the potential for a peak demand coming. Is it late 2020s? Is it going to be early 2030s? Is that being accounted for in people's shareholder reports and therefore...what people can value stock prices at for these publicly traded companies? I think a lot of this is just has converged in 2016 that just says, it's time to step back, take a look, see how we want to mitigate risks, and take advantage of opportunities in the changing relationship between renewables and the hydrocarbons business.

Shayle Kann: Do you feel like they do have the sense now that they have line of sight toward profitability for an investment? Shell's getting into wind project development in a pretty significant way. Is the assumption that they ran in and found a positive NPV today or they didn't a few years ago, or do you think it's more they're reading the signs? Seeing COP21 and that all these countries are going to have to come up with ways to reduce their own emissions in all likelihood, which will support the economics of wind relative to other technologies and that they're just trying to get ahead of the curve?

Stephen Lacey: I just want to chime in here. I don't think that there's a line of sight for profitability for many of the companies that specialize in those sectors, both wind and solar. Sure, there are a lot of the big developers and manufacturers that have been profitable, but it's really a quarter-by-quarter issue for them, and in the solar space obviously, it's just been a complete disaster in 2016, in terms of profitability.

Shayle Kann: Well, I would just say, by the way, on the profitability point -- the funny thing about profitability in the sectors that we cover is there are profitable companies, but they're not the ones that you necessarily think of. They're developers who are profitable. They develop an asset. They sell it for more than they developed it for. They can earn a return on that even when you account for their overhead. They're not earning that much money, but they're earning money. More importantly, the companies that are really profitable tend to be the ones that are on the periphery of the market, so asset monitoring and O&M companies and some of the software providers, some of the hardware providers that make the smaller stuff. The combiner boxes and things like that. Those guys make money.

I think one of the challenges is, if you're sitting there and you're Shell or you're Exxon or you're BP, the scale of those businesses is minuscule to you. You can maybe make money, but who cares about making $5 million in profit.

Bill Durbin: Yeah. You took the words right out of my mouth, Shayle. It's not scale at this point. They may be wildly profitable, and maybe tens of millions. That's not moving the needle for Shell. It's not moving the needle for Exxon, for Total, or Statoil. You need billions to move those needles.

Let's just put this in perspective. When the unconventional plays started in the United States, the majors looked at those and said, "There's no materiality. It's too small." Then we ramped up from nothing to 6 million, 7 million barrels a day of oil production. That's material.

Shayle Kann: That's a great point. Let's run through how that happened from the majors' perspective. Initially they said that this isn't material, but obviously it became material. Were they able to ride the wave in time or did they find themselves behind the ball later on?

Bill Durbin: No. They're still not the major drivers in the unconventional plays. There's thousands of producers in unconventionals, and that's been one of the real challenges here is, even in the uncons' play, how can the majors really scale up and capture a large portion of the reserves and the production? Now, don't get me wrong, Exxon made a huge move into this space with its acquisitions. Shell has ventured into it. A number of companies. Chevron is in it. They're in this space but it has taken them time to grow into that position. When you look at the renewable space, how will they achieve scale, whether it's in the United States or it's outside the United States? How could any one company in renewables achieve a dominate market position or a scalable market position where it becomes material?

Shayle Kann: Right. The problem that the renewables' industry has faced is that, anyone who has tried to jump the gun on scale and get there in a short period of time, has found themselves way over their skis. That's basically what happened with SunEdison.

They said, "We're going to," and they even explicitly stated, "We intend to be the first renewable energy super major." They used that term. Then, they made all of the moves that one would make if one wanted to be a renewable energy super major at scale within a couple of years, and it was way too fast, and they fell apart.

Stephen Lacey: It's also what happened with BP when they rolled out their Beyond Petroleum Campaign. They had a very diversified set of investments and many of them didn't pan out and it just wasn't a financially successful endeavor. Do you have comments on that, Bill?

Bill Durbin: Well, let's roll the clock back during that time period. What were the economics of solar at that time?

Shayle Kann: You're probably looking at $8 to $9 a watt installed when BP was still manufacturing solar in Maryland.

Bill Durbin: Yeah. It was not cheap. Regulations have moved on and markets have moved on since then. It was probably from a strategy perspective, when do you know is the perfect time to get into a fledgling industry, especially one, again I'll go back to the point where this sector has enjoyed a lot of regulatory support and policy support to get it off the ground. Hydrocarbons have gone through the same thing, don't get me wrong. I'm not holding that out from a pejorative perspective, but it was a matter of trying to understand just where were those policies are going to go, and how was that market is going to unfold? There were just too many unanswered questions around regulatory tariffs to absorb the renewable energy that's supposed to be coming in.

