Big Oil Dilemmas – Critical to Progress but Damned Regardless

Companies Mentioned:
bp, Shell, Orsted, Equinor, Ford, Volkswagen, NuScale, Siemens Energy, ExxonMobil, Denbury, LyondellBasell, Cyclyx, BlackRock, Huntsman, Navigator, OMV, Interzero, Borealis, Rialti S.p.A., Eastman

Commodities Mentioned:
Fossil Fuels, CO2, Renewable Fuels, EVs, Hydrogen, Ammonia, Polyester, Plastics, Critical Minerals, Ethylene Carbonate, Offshore Wind, Solar, Renewable Power, CCUS, Water

Subjects Covered:
Recycling, Renewables, Carbon Capture, Emissions, New Energy, The Hydrogen Economy, ESG Investing, Climate Litigation, Clean Fuels

C-MACC Weekly Sustainability and Energy Transition Report

Big Oil Dilemmas – Critical to Progress but Damned Regardless

While ExxonMobil may have underperformed BP and Shell since announcing the Pioneer deal, their strategy with regards to lower carbon fuels looks more robust.
Sticking with oil and gas but targeting much lower emissions may not be what the climate activists want, but it is more likely to drive consistent returns and cash.
The FT Energy Transition conference in London exposed many of the stark differences between various interest groups but also showed some good ideas.
The offshore wind industry is maybe not “fundamentally broken” everywhere but is badly damaged, and wind power shortfalls have broader power implications.
Otherwise, we look at chemical companies pushing recycling initiatives, why the Navigator move exposes poor policy, and the unrelenting broad edge in China.

See PDF below for all charts, tables and diagrams

First: The Challenges Of Being an Oil Major – Especially in Europe

We continue to see a disconnect between what investors say they want from the energy transition and how they behave, and this was evident again in the discussions at the FT Energy Transition Conference. “A good investor is underweight fossil fuel companies” was one view, while another was that simply divesting the fossil fuel companies would not change behavior. Interestingly in the UK, we have seen the act of divesting fossil fuel companies change behavior – but the wrong way. Both BP and Shell have responded to very low valuations by walking back transition targets and increasing fossil fuel investments – note the jump in BP’s share price in February 2023 and Shell’s share price more recently. Clearly, the investment community is not driving the behavior that it wants. But this does not make life any easier for the fossil fuel companies as they need to balance very mixed objectives – the world still needs fossil fuels (even if some activists suggest otherwise) – while government incentives around producing cleaner fuel, more clear in some countries than others, lack completion in terms of how tax benefits will be applied or how regulation/permitting will work – which stalls progress.

Exhibit 1: Some of the volatility in the chart reflects oil price movements.

Source: Bloomberg, C-MACC Analysis, November 2023

As we compiled this report, we realized that most of what we had discussed or listened to over the last few weeks was about failure. While most of the headlines over the last week were about US offshore wind, “fundamentally broken” in the words of BP, we also saw plenty of concerns about power infrastructure, and the West’s inability to keep up with China. There have also been plenty of predictions about the likely failures at COP28.

As we head towards COP28, Al Gore is probably right, but in our view for the wrong reasons. Energy transition is missing sound economic analysis, and will likely always be missing it, as there are too many “cooks in the kitchen” and they are all trying to prepare different dishes. If we look at the evidence to date, and there has been a lot of it this year, we see companies and countries pulling back from plans simply because they cannot reconcile the economic impact of what they had planned to do. Not only are the broad ambitions of emission reduction very expensive, but the global economy has also moved in the last two years to make them both more expensive and less affordable. The oil companies are producing oil and gas and developing plans to produce more oil and gas because they see the demand being there. That said, the focus is on M&A today and efficiency versus large capital spending, so the oil companies are not plowing ahead with fossil fuel investments like they did in the past. It is also worth noting that the sellers in these M&A deals are not getting premiums, which suggests that the industry is gearing up for higher costs of decarbonization, and ExxonMobil mentions the decarbonizing opportunities with its Pioneer acquisition in detail. Also, the ExxonMobil acquisition of Denbury is likely motivated by an opportunity to lower the overall cost of CCUS through scale and integration because decarbonizing options are expensive. But the government piece here is equally interesting, not because governments are in collusion with big oil, but because from a regulatory and permitting perspective, institutions are either too cumbersome and/or bureaucratic to move as quickly as many of the climate change initiatives require, or because they are scared of making a mistake – which is what we believe is holding up the Class 6 permitting process in the US – the EPA feels unqualified to judge sequestration options and is delaying in the hope of becoming better informed.

