The supermajor business model that owned a century comes undone
For most of the past century, Big Oil executives found it pretty easy to explain to investors how their businesses worked. Just locate more of the commodities that everyone needed, extract and process them as cheaply as possible, and watch the profits flow.
That’s all over now. The change has been so profound that the chief executive officer of BP Plc recently found himself hyping the profit potential of another commodity. “People may not know—BP sells coffee. We sold 150 million cups of coffee last year,” Bernard Looney said in an interview in August, referring to beverage kiosks attached to the company’s fuel stations. “This is a very strong business. It’s a growth business.”
Perhaps it was tongue-in-cheek, or a way for the leader of the world’s fifth-largest international oil company to emphasize a relationship with consumers. But it’s clear Looney and other oil bosses are struggling to sell their plans for a future in which the world wants more green energy. Last year, for the first time in history, solar and wind made up most of the world’s new power sources, according to BloombergNEF. If the margins on cappuccinos look good right now, that’s an indication of how hard it will be for Big Oil to rapidly ditch its winning formula of drilling, pumping, and refining while spending its way into renewables.
“This is a time of energy transition,” says Daniel Yergin, the oil historian and vice chairman at consultant IHS Markit Ltd. “The supermajors were born of the trauma of the late 1990s,” he notes, and now “this global trauma of the pandemic will also be a decisive period.”
BP oil and gas production, in barrel equivalents a day:
2030 target: 1.5m
Legacy energy companies are for the first time sketching out new strategies that in the near future—as soon as 2030, in some cases—would eliminate hydrocarbons. The industry would like everyone to believe it’s turning its back on fossil fuels for the good of the planet. After decades of denying its role in global warming, however, the reality is that Big Oil has been forced to change by green campaigners, local politicians, and pension funds.
The green transition is more evident in Europe, but the same forces are hammering the industry in the U.S. In another unmistakable sign of the times, last month Exxon Mobil Corp. was dropped from the Dow Jones Industrial Average for the first time since 1928. In the S&P 500, the energy sector is now the smallest component. (The mostly state-owned oil giants of the Middle East, India, and China are, for now at least, largely carrying on as before.)
What is the future of Big Oil without oil? At the extreme of this approach are the pathways sketched out by BP and Italian oil group Eni SpA. These companies claim that in the next decade they will come to resemble a cross between a slimmer version of a traditional oil company and what’s today more like a utility (with, yes, a coffee-selling convenience store chain for drivers of electric vehicles). As the legacy business fades, the theory goes, investments in renewable electricity, biofuels, and EV charging points will pay off.
BP renewable energy:
2030 target: 50GW
If in the past the biggest names of the industry were known as “international oil companies,” the new jargon describes this approach as creating “integrated energy companies.” Michele Della Vigna, the top oil industry analyst at Goldman Sachs Group Inc., expects to see oil giants attempt the same all-in strategy as before. “We believe the coming decade will see them integrating vertically in gas, already evident, and in power,” he says.
Industry executives insist their legacy business is resilient even as they shift away from oil and natural gas, but their actions suggest otherwise. BP and Royal Dutch Shell Plc have already slashed their dividends—for Shell it was the first time in nearly 80 years. Returning profits to shareholders has long been a pillar of oil’s strength on financial markets. And those like Exxon who are keeping their shareholder payments untouched are taking on far more debt to do so.
The fossil fuel industry as a whole has taken billions of dollars in writedowns, in part linked to the rise of U.S. shale production and the impact of the coronavirus pandemic. If demand peaks earlier than expected, as some in the industry now fear, the most expensive and polluting oil fields such as tar sands in Canada may never be developed. The term of art for these uneconomic oil resources is stranded assets. The consultants at Rystad Energy AS estimate that 10% of the world’s recoverable oil resources—some 125 billion barrels—could become obsolete.
Add it all up, and the Not-So-Big Oil of tomorrow looks greener, smaller, and nimbler—and also less profitable, more indebted, and paying lower dividends. That spells the end of a business model that hasn’t changed much since it was pioneered by John Rockefeller: Integrate oil production with refining, and market it under a single umbrella.
This formula built an industry that made possible 20th century automobile culture, reshaped cities, produced political dynasties, and defined modern life. With hydrocarbons occupying a central role in the global economy, the model became a cash machine and a darling of long-only shareholders who adored its fat and predictable dividends. Oil interests became a powerful political force. The model was durable enough to survive the oil crisis of the 1970s, the rise of OPEC, wars in the Middle East, and the emergence of the ecological movement in the ’80s.
