Rystad Energy - Energy Knowledge House
Rystad Energy - Energy Knowledge House

Commentary

How are E&P companies navigating energy transition? Part 1: Diversification

Last year’s oil-price shock – the first since the Paris Agreement was signed in 2015 – accelerated the upstream industry’s shift towards lower-carbon business strategies. As revenues and returns plunged, oil and gas companies came under increasing pressure from governments, regulatory authorities, shareholders and the general public to transform for a decarbonized future, while still delivering profitable oil and gas production in a world where peak oil production is coming sooner than previously thought. Many petroleum players have met this challenge head on with substantial commitments and strategic measures. Rystad Energy has analyzed how E&P companies are tackling the new reality with growing demand for clean energy investments, portfolio resilience and decarbonization to find out how companies can manage the risks and opportunities of energy transition most efficiently. This first commentary outlines our analysis and zooms in on energy diversification, while the following two commentaries look at portfolio resilience and decarbonization. We have also published a comprehensive special report detailing our findings.

Last year’s oil-price shock – the first since the Paris Agreement was signed in 2015 – accelerated the upstream industry’s shift towards lower-carbon business strategies. As revenues and returns plunged, oil and gas companies came under increasing pressure from governments, regulatory authorities, shareholders and the general public to transform for a decarbonized future, while still delivering profitable oil and gas production in a world where peak oil production is coming sooner than previously thought. Many petroleum players have met this challenge head on with substantial commitments and strategic measures. Rystad Energy has analyzed how E&P companies are tackling the new reality with growing demand for clean energy investments, portfolio resilience and decarbonization to find out how companies can manage the risks and opportunities of energy transition most efficiently. This first commentary outlines our analysis and zooms in on energy diversification, while the following two commentaries look at portfolio resilience and decarbonization. We have also published a comprehensive special report detailing our findings. 

The oil and gas sector has weathered many downturns with the standard playbook of cutting capex, reducing costs and tapping credit lines. Last year was no exception as E&P investments were slashed by 30%. At the same time, tough times have forced some E&P players to adopt new strategies and reset priorities to remain competitive and investable. Comprehensive cost cuts became the top priority in 2014, when the explosive growth in US shale overwhelmed demand and sent oil prices diving to $43 per barrel from $100. Much of the reductions were delivered by lower supply chain costs, efficiency improvements, project concept revisions and generally doing “more with less”. Advanced digitalization and cognitive technologies become inseparable parts of the supply chain and led to performance improvements.

The most recent downturn has brought challenges of a different kind: Since there is almost nothing left to squeeze from the supply chain, budget cuts had a direct impact on operational performance and short-term operational plans. To stabilize returns, E&P players have revised and reshaped their portfolios at a time when decarbonization and environmental, social and governance (ESG) issues have risen to the top of the global agenda. As a result, the E&P sector is entering a new investment cycle focused on decarbonization and portfolio resilience. Some upstream companies may never return to their pre-crisis level of oil and gas investments as they instead channel their spending into low-carbon businesses (Figure 1).

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Energy transition is a multidimensional topic. We have studied how upstream companies approach the new market reality through a series of criteria that we regard as key distinguishers and important indicators of potential success, and will present out findings in this series of commentaries. It’s important to keep in mind that the priorities may differ depending on the markets in which the companies operate: for European majors, investments in renewables is an inseparable part of the energy transition strategy, while for Asia-focused players, gas production is a more important ingredient in the energy transition as gas can substitute coal and fuel oil in many Asian countries. There is therefore no single, perfect strategy to “win” the energy transition. We have distilled this complex topic into three main pillars of energy transition for the E&P industry: energy diversification, portfolio resilience and decarbonization (Figure 2).   

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Our research covers the top 25 E&P companies by oil and gas production in 2020, excluding national oil companies (NOCs) but including NOCs with international activities (INOCs). These 25 companies are responsible for almost 40% of global hydrocarbon production and the same share of global E&P investments (Figure 3). The trends within this peer group are believed to be representative on a global scale.