Al Gore on why the ‘deck is stacked against’ COP28

Meanwhile, the talking heads pile on the pressure – insisting on faster progress, which will make the economic and practical challenges harder. Looking at just a few stories from the last week we see Ford pulling back on EV investment because it cannot make money – see our detailed work on EVs – EVs: We Could See a Competitive Bloodbath in 2024 – short sellers attacking NuScale, more on the troubles at Siemens Energy, and commentary on the collapse of the stocks of the solar sector. There are plenty of headlines about new initiatives with new technology, and companies taking stakes in recycling. Still, those trying to build operating businesses in all aspects of energy transition today are struggling. While some struggle more than others to get what Al Gore and the EU Commissioner want, everyone should prosper. Only if they are prospering will we get the activity needed to accelerate the transition – COP28 should focus on making the enabling industries profitable/investable – none of this will happen if no one is willing to pay for the transition costs.

At the risk of flogging a very dead horse here, while the West struggles with everything we discuss above – ambitions that do not match with action, and costs that no one is willing to cover – China presses ahead. Not only does this drive local energy security and self-sufficiency, but also drives industries to lower emissions likely much faster than their Western counterparts – this becomes self-fulfilling, as the country can drive down decarbonizing costs through scale and will likely maintain its dominance in the supply of materials and equipment because of its overwhelming cost advantage. The West cannot keep up without both subsidies and stimulus for demand. The Senate Republicans in the headline below are clearly not reading our work. If they did, they would realize that imposing an emission or carbon-based tax on products from China is shutting the doorway after the horse has left. Not only does China already have a low carbon base within its industry that is better than in the US, but it is accelerating at a pace that the West will never be able to keep up with. We predict China will have a million tons of green hydrogen before the rest of the world has a million tons cumulatively. The challenge for China will be convincing the rest of the world that its product is low carbon, and the audit process must be very transparent. The US Senators should, in our view, be much more focused on improving the regulatory and permitting dilemma that we have in the US, and which is constraining low carbon progress here, whether it is the wind challenges in the Northeast of Class 6 permits on the Gulf Coast, or pipeline permits for CO2 in the mid-west.

Senate Republicans introduce a climate bill — aimed at China

Lastly, there are now so many ways to depict the shortage of critical minerals/metals that are expected in the West, but there are not many charts to suggest how this might be prevented or at least mitigated to a degree. When you look at the BlackRock headline below and noted above, it is challenging to come up with any scenario that will change the picture below by 2033 – ten years is not a long time when it comes to mining investment – especially when you add the permitting overlay.

BlackRock warns investor disdain for mining threatens green transition

Exhibit 2: Driving the energy transition: the EV and batteries outlook

Source: Wood Mackenzie, October 2023

Exhibit 3: How China Increasingly Dictates The Speed Of The Energy Transition

Source: BloombergNEF, October 2023

We have a couple of takeaways from the FT Energy Transition conference in London this week. There has been a lot of discussion on power grid inadequacies and the amount of money that will need to be spent to upgrade grids all over Europe. There is an expectation that some of the grid bottlenecks will never be upgraded, and this is driving an opportunity to invest around curtailed power hubs, especially where wind turbines are being shut down because peak generation does not match demand. That power has a very low value, especially in countries where governments are paying generators for the lost sales opportunity. You can do a lot with free power – and if the product you make from it – hydrogen, e-fuels, ammonia, etc., also has local production incentives, you can cover the cost of relatively expensive electrolyzers and batteries, or just more electrolyzers and hydrogen storage. Referencing our hydrogen report this week – Déjà Vu – Are Electrolyzers Heading The Way of EVs – Too Many Players – there is a compounding problem, which is that all the electrolyzer producers recognize that their path to success is scale, and so they are all spending to add manufacturing capacity – which has the problems of creating too much capacity and stretching cash and borrowing in a more expensive market for money.

