How big oil is transitioning to power the future?

By

Andy Brogan

EY Global Oil & Gas Transaction Advisory Services Leader

Transactions and strategy leader in Oil & Gas. Speaker and industry advocate. Optimist. Music addict. Avid traveller.

5 minute read 19 Aug 2018

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It’s wise for oil companies to diversify. But the most astute forms of diversification stay close to the original business. 

Windmills. Electric cars. Solar panels. When the cost and performance of emerging technologies improves, incumbents get nervous. Eventually the oil age will end, and it won’t be because we’ve run out of oil. Something better will come along. Something cheaper. It’s inevitable, and the question is how the oil and gas companies of today become the energy companies of tomorrow.

This question is urgent because we’re living in a world where there are predictions that peak oil demand will be reached in years rather than decades, stubbornly low oil prices and investor demands for more climate-related disclosures. It’s a good bet the answer to the question about the future of energy will have something to do with electricity.

Electrification has always been a catalyst for the broadening and deepening use of energy. In 2000, Neil Armstrong, speaking for the National Academy of Engineers, called electrification the greatest engineering achievement of the 20th century, ahead of the automobile, airplane and television.

Power generation is the single largest use of energy in the United States. In 2016, 39% of all energy used (37.8 quadrillion BTUs) flowed through the electric power grid.[1] The question has never really been whether electricity would eventually dominate the way that energy is delivered, but rather how the electricity system would be fueled. A bet on the answer to that question (natural gas vs. renewables, solar vs. wind) is a bet on the future of the energy industry, including oil and gas companies.

Oil companies have ventured into the power sector before, but those investments were focused on creating markets for natural gas and creating optionality for gas marketing and trading operations.

Monthly Energy Review, U.S. Energy Information Administration, 28 June 2017

37.8 quadrillion BTUs

The amount of energy that flowed through the electric power grid in 2016 – 39% of all energy used

Can big oil become big green power?

Renewables have had a small place in the portfolios of the majors for many years, but investment in these businesses has ebbed and flowed and has never become material or profitable.

We looked at investments in low-carbon or renewable sources of energy and clean technologies by 10 international oil companies since the beginning of 2014. Collectively, these companies have invested more than US$16b (out of total capital expenditures of more than US$350b) in future energy solutions, either independently or with partners.

The actual level of investment by these companies could be closer to US$20b because the value of some deals was not disclosed. Half of the total investment, some US$7.9b, has centered on renewable power generation projects. Forty percent of the total investment has been directed to wind energy and 9% to solar power. Several integrated oil and gas companies are beginning to invest heavily in various renewable technologies such as advanced battery technologies and offshore wind power.

The research showed the companies are all placing their bets on one energy source or technology rather than building portfolios of diversified low-carbon solutions to spread risk. Some are betting on wind, others solar, while some stick closer to their core business with biofuels. This suggests a wealth of options but no obvious way forward that works for the industry and the world as a whole.

The question that must be asked is whether an oil company’s core skills and culture can be translated to the renewable energy business. What is it that makes an oil company successful, and does it lead to success in the renewable power business?

In many ways renewables would seem to play to some key oil and gas sector strengths. The industry has capital to invest, investment-grade credit ratings, technology know-how, large-scale energy project management capabilities and years of community engagement experience. If those things were all that mattered, oil companies could have built and owned nuclear power plants. Who thinks that would work out?

So far, success in the renewable power space has been built on relationships with regulated power distribution companies and regulators (not a core strength of big oil). In the here and now, renewable power doesn’t always compete on efficiency or economics (a core strength of big oil).

If we look at it objectively, the oil companies’ natural and probably most profitable investment in the power sector is in a business they are already in — natural gas

Isn’t a natural gas producer actually a power company?

In Europe and the US, concerns about greenhouse gas regulations will make it difficult to find capital to maintain coal operations as a power source for electricity. Commitments to control climate change will continue to make coal-fired plants unsustainable globally. The emergence of hydraulic fracturing techniques has made gas plentiful and secure. The substitution of gas-fired for coal-fired electricity (with new renewables just about covering demand growth) has been the trend.

What does the future look like? Renewables will grow, too, but not enough to keep cheap gas from also growing.

If we look at it objectively, the oil companies’ natural and probably most profitable investment in the power sector is in a business they are already in — natural gas.

Summary

Oil and gas companies should start looking to the future while maintaining their unique strengths and perspective.

About this article

By

Andy Brogan

EY Global Oil & Gas Transaction Advisory Services Leader

Transactions and strategy leader in Oil & Gas. Speaker and industry advocate. Optimist. Music addict. Avid traveller.