As the clean energy transition continues, it’s getting harder for oil and gas majors to ignore.
That doesn't mean it's easy to reorient these companies around a new set of technologies. For majors dabbling in clean energy, there are some risks with undefined rewards.
“Diversification into renewables is a difficult business proposition for the majors. It’s a challenge for their CEOs to keep their shareholders happy and also make sure the business transitions into the low carbon future,” said Valentina Kretzschmar, director of corporate research at Wood Mackenzie. “At the same time, most of them understand this is the future — this is the way things will evolve.”
Balancing the perceived risk profile of renewables projects with their potential is among the chief challenges now confronting oil and gas majors.
A new report from Wood Mackenzie Power & Renewables seeks to highlight areas where oil and gas majors may find an easier entrance into the market.
Author Tom Heggarty, a senior solar analyst at WoodMac, said success will hinge partly on majors detaching from traditional thinking about risk and return — which are both lower in renewables projects than in oil and gas — and considering clean energy as a new business prospect.
“That’s the key pushback we get when we speak to companies like ExxonMobil, Total or any of the oil and gas majors,” said Heggarty, of the lower returns for renewables projects. “What we’re saying to some of these companies is they need to think about these investments in a totally different way.”
Growth in renewables
Oil and gas majors are indeed thinking about clean energy investments. The growing market is forcing them to diversify.
In 2016, additions of wind and solar generation outpaced combined additions from coal, gas, oil, nuclear and hydropower in the electricity sector. That trend accelerated in 2017, the last year for which WoodMac presents data.
In the coming decades, analysts project the percentage of power generation capacity from wind and solar, separately, will rival gas and coal. Renewables combined equal 35 percent of power generation compared to 44 percent from coal, oil and gas by 2035.
Capital pouring into the solar and wind industries is only 40 percent of the capital moving into upstream oil and gas through 2022. But analysts project that renewable installations will grow — even while total investment figures remain flat — because of falling technology costs.
By comparison, investments in unconventional oil and gas (which includes shale gas and tight oil) make up less than 50 percent of investments in solar and win, at about $432 billion.
For U.S. majors, a transition "when the time is right"
So far, investments from majors have been most concentrated in Europe. According to Kretzschmar, that’s based on a couple of factors. She said pressure spurred by the Paris climate agreement — which the U.S. plans to exit — has manifested mostly in Europe, with government, investors and consumers all pressuring majors to clean up business practices.
That’s encouraged companies, such as Royal Dutch Shell and Total, to get serious about cleantech investing over the last several years. Greentech Media reported on this phenomenon through 2017 and 2018, covering Shell’s investment in thermal-storage firm Axiom Energy and Total’s acquisition of battery maker Saft.
By comparison, U.S. majors are dawdling.
There's less pressure for sustainability in the U.S. Plus, ExxonMobil and Chevron have more flexibility because of the different “structural makeup” of their portfolios. “It’s really protecting them on the downside and making them more comfortable looking to the future,” said Kretzschmar.
Exxon’s reported interest in clean energy contracts indicate an interest in evolving strategies even in locations where cheap fossil fuels will be available in the future. “We believe that when the time is right for these two companies,” said Kretzschmar, “they will be considering a move into other clean energies.”
Points of entry
WoodMac’s report shows that many renewables projects already compete with oil and gas plays.
Oil and gas projects are generally much larger than renewables projects. But certain large-scale wind and solar projects can compare to oil and gas projects in investment and size. According to WoodMac, the energy production for illustrated oil and gas projects will likely be much lower than presented in the above chart.
Heggarty said majors can play to their strengths by investing in certain types of clean energy projects over others. The renewable project in the chart above that most closely rivals an oil field development, the Dogger Bank Offshore Wind Farm, hints at the types of projects where majors may see the most success.
For example, offshore oil experience, as needed for ExxonMobil’s Ben Nevis offshore oil field in Canada, translates to offshore wind because of the in-house engineering experience already required for offshore oil and gas exploration.
Majors could also thrive in tenders favoring extremely large procurements or big balance sheets, according to Heggarty.
In Europe, for instance, the move toward non-subsidy or lower-subsidy auctions puts more onus on the developer. Heggarty said the lack of government support plus the exposure to wholesale prices plays better for companies with access to capital and familiarity with electricity pricing.
“These kinds of projects are inherently higher-risk,” said Heggarty. “That limits the pool of companies that are going to be able to develop those projects.”
Big balance sheets and familiarity with daily electricity trading allows majors to more easily take on that type of risk.
The cost of capital for wind and solar is “extremely low,” according to WoodMac, while the higher risk of oil and gas projects makes weighted average cost of capital for those projects higher. But for “merchant projects” without fixed revenues, the big balance sheet of majors could present a distinct advantage compared to smaller firms.
In emerging markets with large tenders where oil and gas majors already have business, like Iran, majors could also benefit from their on-the-ground relationships as well as their finances.
“They have that scale, they have that balance sheet strength that most players in the renewable energy market just don’t have,” said Heggarty.
Perhaps more challenging than finding a niche will be convincing majors the investment is worth it. Though renewables projects present less risk than their oil and gas counterparts, they also yield smaller returns.
“The key challenge for them is how to create value from these renewable investments,” said Kretzschmar.
Returns for renewables projects already rival those for downstream oil and gas, as well as some upstream activities such as exploration. But it's undeniable that the returns available for many upstream oil and gas sectors currently outpace those of clean energy projects. Heggarty said companies should steer away from weighing the particulars of clean energy projects directly against those of oil and gas.
“Oil and gas companies are comparing renewables projects on a similar basis,” said Heggarty. “Although they are both in the energy space, they are very different propositions. Totally different risks, challenges and returns at the end of the day.”
Though majors lag behind in the clean energy space, Heggarty said they can pivot relatively quickly.
“Certainly, large oil and gas projects will take significantly longer to develop than wind and solar projects,” said Heggarty. “If the majors want to move quickly in this area, that’s something they’ll be able to do.”
Despite the opportunities, though, Kretzschmar said that pivot will likely come when regulators and consumers demand it, even if companies understand that “electricity is the future of energy.”
“None of the oil and gas companies will be leading the transition,” she said. “They’re followers.”