Recycling and Renewables

For recycling, scale is one of the key drivers of lower costs as long as you do not end up paying too much to get the materials to the sorting facility and as long as you are not moving too much stuff that you cannot use. We would encourage OMV and Interzero to go further and encourage in-site investment to deal with the components that do not lend themselves to easy mechanical or chemical recycling – such as gasification or simple incineration to produce heat/power. The economies of scale would be enhanced if you could add value to every stream coming out of the sorting system.

Borealis expands its mechanically recycled plastic compounding capacity with closing the acquisition of Rialti S.p.A.

Exhibit 4: Eastman highlights that its polyester molecular recycling facility is on track for start-up in 4Q23 – see more detail in the YouTube clip: Eastman Recycling Facility – YouTube, which is also highlighted in the slide below.

Source: Eastman Chemical – 3Q23 Earnings Presentation, October 2023

Exhibit 5: LyondellBasell acquires 25% stake in Cyclyx

Source: Cyclyx, Sustainable Plastics, October 2023

Carbon Capture and Emissions

We wrote about the Navigator pipeline cancellation in our somewhat negative Sunday Piece – Too Hot To Handle: If Climate Change Is Real, We May Be Screwed – where we focused on how the rigidity of solutions sought by the climate advocates and the rising costs of these solutions would likely cause the failure of all initiatives. Not allowing a pipeline system – THE safest way to move anything liquid or gas in large volumes – is another obstacle in the way of practical solutions to emission abatement. We think that ethanol is a better fuel for vehicles because it comes from a renewable resource, but corn fermentation produces CO2 – which is bad – but it produces it in the easiest concentration to capture – which is good – unless you cannot move it to be sequestered. We keep asking for more “good enough” common-sense solutions to address emission abatement, but maybe we must get “stupid” out of the room first. Another example is what BlackRock refers to below – investor disdain for the metals sector when every forecast of how to drive transition demands more metal use.

Exhibit 6: Rock and a Hard Place – Fierce Opposition, Lack of Regulatory Framework Squeeze CO2 Pipeline Projects.

Source: RBN Energy, October 2023

As the CBAM mechanism is rolled out in Europe we expect to see lots of analysis and opinions over the next year of who will get hurt the most and how impacted trading partners will react. China may be able to move material into Europe with lower carbon footprints if the EU can get comfortable with the accounting in China, and it will be interesting to see how the EU feels about blue ammonia from the US or green ammonia from Saudi Arabia. The one conclusion that sems obvious to us is that goods in Europe will be more expensive for the consumer than in many other regions and the net effect may be a hit to relative economic growth in Europe.

Exhibit 7: CBAM is now active. A guide to what companies must do to comply and CBAM time schedule

Source: Energy Post, Carboneer, October 2023

Renewable Fuels, Power

The other takeaways at the London conference were the very clear divides between those who see a need for fossil fuels for a while and those who believe we can get rid of them quickly, as well as those both for and against nuclear. Despite the financing challenges and current energy prices in Europe, there was a very strong “everything will be all right” theme at the conference, a notion that we think is misplaced, mainly because the cost of accelerating progress is very high, and this will continue to slow things down. Faster-tracked green hydrogen projects in Europe, for example, might find themselves with very uneconomic power prices, or where they have low-priced PPAs, they may find political pressure to allow that power to flow into a much higher value retail market. We may also see timing issues with the start-up of facilities that need renewable power and the availability of that power. All agreed that the IRA hands the US a significant competitive advantage, but if permitting and regulations are not streamlined, we may see some further failures in the US, like the offshore wind issue.

With the wind failures in the US, we are seeing a lot of analysis around the shortfalls in power generation that the slowdown in wind investments could create, and the conclusion is that “everything will not be all right”. What we are not seeing is any good analysis around what happens to make up the power generation shortfall, but we suspect that the large oil and gas companies pursuing more gas will likely be the winners. More natural gas-based generation is almost inevitably the best way to make up this shortfall and any broader shortfall because of consistent, in our view, estimation of how quickly power demand will grow from here.

