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The transition toward a lower-carbon energy world has created
new challenges for upstream oil and gas companies. In addition to
existing pressures, including commodity price volatility and
geopolitical risks, these companies also face growing pressure from
shareholders, governments, and the general public to reposition
their business models to compete in a new energy landscape. For
now, the majority of the upstream industry remains focused on the
core oil and gas business. A growing array of companies - spanning
international oil companies (IOCs), national oil companies (NOCs),
and the service sector - has begun to incorporate the low-carbon
segment into their strategies while taking steps to build
integrated business models across the energy value chain, diversify
existing corporate portfolios, and reduce portfolio concentration
risk.
Spending in this area remains small on a relative basis. IHS
Markit forecasts the low-carbon segment to account for only 3% of
overall corporate capex, in aggregate, for the largest IOCs and
NOCs in 2020. Nevertheless, absolute low-carbon spending has surged
and is expected to approach $14 billion for the overall industry
this year, per IHS Markit estimates. We expect this trend to
continue: for example, aggregate low-carbon spending among the
Global Integrateds peer group is forecast to surpass $10 billion by
2025, up from $6 billion in 2018.
Some IOCs and NOCs are taking multiple approaches to
incorporating low-carbon businesses into their portfolios. These
range from internal research and development of low-carbon
technologies (e.g., Eni's development of polymer-based solar panels
at its Novara R&D facility) to strategic partnerships (e.g., a
50:50 joint venture between Bunge and BP to create a bioenergy
company in Brazil) to external investments in standalone low-carbon
companies (e.g., Suncor Energy's investment in Enerkem). Each
approach has strengths and drawbacks. For example, internal
development of low-carbon energy solutions requires a trade-off
between extended time to build the technical and commercial
capabilities in the organization and the benefits of strategic
differentiation achieved by developing a proprietary solution.
Given the urgency for oil and gas companies to demonstrate their
commitment to incorporating low-carbon initiatives into their
portfolios, investments are an attractive option. Companies can
quickly access business segments beyond traditional oil and gas
operations, such as new parts of the energy value chain or
geographies outside of oil- and gas-producing areas. Two classes of
investment of particular interest are M&A and corporate venture
investing. The M&A market allows companies to establish a new
or growing presence within the low-carbon segment, via
acquisitions, direct investments, and joint ventures. Corporate
venturing is another option, in which E&P organizations
incubate new technology at arm's length from the parent company.
Through in-house venture capital groups, companies take small
equity stakes, typically $1 to $5 million, in startup technology
companies. Unlike traditional venture capital, which seeks to
maximize its financial returns through investment exits, corporate
venture capital groups also have strategic goals - such as
developing technologies to enhance operations, commercializing
internally developed intellectual property, or gaining market
insights into emerging technology trends - in addition to financial
ones. In many cases, the benefits of the strategic objectives
outweigh the value of the financial goal.
Low-carbon M&A and venture capital activity by oil and gas
companies reached record levels in 2019, pointing to the rising
interest in this segment. In the M&A market, oil and gas
companies were involved in 33 low-carbon transactions during the
year (up from 20 in 2018); meanwhile, this group of companies
participated in 45 low-carbon venture capital deals during the year
(compared with 39 in 2018), per IHS Markit data (see Figure 1). The
number of large-scale transactions has also increased, with eight
M&A deals of at least $250 million occurring since 2017
(including Total's $510 million solar joint venture with Adani
Group and Galp Energia's €450 million acquisition of a solar
portfolio in Spain, both in 2020).
Despite this trend, individual responses by oil and gas
companies vary significantly. While full-fledged transitions away
from fossil fuels toward low-carbon energy have thus far been rare,
several companies within this sector have earmarked a growing share
of capex for low-carbon energy opportunities. Spending in this
sector has been driven by the Europe-based Global Integrateds, for
whom IHS Markit projects an 8% allocation of corporate capex in
2020 to the low-carbon segment.
Oil and gas companies have also pursued varying low-carbon
investment strategies. For example, while some companies have opted
to develop complementary low-carbon business lines from existing
capabilities (e.g., Equinor with its Hywind floating offshore wind
technology), others have pursued a more diversified approach, with
an array of smaller-scale investments but across a broader range of
sectors (see Figure 2).
Each investment approach presents its own set of risks.
Companies opting to maintain a focus on existing core oil and gas
operations aim to benefit from the fact that the oil and gas sector
is generally considered a mature business, with understood risks
and returns. However, a traditional pure-play, upstream-oriented
portfolio may not deliver on stakeholder expectations for returns
alongside reduced carbon intensity, as would be consistent with a
low-carbon world.
Companies that specialize in a small number of low-carbon
segments may be able to achieve synergies with existing upstream
operations and benefit from long-held expertise. The challenge for
this strategy, however, is to make the right bets on low-carbon
technologies. The rapidly transforming low-carbon sector creates
new innovations which could quickly render other technologies
obsolete, potentially resulting in some unproductive
investments.
Companies pursuing a diversified strategy with smaller-scale
investments benefit from broad-based exposure amid an uncertain
outlook for winners and losers in the low-carbon segment. However,
this approach may increase the cost and difficulty of achieving
material scale in desired areas at a later time. Furthermore, this
approach also generally involves venturing into unfamiliar, often
early-stage technologies with uncertain prospects for
profitability.
Nevertheless, the emergence of these diversified approaches
offers companies a chance to differentiate themselves amid an
increasingly challenging upstream landscape. It also provides
investors with the opportunity to target companies whose views are
in line with their own longer-term outlooks on the energy
landscape.
Dr. Carolyn Seto is a director in the Upstream
Technology and Innovation practice at IHS Markit. Chris DeLucia is an associate director with the Upstream
Companies and Transactions team at IHS Markit.