Endgame Strategies

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January 2021 Sarah Miller


The key question facing the oil industry as 2021 opens is how to regain investor confidence. The first step toward an answer -- if there is a positive one -- is to understand why so many investors are pushing oil companies toward a wrenching transition away from their core products or, failing that, into oblivion. Top index fund managers BlackRock, State Street and Vanguard are leading this drive. They appear less concerned about the traditional issues of dividends and shareholder returns than about ensuring that less oil and gas is produced over time. It's possible this radical stance reflects genuine conviction that drastic action is required to stabilize the climate and prevent severe weather and social upheaval from bankrupting the insurance sector and, eventually, these giants’ own core operations -- perhaps mixed with fear that if big finance doesn’t act effectively on the climate, the populace will turn against capitalism. If so, the path forward for traded oil companies is a narrow one.

It’s certainly the case that thinkers and theorizers of the financial and business world are openly voicing concern about the ability of capitalism to fend off attacks from the right as well as left. Bastions of the capitalist establishment as entrenched as McKinsey are “Rethinking the future of American capitalism,” to quote a recent McKinsey Global Institute headline. While extolling the achievements of US “neoliberal” global leadership, McKinsey not only points to systemic challenges from inequalities of various sorts and shrinking spending on “public goods,” it notes: ”Climate change also poses a challenge to capitalism through potentially the largest disruption to the market economy.”

Similarly, in a report entitled To Save Capitalism We Must Help the Young, Deutsche Bank analysts point to the possibility that a “populist politician” -- which in European parlance generally means a right-wing nationalist, not a Bernie Sanders-style democratic socialist -- could “corral the anger of the young” over the next decade, leading to “sudden and seismic shifts in the established capitalist order.” They propose a list of possible fixes, including a “super tax” on corporations to help fund “massive investment in climate change.”

The Harvard Business School is developing a system of Impact-Weighted Accounts. The aim is “to drive the creation of financial accounts that reflect a company’s financial, social, and environmental performance.” They want to “transparently capture” all those externalities such as pollution and destruction of small communities and natural resources that standard economics has always ignored, to the irritation mainly of environmentalists -- until now.

As Bloomberg recently noted, such research “throws out the playbook” developed by 20th century neoliberal economic icon Milton Friedman. That is, to the extent that the Business Roundtable of top US chief executives didn’t already do that in 2019 by rewriting its definition of the purpose of a corporation to state that “companies should serve not only their shareholders ... but also deliver value to their customers, invest in employees, deal fairly with suppliers and support the communities in which they operate.”

These are obviously not organizations out to destroy capitalism. On the contrary, they are seeking ways to ensure that capitalism transforms into a system resilient enough -- to use another bit of terminology historically favored more by the environmental community -- to withstand multiple onslaughts: From opponents of extreme economic and regional inequalities who increasingly populate both the political left and right; from the pollution that is feeding mass lawsuits and other potentially corporate-destroying public uprisings; and most of all, from the “climate crisis.”

These reformers of capitalism overlap, and are closely aligned, with the fund managers and others who are insisting oil and gas companies should publish detailed plans for transforming their carbon dioxide-centric businesses into something “aligned with Paris targets,” referring to UN climate-change goals.  

What to Do?

So what is an oil company to do? Vanguard, State Street and BlackRock cannot easily be ignored. Between them, they own 15%-20% of the biggest US oil companies, which are now feeling the kind of pressure that earlier this year led European majors to pledge to gradually trim -- and eventually eliminate -- net CO2 emissions not just from their own operations but from their end products (PIW Dec.4'20).

The shift in sentiment has been abrupt and it could always reverse again. But the drop in energy demand and potentially long-lived lifestyle changes associated with the 2020 pandemic have heavily reinforced the conviction that the old ways have to die and globalized capitalism must retain control over new ways as they start to take shape.

This means it may be time to dust off a Harvard Business Review study from back in 1983 that has become something of a classic: End-Game Strategies for Declining Industries. After studying 95 companies that faced declining markets, authors Kathryn Rudie Harrigan and Michael E. Porter identified four strategies for dealing with shrinkage: divestment, harvesting, leadership and niche.

For the oil and gas industry, each of these approaches has problems, due not least to the sheer size of the business. But looked at together, they might trigger a breakout from the uncomfortable constraints of an “electricity or die” take on corporate possibilities, especially if opportunities are considered for stitching together bundles of these strategies to apply sequentially and/or simultaneously.

“Harvesting,” defined in the study as “eliminate investment, generate maximum cash flow, and eventually divest,” sounds remarkably like the advice handed out by the investment community to US shale oil producers and others. But many of the companies studied by Harrigan and Porter did better for their shareholders by selling out quickly before asset prices tanked.

Evident problems with quick divestment for the oil industry are that it may already be too late, with few remaining buyers; and second, that certainty about the speed and pattern of decline in demand for the industry’s output is a critical factor -- and one on which there’s no consensus when it comes to oil or gas.  

The leadership strategy laid out in the study looks much like that being pursued by Saudi Aramco, Rosneft and perhaps Exxon Mobil. The aim is “to reap above-average profitability by becoming one of the few companies remaining in a declining industry.”

Profits are higher because a leadership company “can exert more control over the process of decline and avoid destabilizing price competition.” That process could involve continued attempts to knock out “destabilizing” competition from the likes of the US shale industry -- perhaps making it more likely the oil industry will suffer from “bitter warfare” than that it will “age gracefully,” to use some of the description the study applies to declining industries as a whole, rather than individual companies.

The “niche” idea has petrochemicals and LNG written all over it when applied to the oil and gas industry. “The objective of this focus strategy is to identify a segment of the declining industry that will either maintain stable demand or decay slowly, and that has structural characteristics allowing high returns.”

The problem, of course, is that niches by definition are relatively small. Also, the authors' recommend that companies adopting this strategy should move “pre-emptively to gain a strong position in this segment while disinvesting from other segments” may be a nonstarter for many integrated oil and gas firms.

Nowhere in this study do the authors recommend that companies in a declining industry simply switch from the business they are in to some other industry that is encroaching on its turf. Moving into alternative electricity generation and distribution -- or solar panel manufacturing -- as European majors are doing with varying levels of conviction -- is not a strategy with great appeal to economists and management professors, who are apt to look at the highly different types of expertise required in the power sector versus fossil fuels as prohibitive.

Nor does this approach have much appeal to investment banks or fund managers. Building new businesses from scratch through venture funding is likely to be much more remunerative for the financial sector than propping up once but no longer terribly valuable oil firms that want to stay alive by “harvesting” the remainders of what had been a high-return business and moving into a sector focused on growth at the expense of profitability.

Could it be that Exxon actually has a point in rejecting new energy? Or to put it another way, that the best focus may be on finding a good endgame strategy, not an escape hatch.

Sarah Miller is a former editor of Petroleum Intelligence Weekly, World Gas Intelligence and Energy Compass.

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