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Many large and primarily European oil and gas (O&G)
companies—including Shell, BP, and Total—have significant
expansion plans for renewable energies over the next decade, and
the M&A activity of O&G companies in the renewables space
has recently surged. This uptick comes at a time when many
renewable markets globally are suffering from dampened power
demand, low wholesale power prices, reduced government support,
high competition, and low project margins. This incongruity creates
concerns that O&G companies are pushing up renewable project
valuations and overheating the sector.
IHS Markit recently published a report examining the role of
O&G companies in low-carbon M&A, the impact on renewable
project and company valuations, and how the investments are setting
up O&G companies for long-term growth in the low-carbon
space.
Aggressive growth targets, competition from power
utilities, and limited experience force O&G companies to meet
their green commitments primarily through M&A
O&G companies are accelerating their expansions into
renewables, driven by a challenged O&G market; short-term
environmental, social, and governance objectives; and policy
changes.
However, among the reasons behind the swings in investment
patterns, one of the biggest catalysts has been a change in the
perceived risk-adjusted returns of different segments of the energy
sector. Indeed, since 2015, renewables and utilities have generally
outperformed O&G in terms of profitability, and with less
volatility (Figure 1). This is a departure from the traditional
view that low carbon cannot compete with O&G from a returns
perspective.
As a result, O&G companies have accelerated their transition
to the low-carbon segment given the potential benefits of portfolio
diversification, integration across the energy value chain, and
greater clarity and stability of returns—all of which can help
reduce portfolio risk.
The urgency among some O&G companies reverberates
into renewable project and company valuations and could lower
profit expectations
While O&G companies have the impetus to rapidly make their
mark in the renewables space, they are entering a market with
dwindling profitability and fierce competition. The fragmented
renewables sector is already consolidating in favor of some
well-established power companies.
The vast scale of O&G company commitments and the high
return expectations of O&G companies, alongside this
competition from other market participants, are heating up the
M&A market for sizeable companies or developers with large and
well-advanced asset portfolios.
The uptick in the valuations of large renewable players and
well-advanced assets—and the resulting reduction in the margins
that the acquirers can expect—comes at a time when, in fact,
numerous renewable projects face financial difficulties stemming
from dampened power demand, reduced public support, intense
competition in renewable auctions, and/or capital flight.
These market challenges mean that alongside the battles for
takeovers there is market interest in partnering and risk sharing.
Indeed, large power utilities and independent power producers are
often keen to share the equity burden with partners.
Over time, O&G companies can shift renewable
investments from the M&A space to their own greenfield
projects, hence calming activity in the secondary
market
The inroads made by O&G companies should allow them to
progressively gain experience and later reposition themselves as
low-carbon players through more organic growth.
Indeed, the M&A activity of O&G companies has focused on
investing in low-carbon companies rather than assets. Consequently,
O&G players are gaining not just one-off project returns but
also access to project pipelines, expertise, and long-term business
visions.
Also, O&G companies are trying to differentiate themselves,
either through investments in less mainstream or nonpower
technologies (including operations closer to their traditional core
activities) or by taking on a different risk profile than their
competitors.
With these developments, O&G companies can be much more than
contributors of capital to the renewables space. Instead, they can
add value by offering a different risk appetite, integrating
renewables into portfolios of other alternative energy fuels and
technologies, bringing in new client networks, promoting research
into otherwise underfunded or longer-term solutions, and finding
new ways to unlock value from low-carbon energy.