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In this first commentary of the series, we take a closer look at the energy diversification dimension, which includes investment diversification and financial performance

Investment diversification
In the past five years, more and more upstream companies have beefed up their investments in clean energy and across the electricity value chain, though the specific investments vary between company types and core markets. Asian national oil companies with international activities (INOCs) have the greatest share of investments related to non-E&P segments (Figure 4), however much of this is directed at their midstream and downstream businesses and is therefore still fossil-fuel-related. Future investments in this group may include some attempts to incorporate renewable energy sources as part of their “future-proofing” strategies: Malaysian state-owned oil and gas company Petronas, for instance, plans to allocate 5% of capital spending to renewable energy and has formed a new business unit to gather LNG, gas, power and new energy under one banner for cleaner energy solutions. In the same fashion, Chinese offshore upstream giant CNOOC recently pledged to raise renewable energy spending to more than 5% of its total budget with a focus on offshore wind projects, seeking to leverage its experience from offshore oil and gas projects.

European majors dominate in the middle section of the chart in Figure 4, with non-E&P investment shares between 20% and 30%. Most of their non-E&P budgets are still directed at refinery and downstream activities, but we see that these companies are gradually expanding into low-carbon technologies and clean energy, underpinned by solid medium-term investment commitments.

Total has been one of the pioneers among oil majors in terms of renewable energy investments. The French major this month said it will allocate more than 20% of its net investments this year to renewables and electricity, and proposed to change its name to Total Energies to emphasize its transformation into a broad energy company focusing on LNG, renewables and electricity.

The European majors have different approaches, however. While BP and Total are agglomerating renewable energy assets, their Anglo-Dutch peer Shell is counting on selling, not producing, renewable electricity as the key to energy transition success, questioning the ability of renewable projects to generate competitive returns. There is also a notable distinction to be made between US and European majors’ approach to energy transition. US supermajors ExxonMobil and Chevron have set modest targets to lower their net greenhouse-gas emission intensity from oil production, but have not made any move to reduce the emissions intensity of the energy products sold to consumers. They are also not in a rush to commit investments beyond their core business of oil and gas. Their European counterparts, on the other hand, have set ambitious targets to become “net-zero” companies by 2050 or sooner and are busy branching out into solar, wind and other forms of renewable energy production.

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Another driver we have looked at to determine investment diversification is renewable power capacity under ownership by 2030. Wind and solar remain the low-carbon investments of choice, and the investment opportunities are expanding as the development cost continues to drop. We also see a surge in capital directed at renewables projects, partly due to growing ESG pressure. The European oil majors along with players such as Repsol and Equinor have taken great strides into this market over the past five years in line with their diversification and decarbonization plans (Figure 5). The main expansion vehicle for them is M&A activity, with a growing number of clean-energy deals being completed each year. The European companies have also shown their commitment by sparing their low-carbon businesses from major budget cuts during the last downturn.

Conventional investment logic says that low risk equals low gain, and it is no secret that investments in renewable energy have historically yielded much lower returns than conventional oil and gas projects. In a low oil price market that is no longer a rock-solid truth, however. We now see that European E&Ps are trying to gain momentum in the fast-growing renewable energy industry, seeking a shield from the boom and bust cycles of the oil market.

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When we place E&P players along both these two dimensions – average share of non-E&P investments in the last five years and installed renewables capacity by 2030 – we can see who are the leaders and laggards from an investment diversification point of view (Figure 6). European E&P companies are taking the lead with ambitious plans for renewables, as their path to energy transition lies with investments in the low-carbon energy systems of the future. For companies that choose to stick to the traditional oil and gas segments it may be more crucial to focus on decarbonization and gas production growth. 

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Financial performance
As they navigate oil-price fluctuations and new energy markets and technologies, E&P companies must also make sure they keep their eye on the ball – or more precisely their financials, as shareholders and other investors will still expect stable returns. Many E&P players rely on sustained profitability in their core business to fund expansion into low-carbon opportunities, which in the long run could weaken their financials and prevent them from fulfilling their energy transition ambitions. We have therefore included total debt to equity ratio in our analysis to indicate the companies’ ability cover all outstanding debts with shareholder equity in the event of a business downturn (Figure 7).  

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The energy transition is a growing investment trend for the oil and gas sector, which is now entering a new investment cycle with priorities shifted towards decarbonization and portfolio transformation. In this new market reality E&P players are pivoting their long-term strategies around these principles, adjusted to their specific market conditions and legacy experience. However, they still have a long way to go before investments reach a level that is sufficient to propel the oil and gas sector into a truly low-carbon future.

Follow the links to read the other commentaries in this series on portfolio resilience and decarbonization and the special report detailing our findings. 

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