Diversification into low carbon raises questions about returns for oil and gas companies

Investments in the low-carbon segment among global integrated oil and gas companies have become increasingly material in recent years. In fact, IHS Markit currently forecasts nearly $7 billion in average annual spending in the low-carbon sector among this peer group between 2019 and 2021. This higher spending has led to questions about the profitability of investments in sectors outside of the traditional oil and gas business. Chris DeLucia from our upstream companies and transactions team discusses the returns in this two-episode topic on our Upstream in Perspective podcast. In part one, we discuss recent investments in the low carbon space. In part two, we explore how oil and gas companies are evaluating returns.

Jessica Nelson:

When we spoke last October, it was following your report at that time that investigated the low-carbon strategies of several integrated oil and gas operators. What has changed since that discussion in terms of how oil and gas companies are approaching the low-carbon space?

Chris DeLucia:

There's definitely been continued progress in the space. I think one of the biggest things that we're seeing is that there's been continued growth in investment within the low carbon sector among oil and gas companies. Based on our data, we saw nearly four billion in acquisitions in the low carbon space from oil and gas companies in 2018. That compares with about $1 billion annually in each of 2016 and 2017. A pretty big uptick there in terms of M&A activity.

And that included a few big acquisitions in the space. We had Total's acquisition of Direct Energie for $1.7 billion. We had Repsol's acquisition of Viesgo for a little under $900 million. And then we had Equinor's acquisition of Danske Commodities for about $470 million. Quite a bit of a pickup there in terms of M&A activity among oil and gas companies. But, even outside of M&A, we've seen continued investment in the space.

If we look at our global integrated group of companies, for us that includes the Supermajors, plus Eni, Equinor and Repsol. If we look at our estimates for spending in the low carbon space for those companies over the next few years, we're seeing about $7 billion in aggregate among that group of companies. Again, for investments in low carbon annually through the near term.

Hill Vaden:

And, that's low carbon outside of traditional oil and gas businesses?

Chris DeLucia:

That's a good question. It's any low-carbon businesses in addition to any modifications or investment in terms of emissions reduction within the upstream space. If they're looking at improving efficiency within their upstream oil and gas operations, we'll include that in that bucket as well. And, things like a carbon capture.

Hill Vaden:

Carbon capture. Okay.

Chris DeLucia:

If we group all those investments together, we're looking at about $7 billion annually. And for those companies in total, that equates to about 5% of their corporate CapEx, still relatively small in the grand scheme of things as far as overall corporate spending. But that's becoming increasingly material. And it is a bit of a pickup from what we've seen over the past couple of years when spending may have been closer to 3 to 4%. Just increasing growth in that space there.

Not only is the absolute level of spending increasing, but we're also seeing an increasing array of companies that are getting involved in the sector. We've tended to focus our analysis on the global integrateds, really the majors just because those are the companies that have been making the bulk of these investments in the space.

But we're starting to see a bit more activity from some other peer groups. We've seen a pickup in activity among the NOCs. Not quite to the same extent that we've seen from the majors, but we have started to see a bit more activity from some of the big NOCs in the space. A couple of examples there. We had a Petronas' acquisition of Amplus Energy, a solar developer that happened earlier this year.

And we've also seen CNOOC reenter the offshore wind market after they exited that space a few years ago. A bit more activity from the NOCs and also from some of the US independents and international E&Ps. Again, not quite to the same extent as some of the bigger companies, but we have seen a pickup in movement there. A couple of examples, ConocoPhillips and Santos, announced that they are starting a battery project at their Darwin LNG facility. We've also seen investments in carbon capture utilization and storage by companies like Occidental and BHP. Again, just a broadening array of companies that are getting involved in the sector.

And then just the last thing I'd note about what we're seeing is that we're starting to see more diversity as far as the sectors into which these investments are being made. Certainly, there's been a traditional emphasis on things like a solar, wind and biofuels as well as areas like carbon capture, CCUS, in addition to upgrades on existing oil and gas operations.

We're also starting to see some movement into some new areas, some new low carbon segments things like low carbon power distribution, batteries and storage and electric vehicles as well. Just a broadening array of sectors where we're seeing investments being made by these companies.

Jessica Nelson:

You're triggering my memory because I think last time we talked a lot about how we were seeing activity in Europe, maybe not from a lot of companies operating in the US. Good to hear that there's some changes there. Speaking of that we can't help but notice another change being the aggressive commitments to the Permian Basin by US supermajors Chevron and Exxon.

And somewhat related, we've all heard a lot about probably the largest energy transaction of the year Oxy's proposed takeover of Anadarko. And, Anadarko's undrilled Permian inventory being the main driver of that deal. Let me ask you a big question here that I think a lot of people have. How do you balance the upstream sector's long-term interest in low carbon and the near-term interest in oil?

Chris DeLucia:

Yeah. It's a fair question. I think the key here is to recognize that these companies are still looking to focus on their core area of expertise. And for the companies that we're looking at that remains largely oil and gas. Even for the diversified companies we see a focus within upstream. For the global integrated, we're looking at the upstream sector accounting for about 80 to 90% of corporate CapEx.

We're really seeing companies trying to maintain that focus on their core area of operations, while looking to diversify into these other sectors. But I think the other thing to think about here is just that, while we are seeing growth in the low carbon segment, we're seeing a growth in and demands for increased investment in the space.

We still do see continued growth within the oil market. If we look at IHS Markit base case scenario, we're looking at oil demand growth to continue into the late 2030s. And that's consistent with the internal view of a lot of the oil companies that we're looking at - where there's still the expectation for that continued growth in oil demand. Companies are looking to maintain that position and maintain that exposure to that core area of expertise. And, maintain that portfolio that's exposed to continued growth in the oil sector.

Hill Vaden:

When you're looking at some of these big low carbon investments, relative to some of these bigger deals, you think about the Oxy-Anadarko deal or even the BG-Shell deal from several years ago, are we talking dimes versus dollars when we were comparing that to the low carbon entry into some utility space to some of the traditional oilfield mergers?

Chris DeLucia:

Sure. It's definitely not quite to the same extent. If you look at some of the biggest acquisitions that we've seen in the low carbon space, they are significantly lower than some of the investments that we're seeing within oil and gas. We're talking about kind of low- to mid-single digits in billions as far as some of the acquisitions.

You think about Total's acquisition of an interest in SunPower back in 2011, I think that was right around $1.6 billion. Their acquisition of Direct Energie last year was $1.7 billion. Repsol bought Viesgo' that was about $900 million. We're looking at significantly smaller deal size relative to the oil and gas acquisitions that we've seen.

But, the number of these transactions has been increasing as well. So, even if the absolute number is smaller, the sheer number means that in aggregate these are becoming increasingly material, but still orders of magnitude smaller than what we've seen in the oil and gas space. It is definitely a different story there.

I think that gets back to the initial point here where these companies are still looking to maintain that core exposure, but they're also trying to transition and be positioned for that changing energy landscape. And especially given the general uncertainty about the pace and the timing of this transition. I think we're sort of seeing a gradual shift, but one that's becoming increasingly material as they look to be positioned for that change as it starts to accelerate.

We explore low carbon profitability for oil and gas in more depth in our two-part podcast. Listen to both part-one and part-two on Soundcloud or find us on iTunes or Google Play.

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Posted 30 July 2019

This excerpt has been professionally transcribed as accurately as possible. Please note, some words and phrases may have been unintentionally excluded.

This article was published by S&P Global Commodity Insights and not by S&P Global Ratings, which is a separately managed division of S&P Global.