Shayle Kann: Yeah. I think the other thing, too, to point out particularly about BP's foray into solar in the early 2000s, is where they went in the value chain, which makes logical sense if your core business is to be an upstream producer of oil and gas. You should then assume if you're going to get into oil, you should be an upstream producer. You should make solar panels, which is what they did. It turns out, within solar at least, I think this is true of wind as well, that's a really hard place to compete and make money. Chinese manufacturing scaled up and got very, very cheap. Technology kept improving. Costs kept going down and BP couldn't compete with its technology or with its cost and manufacturing in Maryland.

It's possible that, though it made sense for them given their core business, the place to be if you want to be able to compete within renewables is downstream, not in the manufacturing side or, at least, not in the panel manufacturing side or turbine manufacturing side within wind, which is what they're doing now, by the way. That means the extent that they're all getting involved, except for batteries, Saft is a battery manufacturer, but Shell getting into wind development. BP is doing some power trading in wind development. All of that, that's downstream stuff, which I think is the right move.

Stephen Lacey: That relates to the other component of 2016, which is that it's been a hard year to be an upstream company in oil and gas. Obviously, prices have been stubbornly low. Do they retrench and focus on the core, more in a situation like that or are they going to be more exploratory because they need the hedge?

Bill Durbin: You mean in terms of driving investments into renewables?

Stephen Lacey: Yeah. Renewables and any adjacent non-core businesses.

Bill Durbin: Well, first and foremost, they're going to get their costs under control. When prices have come off, as they have in oil and where they've gone in gas over the last several years. Depending on what the price expectations were when investments were made, they need to readjust the cost structure, and that's what you've been seeing ever since the price of oil came off from 100 and dropped down into the upper 20s at one point, has just been a perpetual focus on reducing costs.

It does inhibit the ability to invest in alternative types of industries, simply because you have constrained cash flow. With constrained cash flow, you're just going to have less mobility to be able to take on new types of investments. It doesn't stop because these companies are profitable companies and most of them have very healthy balance sheets and they can fund those investments, but they'll need to be more cautious about stepping out into areas that they need to learn more about how those markets operate.

I think that's what is so intriguing about the whole renewables' sector, both from traditional energy companies, but also from companies that are looking at the transition that global energy is under today. Because of the change in cost structure to renewables and consumer choice around consumables -- I'm not just talking about residential users, but across the spectrum -- in terms of what the opportunities are for companies, like Google, to go 100 percent renewables on an accelerated time frame.

If this was 2000, we couldn't be having this conversation, but technology has moved on. Markets have moved on, and now there's a certain critical mass and scale to the renewable sector that is having all companies, particularly in the energy space, trying to understand, "Does my business model meld with this industry, or do I need to move into this industry, or do I just ignore it and stay specialized in my hydrocarbon base industry?"

I think there's a lot of strategy questions that are being asked these days and some companies, like Statoil and the like, are voting with the solutions that they've identified.

Shayle Kann: Yeah. You know, we've talked a fair bit about renewables. The other thing that we talk a lot about at GTM that I imagine at least is somewhere on the minds of a lot of the producers, oil and gas producers, is vehicle electrification. If you believe Tesla and its cohort, it should be an existential threat to these companies in that demand would go down just because we end up electrifying vehicles. If you look at the vehicle manufacturers for the most part, they're at least rolling out EV models across the board, so they're willing to give it a real shot. It's still a tiny portion of new vehicle sales in the U.S., let alone globally.

I guess, as you talk to the executives at the large oil and gas producers, how much is vehicle electrification on their minds, or is it still such a small threat that it's distant to them?

Bill Durbin: No. It's on everybody's minds. It's because once you start eroding oil's monopoly or dominance in the transportation sector, you start eroding oil's participation in the global economy. The big question is, what is the time frame for that to occur? What are going to be the key drivers for that to occur? Where is it going to happen first? When do you get that moment of quickening where you can make that transformation from internal combustion engines to electric vehicles?

I think as long as Tesla's cars are in the $35,000 to $100,000 price range, that time scale's going to be longer than people may be anticipating.

Shayle Kann: Right. Yeah. You know, it's interesting. It's making me think about some of the countries that are major oil producers. I'm thinking of the UAE right now, so if you're the UAE, so much of your economy is driven by your resource wealth. UAE seems to recognize that that's finite and will at some point end, and say, over the years try to do a bunch of different things to build up a new energy economy out of the UAE.

