Back to black? European oil giants' dilemma as renewables retrenchment puts targets at risk

UK supermajor BP seemed to be ringing in a new era in 2020 when it tied its net zero strategy to a calculated decline in its own oil production, pledging to plough profits into renewable power instead.

CEO Bernard Looney told investors that time to address climate change was "running out fast” and promised steady returns of 8-10% from renewables to gradually replace the risk-reward game of oil and gas.

A European Climate Law, perennially low interest rates and the rise of ESG investing helped persuade the boards of major European oil companies to underpin their own net zero commitments with big plans for renewable energy, which in BP’s case amounted to a 50GW target by 2030.

Shell talked of “providing enough renewable energy for 50 million households” by 2030 while TotalEnergies promised a gross 100GW of renewable capacity, but only BP promised a measurable transition away from fossil fuels, with its oil production projected to decline 40% by 2030.

Offshore wind seemed the obvious choice for these experienced and cash rich deep-water operators, leading to a spending splurge on tenders.

All change

Fast forward to the recent round of second quarter earnings and there was relatively little to be heard from oil companies about wind.

There have been some outright retreats — Shell has sold interests in big offshore wind projects in South Korea and the US and absorbed its renewable solutions business into a European Energy division, but CEO Wael Sawan’s single-minded pursuit of share value and higher returns on investment at that company is merely the most visible example of a broader trend.

Understanding these shifts starts with the geopolitical and economic upheavals of the last three years, says Rohan Bowater, an analyst with investment advisory firm Accela Research.

“Many energy transition plans which included targets and initial investments in renewables were set during the Covid-19 pandemic in a very low oil price environment. It was easier to set these big aspirational targets then,” he muses.

“The price spike and windfall profits that came with Russia’s invasion of Ukraine invasion explain the pivot we are seeing now. That's when we really started hearing all those very vocal investor concerns, especially directed at BP and Shell.”

As oil companies around the world wallowed in record profits after the invasion, the two UK-listed supermajors were particularly bothered by a growing valuation gap against US peers.

This gap probably had its roots in the US shale boom but arguably widened as the likes of Chevron and ExxonMobil focussed their own energy transition strategies on decarbonising rather than replacing fossil fuels, often presenting robust carbon pricing as a contingency even for this.

Investors who would rather see the European majors concentrate on oil and gas projects in the same way have gained influence since the energy shock of 2022.

There has been no weakening of this trend since oil and gas prices declined from their highs of 2022, partly because energy security has been worrying governments at least as much as climate change but also because it remains hard to compete with oil profits.

When energy consultant Wood Mackenzie was assessing the impacts of a declining oil price last year, it noted that a weighted average internal rate of return on a $60 barrel would still clock in at 19%. In fact, the price of Brent crude has averaged around $83 so far this year.

Activist shareholders Bluebell Capital Partners have called on BP to ditch the commitment to cut oil and gas output outright.

The retrenchment seems to be spreading to biofuels, in a European market where demand has lagged investment.

Shell recently paused construction at a giant Rotterdam facility intended to convert waste into jet fuel and biodiesel, taking a $780m hit and citing technical difficulties.

BP also dropped plans for two out of the five biofuel refineries that were in its investment pipeline.

To meet decarbonisation commitments, the European oil companies seem to be throwing more weight on carbon capture and storage (CCS).

Shell’s most significant low carbon investment in the quarter was a CCS project aimed at reducing emissions from a refinery and petrochemicals complex in Canada, helped by a carbon credits scheme there.

Norwegian oil and gas giant Equinor, another offshore wind pioneer, similarly trumpeted new three CCS licenses in Norway and Denmark as its quarterly highlights in the low carbon space.

But in a study of the top five Europeans' oil majors’ plans to meet net carbon intensity (NCI) targets, advisory firm Accela Research found that all of them are falling short of what is needed to meet their own 2030 targets.

Looking at what has been achieved so far, Accela found that TotalEnergies' 7% NCI reduction for 2019-23 came out on top and Equinor was shown to be lagging, achieving just 1% after committing a 20% reduction.

