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Our Take: Renewables Trade Returns for Scale

Copyright © 2021 Energy Intelligence Group

Oil and gas companies are staring down heightened competition for their products as renewables become the cheapest power generation option globally in the not-so-distant future and electrification of transport takes off, according to Energy Intelligence analysis. Photovoltaics continue to enjoy relentless cost declines, and even offshore wind will soon compete with fossil fuels on cost in most locales. Diversifying into these markets could offer current oil and gas giants continued growth at scale -- but with the potential trade-off of lower returns, especially in the medium term. • Technology and policy support are driving momentum in intermittent renewables such as solar and wind, challenging previous estimates of how much grid capacity they could support, according to our levelized cost of energy analysis. Advocates now think solar and wind could make up 80%-plus of the global energy mix without difficulty, as storage (pumped hydropower, hydrogen and batteries), large, interconnected networks, demand-side management and smarter grids all combat intermittency. • Solar and wind offer producers near-certainty in demand given global decarbonization goals. But continued commoditization and a significant influx of capital will pressure returns. Most European majors are aggressively pursuing renewable power in some fashion and reckon they can achieve 8%-plus returns by levering projects (EIF Dec.2'20) (EIF Apr.14'21). But there is increasing recognition that underlying assumptions may have been too generous, with this week seeing Equinor lower its expected returns from renewables to 4%-8% from 6%-10% previously. Royal Dutch Shell is among those hoping to boost company-wide returns by participating across the supply chain to connect customers with diverse energy supplies, offering some potential cushion (EIF Feb.17'21). • Such returns contrast with the mid- to high-teens typically targeted in upstream oil and gas, making the shift to renewable power a tough pill to swallow for oil majors that aren’t yet targeting net-zero emissions. The strategic dividing line in part comes down to views about whether such returns are still feasible for oil and gas longer term. Our levelized cost of energy analysis shows gas facing mounting cost pressures if it is to reach its market share potential, with some LNG buyers in key developing Asian countries already looking for prices in the $5-$6 per million Btu range, versus a 12-month average of $7. We see gas prices in such markets needing to sit below $5.50/MMBtu to decisively beat onshore wind and $3.25 to match solar. • Still, US majors and large independents aiming to stay out of renewable power are hoping oil and gas demand from harder-to-electrify sectors (e.g. heavy transport and industry) will remain robust enough to deliver stronger returns over time, even if they are somewhat diminished. The challenge here will be fighting for those returns in a crowded, declining market as electrification accelerates and non-carbon fuel alternatives grow. Even if returns come through, strategies solely focused on oil and gas could leave companies facing future shrinkage.

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