The energy transition will be led by companies who are all in

15 12 2023 | George Darrah

Both bp and Shell recently announced a doubling down on fossil fuels. Exxon and Chevron never stopped being doubled down. Total, the last hold-out for an oil and gas company led energy transition, will soon follow. These strategic shifts have resulted in shock and anger being directed towards these companies, perhaps even a sense of betrayal. For a snapshot of what many are feeling, look at the linkedin comments under recent communications for bp or Shell. Shell’s CEO even received a letter signed by 8000 dismayed employees deploring that Shell’s desire to be a ‘leader in the energy transition’ was now in tatters. Oil and gas companies are doubling down when we need to phase down.

But we should not be surprised that legacy oil and gas companies will back pedal on their commitments to net zero. This is for a handful of interrelated reasons but boils down to a simple fact: today and for the foreseeable future, clean energy is not as profitable as fossil energy. To follow the cascade of decisions that are playing out in the board rooms of the majors right now:

Renewables just have a lower ROI than oil and gas – upstream oil and gas projects typically expect an IRR of 20-25%, while offshore wind, where oil and gas companies claim to have specific logistical and engineering advantages, IRR’s come in at well below 10%[1]. To even come close to upstream oil and gas project IRR’s, these companies will need to own the entire value chain, even setting up their own retail electricity distribution co’s. And these are quietly being shuttered down as we speak, Shell recently selling its retail energy business to Octopus. Diverting capex into renewables vs oil and gas is a big opportunity cost.
Super majors are constrained by a high-cost base – salaries at oil and gas companies are higher than in renewables. For an electrical technician in the North Sea, it can be a £20k difference[2]. It’s very hard to start paying everyone less. And final salary pension schemes are immensely expensive to maintain.
These companies are ‘cash machines’ for their shareholders – since the Paris agreement was signed in 2015, shareholders in bp and Shell have earned a total of £131bn[3]. Shareholders expect to be rewarded handsomely for their investments. When they are not, the shareprice of these companies tank.

This is the simple explanation for bp, Shell’s and Total’s (future) pivot back towards oil and gas. The directors of a company are legally obliged to act in the best interests of the shareholders, which really means doing things that increase the financial value of the company. This situation is particularly acute for publicly traded companies, such as bp and Shell, where board decisions are rapidly ‘valued’ by the markets. So, when bp announced its was scaling back its energy transition plan in February this year, the share price jumped by 8%. bp or Shell has no desire to be a leader in the energy transition, unless it’s the best way to deliver shareholder value. If it’s not, it doesn’t matter.

Think about the rash of net zero targets that companies have signed up too. Consider this a miracle in itself! Most companies are not doing this because it is ‘the right thing to do’ but because the board decided that it was in the interest of the shareholders, not the planet, to incur the costs of planning and committing to (and then executing) a net zero target. The only thing that really matters to a board when setting a net zero target is whether the company will be more valuable as a result.

So, in this light, bp’s refocusing on its core fossil business was just a rationale response to market signals. In immediate hindsight it has seemed remarkably prescient – renewable energy supply chains (especially offshore wind) are creaking to breaking point, funding long-term capex has become massively more expensive, and wavering politicians in bp’s core markets are giving little confidence in the grid upgrades needed to deploy renewables at scale.

The company’s strategy has no moral compass other than that imposed on it from outside from regulation and reputation, nor should we expect it to. Unfortunately, an unintended consequence of the ESG movement is that oil and gas companies are being asked by their shareholders to double down on fossil fuels, as ESG-conscious European investors’ holdings are acquired by less judicious US investors. Formerly state-owned Total, the last supermajor with ambitious renewable targets, now answers to a majority of US investors who have given the CEO 6 months to prove that the renewables business can match the ROI of the fossil business, or it gets sold off. Unfortunately, we’ll be hearing from Total too in 2024 as they refocus on oil and gas.

The supermajors will continue to pursue oil and gas, and they will continue to dabble in renewables at the bottom of each oil cycle as ROIs converge. But they cannot be leaders in the transition. Their legacy business is too profitable, their cost bases too high, and the expectation of their shareholders is that they continue to be cash machines. These companies should be wound down over time and any renewable assets spun off into newco’s without the parent company’s liabilities (including salary expectations!). Orsted chose to do this a decade ago with the luxury of state backing. We will have to do this by voting in politicians who remove subsidies for oil and gas projects and increase support for the energy transition.

And for us at Systemiq Capital, at the core of it all is investing into and supporting this generations most outstanding founders build and scale the clean energy super majors of tomorrow.

Special thanks to co-contributor Louis Millon

The energy transition will be led by companies who are all in

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