Exhibit 8: The chart below highlights the estimated investment required to meet 2030 government offshore wind targets relative to its estimated base case, excluding China, and considering current investment announcements. See – ‘Unrealistic’ global offshore wind expansion target would require $27 billion by 2026, says Wood Mackenzie.

Source: Wood Mackenzie, November 2023

Exhibit 9: Offshore wind is facing more challenges than onshore wind, where expectations still remain relatively high. With this in mind, many of the interest and capex cost headwinds will face onshore wind and other green power roll-outs.

Source: BloombergNEF, November 2023

Exhibit 10: Europe’s lopsided renewables transition: Solar installations set to soar in 2023 as wind sector’s progress falters

Source: Rystad Energy, October 2023

Exhibit 11: Solar and wind power curtailments are rising in California

Source: EIA – Today In Energy, October 2023

Exhibit 12: US offshore wind developers continue to raise red flags from higher interest rates and capex costs

Source: BloombergNEF, November 2023

ESG Investing

At the FT Energy Transition conference in London this week there was a lot of discussion on the US wind problems, with the presenter from BP saying that the offshore wind industry in the US is “fundamentally broken”. This follows substantial write-downs in the last week from BP and Equinor, and a much larger write-down from Orsted today. We highlight the news article, New York rejects Orsted, Equinor, BP requests to charge more for offshore wind, as the participants in the project clearly look to find ways to salvage what has happened. This is a consequence of rising costs in the US and, in our view, far too much optimism in the first place. It was known from the start that vessels operating in the US wind sector would need to be “Jones Act” compliant – so new vessels were made in the US. This is one of the constraints to the efficient deployment of offshore assets – only one vessel has been built to date for the Northeast. This is just one example of a constraint to development that should have been well-known to the developers and the investors. In one of the discussions this morning, there was also a lot of blame put on regulation and permitting delays in the US, and this is another example of where the IRA in the US is encouraging investments that the US approval process cannot keep up with.

As we look at the events in the Wind sector and the very poor results from many of the renewable companies, the setup looks even worse for lending into the higher-risk energy transition or other sustainability segments. The write-downs at BP, Equinor, and Orsted would be physical losses for lenders to the space and this will likely raise the risk premium even further for projects in the near term. At the conference today, there was a lot of talk about what made a good – financeable – project today, and it all came down to technology risk and time to implementation – there is plenty of money for the relatively risk-free, fixed return-like infrastructure-esque projects. Still, costs escalate quickly once you move outside of that comfort zone. The other confirming data point we got today was that we are not the only ones who believe that the IEA is too low in its estimate of power demand growth and overall power demand as a consequence. One estimate is that power demand may be growing at 3x GDP for some time. Interestingly, outside of the US wind issue – most power generation and grid upgrade and expansion projects will meet the risk and return profile to get funding – it is technologies that might want to use that power that are stuck in the “uninvestable” box today.

Exhibit 13: The better market this week is more of a driver of the data below than anything specific to the industries – wind and solar making a small bounce off a lot of recent underperformance.

Source: Capital IQ, C-MACC Analysis, November 2023

Exhibit 14: Water scarcity and conservation was a subject discussed at the FT conference with those chasing green hydrogen very conscious of the need to use anything other than drinking quality water – so more clean-up in each case – good for the desalination and RO business in general

Source: Capital IQ, C-MACC Analysis, November 2023

Other – China – Again!

Huntsman suspending an ethylene carbonate project because the Chinese can make it cheaper should be an eye-opener for the industry. Although the low cost of ethylene in the US is a more minor component of the final molecule, the fact that China can undercut the US, or at least price low enough to discourage more capital spending in the US, speaks to the efficiency in China and some of lower local cost opportunities. In some of our ethylene work, we have suggested that China may have significant pockets of very low-cost ethylene because of the discounted crude and condensate available from Russia, and we have noted that a 20% lower naphtha cost in Asia would produce ethylene competitive with some of the higher cost US production.