When crude prices plunged in 1998 and the oil giants appeared on the brink, the industry responded in true fashion: doubling down on oil in a series of mergers that created the modern petroleum industry. The five companies that have dominated since then—Exxon, Chevron, Shell, Total, and BP—have been doing roughly the same things their predecessors did decades earlier.
This time is different. The existential crisis of the ’90s taught Big Oil how to do the same but better and cheaper. In the 2020s these companies are trying to figure out how to do something completely different—renewable energy—while quickly reducing or offsetting emissions from the oil and gas they sell.
“All the companies are swimming in the same water of energy transition,” says Yergin, “but they are adopting different strokes to get to the other side.”
The answer from BP is far more radical than from Chevron. But even the smaller steps by American supermajors are remarkable by the standards of a conservative and slow-moving industry. Chevron’s last update to its shareholders in July highlighted an oil project, a deal to buy fuel stations, and investment in solar power. It looks like the end of an era.
Which also means “past profitability is no longer a guide to the future,” says Martijn Rats, who covers the energy industry at Morgan Stanley. The writedowns and diminished dividends demonstrate “that the oil majors have entered a new phase.”
Many are skeptical of the green drive in this new phase. BP promised to move “Beyond Petroleum” in the ’90s, only to return to business as usual once prices rocketed above $100 a barrel in 2008. If crude and natural gas prices rise again, these skeptics say, Big Oil will go back to basics—perhaps even under pressure from shareholders.
The difference this time around is that most top oil executives are adamant there’s no going back. “Our transformation is irreversible,” says Claudio Descalzi, CEO of Eni, the sort of comment that’s widely echoed by his peers. Most senior executives simply don’t believe hydrocarbon prices will ever come back to the above-$100-a-barrel days for any sustained period. And the social, and investor, pressure to tackle climate change is unlikely to abate.
And then there’s oil consumption. In BP’s long-term energy outlook, released on Sept. 14, the company acknowledged that the appetite for refined petroleum has all but peaked. “Demand for oil falls over the next 30 years,” BP wrote in its report. “The scale and pace of this decline is driven by the increasing efficiency and electrification of road transportation.”
That’s why most of the industry—even Chevron—is spending billions of dollars on renewable electricity generation, particularly investments in solar and wind power. BP has pledged to generate 50 gigawatts of renewable electricity by 2030, up from 2.5GW now. Reaching that goal would mark a tremendous shift; it’s more than the renewable output of some large utilities today. But it’s still a drop in BP’s hydrocarbon bucket, even as that bucket shrinks. In 2019, BP’s oil-and-gas production was the equivalent of 2.6 million barrels per day. By 2030, the company has told investors, daily oil and gas output will drop to 1.5 million barrels. Renewables won’t fill the hole left by the missing million barrels.
The question is whether Big Oil can deliver on any of its pledges and make money doing so.
Paul Sankey, a veteran oil analyst, has doubts about the supermajors’ ability to rebuild outside their traditional business. “If they can’t make returns in their core competency, what chance do they stand in a new competition?” he says. The new areas that are supposed to become the heart of Big Oil’s future are, at least today, less profitable than the fossil fuels business. Renewable energy usually delivers a return on capital, a typical measure of profitability, of about 8% to 10%. A conventional oil project yields a return of around 15%. One way to generate higher returns is by taking on more debt, something the companies appear to be open to. The supermajors also face strong competition from incumbents that have already mastered the renewables business, including the likes of Italian utility Enel SpA or its Spanish rival Iberdrola SA.
The strategy shift poses a question to investors: Why pour money into legacy players trying to prove a new concept rather than back a utility that’s already making money in the sector? Take an example: Enel today pays a 4.6% dividend yield—virtually the same as Shell’s 4.3%.
The supermajors have some advantages as they move into greener sources. One is the size of their balance sheet, which allows them to invest more and faster than many of the renewables players. Another is they can learn from the mistakes that others made before them. In theory, the oil giants are also well suited to manage big projects.
And green projects can help legacy giants because renewables are, surprisingly, the steadier sector. “Volatility is lower compared to the oil-and-gas sector, and thus more stable,” says Atul Arya, a consultant who used to work at BP in business strategy.
In the end, that less-profitable stability from solar and wind resources will matter. Because even the oil giants most committed to turning green won’t complete their long goodbye to oil and gas anytime soon. The supermajors will depend on fossil fuels for the next 10 to 20 years, at the very least, to generate enough cash to keep shareholders happy and have some money left to invest in clean-energy projects. And perhaps, as Looney of BP says, in more coffee, too.