We are in a weird period where the politics of renewables look unstable, or at least very polarized (right wing pushback against “green crap” and ESG, trade and policy tensions around EV), and market sentiment remains weak (stock market valuations are down, investors remain wary, costs are seen as going up) but investment actually continues to boom, in particular in the solar and battery sectors, and renewable penetration is growing at a record pace.
In this context, I’d like to suggest a few challenges that will become more important in the near future, and will be discussing these over several blogposts.
The first installment is about the probable return of oil & gas majors in the sector, and why this is not only good news.
(others will be added to the list below when published)
oil&gas majors will be back in the sector soon (and no that’s not good news)
Why fans of nuclear are a problem (added 25 August)
(coming soon)
Oil&gas majors will be back
One of the trends of the past 2 years has been the noisy rejection of investment in the sector by the big oil majors, who had previously announced (at least for some of them) ambitious plans. Projects have been abandoned or sold, leading to big headlines criticizing the sector as generally being non profitable enough.
This was largely linked to temporary factors (the war in Ukraine, inflation) that pushed in the same direction, making the traditional oil&gas business more profitable, and increasing costs for renewables (supply chain cost increases, and higher cost of money). The fact that they overpaid in the first place to get in, and do not have the same cost discipline as smaller investors, probably did not help… Stock markets duly pushed the companies in the sector to stick to their core competences.
The noisy headlines acted as a brake on many other investors - this has had a direct impact on offshore wind investment but has also cast a shadow on the sector more generally.
The smarter oil&gas companies moved, quite cynically, but rationally, towards more trading-focused investment: preferring merchant regimes to regulated prices, focusing on controlling the power offtake rather than ownership of the assets, in order to profit from the volatility of prices (read, the massive spikes) and from the continuing link between power prices and natural gas - and LNG - prices, a market they naturally know well and where they have strong positions. A bet on high power prices rather than a bet on renewables, in effect.
In the meantime, the business case for renewables has stabilized (it’s a bit more expensive than before, but so is everything else, in particular any competing power generation), and people are beginning to itch to invest again - but everyone is afraid to be the first to do so.
The temporary factors that gave a boost the oil&gas majors (price volatility, replacement of Russian gas by US LNG) are fading away and the pressure to reduce carbon emissions will continue to be there. The case for massive investments in the traditional oil&gas activities is increasingly hard to make, both politically and financially, whereas the case for renewables remains.
An interesting point to note here is that the transition to renewables will actually not boost demand for natural gas. It may increase the demand for the services that gas-fired plants can provide (like short term increase in production), but these actually require very little gas. A largely renewables system may still have a significant number of gas-fired plants, that provide availability (they sell MW), and other grid ancillary services, but burn little gas (they sell very few MWh). This favors turbine makers but not gas suppliers. And indeed we see demand for gas in the power sector to continue to trend down in most mature markets. In markets where gas use is boosted by substitution away from coal, this trend will accelerate, as the UK is now showing.
So the oil majors will be back to invest in renewables in a big way.
I expect that at some point in the next 24 months, we’ll have one or more transaction(s) that will catch the eye of mainstream journalists and signal, once again, that the sector is “investable”. RWE has been on a buying spree lately, but that seems not to be enough, so I think it will take a transaction by an oil major or maybe a top tier financial player like Blackrock or Blackstone to tip the scales again and turn the market “on” again.
Soon, buyers will push prices up, some will overpay again - and while this is nice for the lucky sellers in the short term, it means again that there will again be a pushback down the road. Renewables are structurally a low margin business - as a cost of capital play, they should never be very profitable (otherwise it just means they are poorly regulated and electricity is more expensive than it can and should be), and investments by players with expensive cost of capital like oil&gas (or private equity) are never a sign of health for the sector, but rather that regulatory arbitrage opportunities are available, and consumers fleeced.
As we have seen, the exit by oil&gas players is noisy and politically damaging to the sector, so their coming back should not be welcome (because they will exit again, eventually), by either developer or regulators.
Very good Jerome. I’m curious, you describe oil majors as having a high cost of capital. Can you substantiate that? What qualifies as ‘high’ and how does it compare to PE (at one end) and institutional investors (at the other)?
Interesting. Though I don't understand why oil companies would like to put their cashflows into renewables rather than into dividends or buybacks.