Big Oil should play its part in the energy transition

Western oil supermajors are being buffeted by opposing currents. Some shareholders — and politicians — want them to pump more; others, along with climate activists, want to accelerate their shift to clean energy. The mostly European companies trying to do their bit to tackle climate change are trading at a hefty discount to US counterparts sticking firmly with oil and gas. BP’s shares rose more than 10 per cent in two days after it said it would slow its planned cuts in crude output but it also faces a revolt by disgruntled UK pension funds at Thursday’s annual meeting. It is little wonder, perhaps, if the likes of BP and Shell are modifying their green targets. But to revert to more of a business-as-usual strategy would be a mistake.

There are dangers in extrapolating short-term dynamics into the future, in a highly unusual environment. A few years ago, as ESG investing gained momentum and then Covid-19 crushed oil demand, producers pledging to go green were not penalised by the markets. A once-in-a-generation energy shock caused by Russia’s war in Ukraine has reinflated prices, led to record industry profits, and brought pressure to raise output to bolster security and ease living costs. The wheel will surely turn again.

Companies that want to thrive long term — and their investors — should be looking out beyond a 10-year horizon. Few in the industry seriously doubt oil demand will peak, probably within a decade or so. US majors such as ExxonMobil have adopted what amounts to a “last man standing” strategy. But they will struggle, in a shrinking market, to compete with low-cost behemoths such as Saudi Arabia. Oil companies that have not by then developed solid positions in wind, solar and clean technologies risk slowly withering away.

As cash-generative businesses with technological and engineering prowess, today’s oil and gas giants ought to have a worthwhile role to play in the energy transition. Some industry executives say their core investors, used to healthy double-digit returns from oil and gas projects, are privately unenthusiastic about funds being deployed into clean energy ventures returning closer to mid-single digits. Arguably, however, there has never been a better time to invest in the renewables sector.

The US Inflation Reduction Act and the EU’s green deal industrial plan are creating new incentives for investment in low-carbon energy; the EU’s carbon border adjustment mechanism has the potential to intensify the shift. And some new technologies, such as carbon capture, utilisation and storage, do offer potentially sizeable returns. If the composition of oil groups’ activities starts to change, so will their investor base over time.

Activists and investors alike might do well to focus less on whether western supermajors are cutting oil output; as long as demand persists, others such as petrostates’ national oil companies will be happy to meet it instead. A better measure is how much of the profits from oil they are investing in clean energy. Though it is slowing its oil output cuts by 2030, BP says it will spend $8bn more on its “transition” businesses. As the consultancy Wood Mackenzie notes, international oil groups and mining majors allocated $157bn, or a “whopping” 30 per cent of their operating cash flow, to buying back their own shares in 2022.

It may be partly up to governments to find more ways to nudge oil companies and others to invest more and engage in fewer buybacks. It is certainly the role of governments, not of oil companies, to curb fossil fuel demand, by adopting more ambitious policies. The climate crisis will be solved only by massive collective action. But it is in society’s interests, and their own, for the oil majors to play a part.