London — The world's transition to cleaner, low-carbon energy presents a unique set of challenges and opportunities for integrated oil companies as they struggle to meet both the needs of investors and climate change goals, according to Brian Gilvary the former chief financial officer of BP.
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Speaking a week after retiring from a career spanning more than three decades at the oil major, Gilvary said oil majors are facing tough decisions on where to invest in emerging portfolios of renewable energy, power markets, low-carbon mobility and battery technology.
One of the biggest challenges is investing at scale in low-carbon businesses which are able to generate returns anywhere close to the levels of traditional upstream oil and gas model, he said.
Historically investors have been used to seeing double-digit average internal rate of returns from the oil sector, levels widely seen as unrealistic outside the world of capex-heavy, upstream mega-projects.
"I think the focus on returns will be crucially important...One of the things I've heard from some investors is they are not looking for energy companies to dilute returns by investing in renewables," he told S&P Global Platts in an interview July 9.
"They can invest in pure-play renewable companies that are already in that space now, they want to be sure oil and gas companies are playing to their strengths when they invest in renewables".
Energy utility challenge
European oil majors have been expanding their renewables energy and power sector investments of late, particularly in the wake of the 2016 Paris Agreement on climate change. BP and Shell have both signaled a return to solar after earlier false starts and Total is challenging EDF in the retail sector and aims to have 5 GW of power generation capacity within three years.
Shell, which acquired UK household energy provider First Utility in late 2017, has launched an ambitious goal of becoming the world's largest electric power company over the next decade.
BP itself has committed to net-zero carbon emissions by 2050, implying a fundamental shift over the coming decades to renewables and carbon abatement.
While expansion into electrification should be part of the low carbon expansion, the expansion into energy utilities may not be a one-size-fits-all strategy, he said.
Dealing with retail users can be "hellishly complicated" and is a very different business model which can be "a big step" for an integrated oil company.
Gilvary was more upbeat on investments in hydrogen, however, which he believes will be a big part of the energy transition with "lots of opportunities" up for grabs.
Balance sheet stress
Gilvary echoes widely-held hopes that the world will emerge from the pandemic with a greater focus on the environment as part of a "green recovery" push by policymakers and corporations.
"There's a lot of cash out there for in terms of people wanting to invest in these areas," he said. "I think we're hitting a sweet spot now on climate. And that's why I hope it accelerates off the back of what we've seen in the last three months. I think the opportunity is huge. I don't think any company cannot play in this space going forward."
But with company balance sheets stretched from rising debt levels during the crisis, efforts to spend more on clean energy will also be under pressure, he said.
"I think it's going to be a tough challenge but we've got to proceed on that...I think you'll see a lot more integrated plays in the energy mix around integrating some of the different energies from hydrocarbons to create long-term sustainable solutions."
Nevertheless, Gilvary said he remains convinced that oil, gas and coal will be an "incredibly important" part of the global energy mix in the future, not least due to the fact that the world's population is expected to expand by a quarter, or some 2 billion people, over the next three decades.
"Therefore we've got to find a way to clean up part of this hydrocarbon mix, and there'll be multiple approaches to that. I think we're hitting a wave now where the world is embracing climate and I think we need to push on from that," he said.
Doubts over the future of IOC business models have also been stoked by the sector's tacit recognition that the outlook for future oil and gas prices is less rosy than previously thought.
BP got the ball rolling last month, announcing it would write off up to $17.5 billion worth of assets after cutting its long-term price assumptions for oil and gas to reflect expectations the pandemic will accelerate the shift away from fossil fuels. The move, followed by Eni and Shell, sparked concern over a wider industry recognition for the potential of more stranded assets as the energy transition hits the long-term value of oil and gas.
Gilvary said the price assumptions are in many ways part of standard impairment testing required to frame a company's long term investment strategy.
"Once you've got that set, you then, ultimately as a company, need to find out what's your point of distinction and what's your competitive advantage over everybody else. In other words, why are you in this? Why do you believe you are the best person to deliver this project?"
Another key challenge for the oil sector is the shunning of fossil fuel investments by banks and financial institutions, creating problems of access to capital particularly for smaller players, he said. With societal pressure building against fossil fuels, Gilvary sees a different suite of investments in the future with the onus on countries' themselves to develop their own natural resources.
Gilvary also cautioned against any complacency by US oil majors to invest in more clean energy due to their focus on shale oil. With the focus of climate protests falling heavily on European IOC's, some believe US companies are will not face the same pressure to lower their carbon footprints. "I'm not sure that's going to hold" he said.
"In the next decade it's going to be fascinating for our energy moves based on what we've seen over the last three or four years," he said.
"We're at quite a unique moment where there are going to be a multitude of solutions and the question is going to be; 'which ones do you want to to play in?' because there are some big opportunities and equally there are some big downside risks associated with these."