They have this thing called Masdar, which has done all sorts of investments in renewables and renewable energy technology. It's not clear to me yet that they're at the point where if you remove their oil wealth, they'd be OK. They clearly are thinking toward that future. I think you can say the same thing to a lesser extent in Saudi Arabia.

Saudi Arabia's got these big solar pipelines that they're trying to build out. They recognize that they want to be building a new kind of energy economy. I just don't think they know how do it exactly yet. It feels like a similar situation, if you're an oil producer and that's your entire business and it's big and very profitable, and you see some future, though you don't know exactly how far off it is, where you're not going to be able to make at least as much money, let alone any money, in oil production. You know you need to prepare for that eventuality, but you don't know how fast you need to move into it and exactly where to go from here. It's a difficult challenge.

Bill Durbin: I'll give you a hint. Just off the top of my head, when you see an activist investor, like a Carl Icahn, buy up someone, like buys shares in Anadarko or anybody, BP or Shell even, and then try to force that board out of hydrocarbons and into renewables, then you know you're probably are getting real close to that transition away from hydrocarbons and into renewables.

We're not seeing activist investors in the major energy companies of the world that are trying to force them to change their business model to a renewables model. They are active in trying to get them to recognize and participate, but I don't think it's going to be on them.

Shayle Kann: You're right, Bill. I don't think we do see that happening, and in fact, to the extent that you can point to any real evidence of shareholders, you know, apart from climate change activism among some shareholders, the real shareholder pushes. NRG would be a counterexample, in fact, where NRG had a CEO who really did want to push very quickly into both renewable energy and distributed energy and was ousted by his board as a result of that and shareholders were obviously not in support, given where the share price went, so to the extent that shareholders are voting with their wallets, they're currently not believers that this is a transformation that the big traditional energy companies have to go through immediately.

Stephen Lacey: Bill, we've got to get your take on what happens to oil, gas and coal after the election. The struggles in coal are largely market related. Certainly, regulations play some part in shutting down coal plants, but I think many of the struggles in coal are clearly due to low natural gas prices. President-elect Trump wants to see fewer regulations on drilling for oil and natural gas. Obviously, many of the jobs impact and reduction in drilling that we've seen in this country has been a result of low oil prices, so what could the president-elect change to increase domestic production of oil and gas and potentially keep coal plants open or perhaps get miners digging up more coal? How do you think those dynamics change underneath a Trump presidency?

Bill Durbin: Oh, it's an interesting question, and a lot of people are trying to get an insight into this. There's not a lot that can happen from government policy that's going to lead to a resurgence in hiring in the coal sector simply because of what you said. Prices are depressed, and when prices are this low and the fact that gas has captured such a large share of the power sector, it's hard to see how any government regulation is going to affect the competitive fuel dynamic between gas and coal that could lead to, again, lead to a large number of miners being brought back in. Unless gas prices really jump significantly, there's probably not a lot we're going to see in terms of an impact from a change in policy.

The same is holding true on the oil side. As I said earlier in our discussion, with the collapse in oil prices, everybody, from the smallest producer to the largest, have been bringing their cost down and increasing their efficiencies in order to maintain margins on the investments that they can make with prices so low. There's not much that can be managed there. You can reduce taxes on or reduce royalty rates, but at the end of the day, you've got to sell that oil somewhere, so there has to be demand for that oil.

Now, the fact that we're seeing a reduction in the OPEC production volumes in Russia, it creates an opportunity for some of the U.S. domestic production to begin to ramp up. That was going to ramp up whether OPEC cut production or not, simply because of where break-even costs are.

I apologize for the long-winded response, but really it's market dynamics that are going to really impact what happens in the coal sector and what happens in the oil and gas sector when it comes to drilling and production.

Stephen Lacey: Yeah. That kind of question warrants a long-winded response because it is so complicated, and you were talking about three very different markets. Very curious about what you think happens to natural gas prices. I presume that they continue to remain low. What does WoodMac think about where gas prices are headed?

Bill Durbin: We expect gas prices to be range bound for a number of years. There's always going to be movement up and down, so I'm not going to say that we don't expect to see any price volatility. There's always going to be some sort of energy price volatility, whether it's demand related or weather related, that can lead to change in prices.