In terms of cash, the study suggested BP would need to spend an additional $71bn to hit its 2030 NCI targets and that Shell would need $53bn more to do the same.

Renewables are not the only way of reducing carbon intensity — the tool box can include CCS, carbon offsetting, battery energy storage systems and even liquefied natural gas — but Accela suggested that the task was running away from the oil companies, finding that it would take ”the equivalent of 309GW of renewables (between 2024-30) to shift the dial on carbon intensity.”

Sticking to it

"We have a strategy and we’re sticking to it – energy is about the long term,” TotalEnergies CEO Patrick Pouyanné said recently.

“We’ll need more electricity, which is an energy that’s growing. While I’m not certain it will be the case over the medium to long term for oil and gas.”

BP’s appetite for acreage for German acreage at last year's offshore wind tender appeared to show that the returns-driven integrated business model can still drive big spending on offshore wind.

The UK company were joined by TotalEnergies in that tender and the pair pledged to pay €12.6bn for 7GW of capacity.

Although TotalEnergies also stressed the merchant aspect of its business model on that German tender, it went on to focus on the integrated approach when it acquired a 50% share in Holland’s 795MW OranjeWind project to power green hydrogen production and decarbonisation at its northern European refineries.

BP was still ahead of TotalEnergies in Accela's ranking of the five major's transition plans toward NCI targets, but this was largely due to the planned decline in oil production and a 44-50% low carbon capex target — the very strategies that are now under question.

BP’s mission to become “a more focused and higher value” company has so far resulted in a softening of the projected decline in oil production to 2030 to 25%, but CEO Murray Auchincloss has hinted at more.

BP’s own energy outlook suggest that global oil demand is only expected to peak in 2025, with the pace of transition in the road transport and petrochemicals industries identified as the key variant in how quickly it drops after that. , Recent reports about the hiring freeze suggest the pressure on returns has only grown.

Equinor's rating is disappointing, considering that the Norwegian major was a pace-setter in projects such as the New York Empire Wind and Beacon Wind in the US, as well as two pre-commercial floating wind arrays in the North Sea.

Equinor was sitting pretty in 2021 when BP paid $1bn for a 50% stake in these US projects but the pair ran into supply chain constraints and regulatory challenges , resulting in heavy impairments.

But Equinor remains an important player in offshore wind, holding a 40% stake in the 3.6GW Dogger Bank and sticking with Empire Wind following a divorce from BP.

The Norwegian company recently underlined its ambitions in South Korea by signing a major supply chain agreement with Samsung Heavy Industries but its march into renewables has slowed.

Visibility on returns

It was not just the spectacular oil profits and higher interest rates that turned the oil majors' investors off wind, but also the lack of visibility on promised returns, Bowater argues.

“In oil and gas, we can easily understand components like the breakeven price or production costs. There's a lot of data out there when you want to talk about margins. But when you turn to renewable projects, it's all still under debate. They tell you they’ve got an IRR for 6-8%, but there's an information gap when it comes to the assumptions underlying that,” he says.

It is in this sense, too, that TotalEnergies stands out, he adds.

“TotalEnergies has not been subjected to quite the same scrutiny and punishment as BP and Shell. We think that is because they have been more transparent about their renewables targets. They commit and they've delivered on their promises," he says.

These commitments include a 10% a targeted return on integrated power, although this includes combined-cycle gas turbines.

“Our view is that investors are rewarding, solid, consistent strategies rather than piecemeal, reactive strategies that turn out to be contingent on the market,” Bowater says.

Shell and BP insist that their diligent, value-based approach is not a retreat from renewables, but a shift to a more selective and accretive approach.

Thus BP did not just drop biofuels projects but also announced an agreement to take full control of the Bunge biofuels unit in Brazil.

And Sawan made it clear that he stands by last year's $2bn acquisition of European biogas producer Nature Energy, while acknowledged that the full benefits of this might have to wait until the energy transition reaches shipping and trucking.

His message was clear, however: the company will look to spend the promised $10-$15 billion in the low carbon space between 2023 and 2025 but will maintain a "clear line of sight on obtaining accretive value".