A bevy of Royal Dutch Shell’s top clean energy executives picked up and resigned from the energy giant. They quit shortly before Shell was scheduled to announce its forward clean energy strategy. The financial press intimated that these executives left because the oil giant was moving too slowly to distance itself from its legacy oil and gas businesses. More resignations were supposedly on the way.
We are not privy to inside information regarding these highly publicized departures but we are not totally surprised either. We’ve seen these dynamics before. As large corporations attempt change—for whatever reason— this change manifests itself in the allocation of investment resources (money) between competing divisions. In a conglomerate all business units compete and capital is allocated to the highest returning businesses. During periods of transition like oil companies are presently experiencing, it becomes increasingly difficult to know which businesses and assets are preferable over the corporation’s investment horizon, typically at least ten to twenty years.
In some instances, (we’re thinking particularly of corporate “greenwashing”), the corporate board and its senior executives feel compelled by public opinion to pay lip service to a transformation they do not believe in. When senior level buy-in to corporate transformations is lukewarm it becomes obvious once corporate capex plans are announced and a potential source of disgruntlement. The oil industry faces more structural problems in transforming itself than other fossil fuel entities such as electricity or natural gas suppliers, despite green publicity campaigns and large sums invested in new, “green” business units.
The electricity sector, which is going through its own “green revolution” now, can be divided into two businesses: the “manufacturers” of power and those that deliver it to consumers. Interestingly the interests of the two businesses are becoming increasingly disconnected. The power distributors, do not particularly care about the source of their energy as long as consumer demand remains robust.
Electricity producers, on the other hand, the actual power generators, are in a funny position. Demand for energy is not likely to taper off and on the contrary could grow dramatically if the transportation system electrifies cars, trucks, buses etc. However consumers increasingly demand that their energy be produced in an environmentally benign fashion. To us this means coal fired generation is on the way out and natural gas plants may face increasing stranded asset risk in the future. But the electricity delivery infrastructure remains valuable so long as large base load power generators produce electricity more economically than locally sourced micro grids.
The natural gas business can be similarly divided into gas producers and those that deliver the commodity to consumers. The delivery firms want a product to store and deliver to customers, whether natural gas, renewable natural gas, hydrogen or some other gaseous product that consumers can use. The natural gas distributors claim that, technically speaking, there is enough potential renewable gas in the country to meet 90% of their needs. The natural gas producers, like the owners of coal fired power stations may feel threatened but the delivery firms don’t care. Whether the commodity product comes out of a fracked well or from dairy farm methane, their infrastructure remains valuable.
Oil companies that explore for, refine, transport and distribute oil now find that a considerable portion of their assets are potentially stranded. Why? Because unlike electric and gas utilities which face solid electricity demand but consumer opposition to some modes of production, oil companies confront a possible decline in product demand plus consumer opposition to the product itself. To put it bluntly, if consumers no longer rely on oil (or do so at diminishing levels) what can the oil companies sell?
Existing businesses with traditional capital structures, even those in secular decline, still have considerable access to global capital markets. The problem here, especially during a period of easy money from central banks, is that oil companies have plenty of investable cash but at a time when other, competing investors are also flush. As a result new asset prices tend to be inflated. And often new entrants don’t have legacy businesses that will be financially undermined by the success of a new, and in this case greener, investment.
The problem here is simple to state but nevertheless economically unattractive for many oil related assets. Whether or not oil companies invest in renewables, their legacy infrastructure declines in value if transportation and other sectors migrate increasingly to electricity. The result is declining demand for their product and the economic consequences thereof. This process of business “cannibalization” is by no means unique to oil. On the contrary it’s almost inevitable in a large conglomerate.
At this point the closest industry analogy is tobacco. Like oil they got caught in a big lie. Not about publicly denying climate change but about smoking not causing lung cancer. But unlike the oil industry tobacco firms paid large financial settlements to the government for the harm they caused. Tobacco companies emerged chastened, smaller but more or less intact as an industry. However, despite all the social opprobrium with respect to cigarette smoking, they continued to invest in the business, and they have retreated from their diversions into other fields. Whether there’s a lesson here for “big oil” remains to be seen.
So this brings us back to our question: will or can the oil industry transition its capital spending so as to remain relevant in the emerging energy and transportation sectors? The news of unhappy, frustrated executives trying to push oil conglomerates to respond to the need to change just brings that question into the limelight. Are frustrated corporate executives right to push for faster change or should they stop wasting time and get a job somewhere else? This is not just about economics and technology but also about corporate identity and culture, which makes the question so much harder to answer.
By Leonard Hyman and William Tilles for Oilprice.com