Winds of change for Big Oil?

BP and Shell have made much of their investments in alternative energy. But Nick Robins questions whether Big Oil is best placed to succeed in this arena

Big Oil is an unlikely ally in the shift to a low-carbon economy. After all, the carbon emissions from the facilities and products of just three European oil groups – BP, Shell and Total – account for some 12% of the global total, close to those emitted by the entire EU.Nevertheless, leading oil companies – most notably BP and Shell – have taken steps over the past decade to position themselves for a carbon-constrained world, cutting internal emissions and repositioning their portfolios, including making investments in alternative energy sources.

These initiatives have been strongly supported by many governments, investors and environmental groups, viewing the conversion of such a carbon-intensive sector as essential to the cause of climate action. So it was no surprise, when BP and Shell announced record profits earlier this year, that calls were renewed for the companies to invest more in green technologies. However, both companies’ results revealed a more complex reality about the long-term implications of climate change for the sector.

The real issue is not The 10% of emissions from these companies’ facilities, but the 90% emitted from the use of their products.

This year the costs of the physical impacts of global warming came centre-stage. For the oil sector, this means increasing risk of losing production due to shut-downs and storm damage, notably in the Gulf of Mexico. At Shell, evacuation and displacement due to hurricanes is expected to cost the exploration and production (E&P) division between $250 million and $300 million before insurance recovery, or just under 2% of 2005 E&P earnings. At BP, the combination of these extreme weather events and the fatal explosion at its Texas City refinery cut the company’s post-tax result by a sizeable $2 billion, more than 10% of the total.

The two companies, in common with their peers, also face the prospect of tightening curbs on their greenhouse gas (GHG) emissions, as the carbon reductions necessary to meet Kyoto Protocol targets – and those of precursor initiatives, such as the EU Emissions Trading Scheme – begin to bite. Based on analysis carried out by environmental research company Trucost, Henderson’s Carbon 100 report last year suggested that the external costs of BP and Shell’s processemissions were equivalent to around 30% of annual earnings.1

Both BP and Shell have generally been ahead of the game in terms of measuring and reducing emissions from their own operations. However, there is growing appreciation in the environmental community that the real issue is not the 10% of emissions from these companies’ facilities, but the 90% emitted from the use of their products. According to the New Economics Foundation, a London-based think-tank, the total carbon cost generated by BP’s operations and products was an estimated $51 billion in 2005, more than twice its record post-tax profit of $19 billion.

Clearly, these environmental costs will be shared with BP’s customers. But there is little reason why the established environmental principle of ‘producer responsibility’ should not apply to carbon just as it does to the solid waste produced by household packaging, automobiles and electronic goods.This would mean oil companies taking most responsibility for generating significant carbon reductions from their product portfolio.

Investments in low-carbon technologies by oil companies remain a sideshow compared with gaining access to new oil and gas assets.

Of course, this means a much harder look at the investments being made by oil companies in low-carbon alternatives. Buried in a parallel statement released on the same day as its end-of-year results in February, Shell announced that it had divested its crystalline silicon solar business to Germany’s Solar-World, for an undisclosed sum. Shell retains some interest in solar through its thin-film technology, as well as investments worth more than $1 billion in biofuels, wind and hydrogen, with the strategic aim of developing at least one of these into “a substantial business”.

BP has also been sharpening its focus in this arena, with the launch of its alternative energy proposition last November. The focus for this new business area is power generation rather than transport fuels, with a basket of solar, hydrogen, wind and natural gas technologies targeted to generate $6 billion in revenues by 2015.

These are large sums, but remain dwarfed by continued commitments to expand oil and gas investments: even if all of BP’s future targeted revenues from alternative energy had been realised 10 years early in 2005, they would have represented only 2% of total group sales. For most analysts, investments in low-carbon technologies by oil companies, exciting as they may be, remain a sideshow compared with gaining access to new oil and gas assets.

This continuing lack of financial materiality is reflected in the limited disclosure in the annual accounts. In Shell’s case, renewables and hydrogen are reported as part of ‘other industry segments and corporate’, while in BP ‘alternative energy’ forms part of the wider Gas, Power and Renewables division.

The increased analysis of listed renewables firms means, however, that the relative performance of Big Oil in this sector can be derived. In solar, for example, it was clear in 2005 that both BP and Shell had been losing market share to more nimble rivals, with BP’s sales growth of 6% in 2005 a fraction of an overall market expansion of some 30%.

Mainstream investment analysts, such as Cazenove, are also beginning to challenge the sector’s current “sterile, conglomerate asset structure”, arguing, for example, for the break-up of BP’s up- and down-stream businesses. In this context, the hard financial logic of expansion into alternatives has to be communicated more convincingly, placing greater emphasis on expected earnings rather than capital expended.

Looking to the future, it’s clear that the first round in the transition of Big Oil to a carbon- constrained world is now over. Climate change is no longer a future risk, but a present reality, bringing real costs to the business in terms of storm damage and tightening regulatory requirements. The road ahead is set to get tougher, with greater clarity required on climate impacts, and firm targets needed for reductions in product emissions. As part of this, oil companies will need to demonstrate why they are better stewards of capital invested in alternatives than their more focused competitors. In sum, this means challenging the unspoken assumption that the companies that played a large part in getting us into the crisis of climate change are also going to be those that lead us out.

Nick Robins is head of SRI funds at Henderson Global Investors in London.

E-mail: nick.robins@Henderson.com

1 Henderson Global Investors, The Carbon 100 – Quantifying the Carbon Emissions, Intensities and Exposures of the FTSE 100, June 2005.