Our Take: Low-Carbon Growing Pains

As BP’s strategic pivot this week made clear, the energy crisis is complicating the international oil companies’ (IOCs’) ability to keep “value over volume” central to their investment thesis while also assuring delivery of energy transition strategies. The energy crisis has not affected the broad brush strokes of corporate strategies, with capital discipline and decarbonization remaining core investment drivers. But different business returns profiles and a more bullish near-term outlook for oil and gas will at times put climate and returns objectives at odds — and amplify the pressure on IOCs to deliver the upsized margins they’ve insisted they can.

• Borrowing conjunctions from the US majors’ playbooks, BP is leaning into a modified “AND” strategy to raise investment in both oil and gas and low carbon, and bias the latter toward biofuels and convenience over renewable electricity. BP will also now keep underlying oil and gas output flat and use more modest asset sales to cut that portfolio by one-quarter by 2030 (previously 40%). 

• Questions have always surrounded the calculus of BP’s transition strategy, making the decision to slow its retreat from oil and gas and to reevaluate the competitiveness of a massive renewables buildout unsurprising, in our view. But the wider challenges that compelled the shift are affecting its peers, too: Shell’s new CEO must confront a sharp equity valuation gap to US majors, Equinor is expected to fine-tune its renewables strategy to fortify returns, and multiple companies have scrapped projects on lackluster economics.

• Renewable electricity returns were always going to be leaner than oil and gas on a cyclical basis, but bumper oil and gas prices alongside rising interest rates have accentuated the gap. Renewable electricity offers a lower risk profile, but majors have yet to deploy these businesses with the scale and integration to demonstrate promised margin uplift over entrenched and emerging specialists, fostering skepticism. 

• The skepticism carries to carbon capture, hydrogen and next-generation biofuels. Promises of double-digit returns are largely hypothetical given the dearth of delivered projects, with government incentives essential in most cases. It also remains to be seen whether these solutions can be scaled up quickly enough to matter. 

• The challenge is that “value over volume” — a seemingly wise and uncontroversial investment thesis — is deeply complicated in practice across businesses with vastly different returns profiles and competing long-term objectives. Transition targets are existential given that lowered absolute emissions are required to mitigate perpetual climate risk, and thus cannot be simply sidelined in the name of maximum profits. If anything, there is greater onus on companies to develop much deeper benches of potential projects to slot in as less-robust opportunities fall to the wayside. Another option is of course to follow returns exclusively — and risk becoming a cash cow that is ultimately wound down. Since IOCs remain intent on retaining viability and prominence, these challenges will have to be resolved.