What I was talking about earlier in terms of cost reductions and efficiency improvements in the unconventional space, just leads to modest price outlooks across the board. Our oil price outlook has a positive slope to it, but that was looking at beginning to see the impact of all of the suspended investment over the last two years, since oil prices have collapsed because there's a lag to all of these projects across the globe that were suspended. As oil demand continues to increase, there's going to be a greater call on that supply and the issue is, how fast can that supply be brought to market? That's how we can see the oil prices rise. Just because oil prices go up, doesn't necessarily mean that you're going to see gas prices pulled up as well. Those are two totally separate markets, both domestically and globally.

Stephen Lacey: OK. It's time to dust off the soap box here and give you an opportunity to share your personal thesis on the global energy transformation. How quickly do you think it will occur? What areas are most interesting to you? Then, from a WoodMac perspective, why make a play for a company like Greentech Media, because clearly that fits into the overall thesis of the company? I would just love to hear some context on where you think things are headed and how that fits into WoodMac looking forward.

Bill Durbin: Well, the last question is the easier question. The excitement around Greentech Media is that it gives WoodMac a greater perspective and deeper view and understanding of everything that we've been talking about today. The interplay between everything that's happening in the renewable sector and the changing technologies around batteries and grid, as well as solar and the impact that it is going to have and is having, on the global energy maps.

Going to your first question and looking at the transitioning of the global energy industry, I've been in this business more than two decades, I hate to admit, just to correct your initial comments, and it is a completely different world today than when I first came in to it. We've gone from a heavily regulated hydrocarbon sector around the world, to a very competitive hydrocarbon sector, to one that is now accommodating and adopting and growing a renewable sector that 20 years ago, was just kind of a, "Yeah; someday that might be competitive; Yeah, someday we might look to see how to bring these really cool technologies to bear into the fuel mix." Now, we look at it and go, "That's a very cost-competitive way of influencing, not just the fuel mix, but also the environment."

How this is playing out globally and the different paces of change, whether you're in the European theater or you're in the Americas, or you're in Asia, looking at how the various demographic trends are in each of those markets and how it impacts the transition of fuel use and the adoption of renewables and the impact on the environment, is a lot of fun to be a part of. Having GTM help us understand that is just a great place to be right now.

Stephen Lacey: Yeah. This is a great way to cap the conversation, and it's kind of an extension of the first question I asked. Shayle, do you want to comment on that from the GTM perspective and where you hope the two companies align and some of the more interesting things that you're looking at from the GTM Research perspective?

Shayle Kann: Yeah. Well, I think what I'm finding, we're four and a half months or so into working with WoodMac...you know, GTM was founded to look at a subset of the energy sector, call it greentech or cleantech or renewables or whatever you want to call it, that emerging part of the energy industry is where we focused all of our attention. As a result of that, for pretty much our entire history, we've looked at that stuff largely in a vacuum and we've looked at it maybe in a context of the power markets a little bit, but definitely not with any depth in the context of the broader energy sector, which obviously in size dwarfs what we're talking about.

I think that's been mostly fine because during our history, most of the technologies that we've been looking at have existed largely in their own silos. They've been policy-supported or regulatory-supported. Demand has been driven by something independent of where, for example, gas prices are. We've been able to do a really good job of understanding these markets just on their own, but the change that's occurring right now in the global energy sector and particularly the fact that a lot of the new demand globally for the technologies that we cover, is driven purely by economics.

Bid prices for utility-scale solar in South America and the Middle East and places like that, when they get down into these 3 cent per kilowatt-hour ranges -- that makes it really competitive on a standalone basis with traditional energy technologies. In order to really understand how that's going to develop and to the point that we were talking about in the middle, how these technologies can scale, you need to have a broader viewpoint. It's great for us to now have exposure to a ton of really smart people who can give us that broader viewpoint. We're just figuring out now how to actually leverage that for what we do, as well as trying to seed some of the knowledge that we've built up over the years within everywhere else at WoodMac, so it's fun for us.

Stephen Lacey: Bill Durbin is the executive vice president for Global Research at Wood Mackenzie. Bill, it's been a pleasure, and here is to a great 2017 together.

Bill Durbin: Thank you very much. Looking forward to it. Appreciate being here, Stephen and Shayle. It's great chatting with you guys.

Stephen Lacey: Shayle, here is to a fun 2016 together on this show and we have some developments that we will be announcing at the beginning of the year and we will continue to have good conversations and segments unpacking all the stuff driving this industry, so Shayle, we will talk to you in the new year.

Shayle Kann: All right. Have a happy holiday season.

Stephen Lacey: Take care, everybody. Thanks for listening. This is The Interchange podcast from GTM Squared. We will be back in January.