WILL INVESTORS FORCE MAJORS TO SPLIT INTO PIECES?
Noah Brenner, London; Casey Merriman, Phoenix; Paul Merolli, Washington; Philippe Roos, Strasbourg - Nov 2,2021
Will energy transition pressures induce massive upheaval in the corporate structure of Europe’s integrated oil sector? It can't be ruled out. Investors are having a big say in the trajectory of Big Oil's transition, as seen with recent shareholder actions that have rocked the sector. This week’s push by activist hedge fund Third Point to convince Royal Dutch Shell to break up into “multiple” companies by separating legacy energy businesses (upstream, refining and chemicals) and growing LNG, renewables and marketing units could prove to be an important test. Should Third Point achieves its goals, big oil companies could be forced into strategies for winding down their operations.
Daniel Loeb’s Third Point has built a near $750 million position in Shell and says that such a split could lead to an “acceleration of carbon dioxide reduction as well as significantly increased returns for shareholders,” according to a letter sent to fund investors. The legacy business “could slow capex beyond what it has already promised, sell assets, and prioritize return of cash to shareholders (which can be reallocated by the market into low-carbon areas of the economy).”
The LNG/renewables/marketing business could combine “modest cash returns with aggressive investment in renewables and other carbon reduction technologies” while benefiting from a “much lower cost of capital,” the letter adds.
Shell CFO Jessica Uhl counters that splitting the company “can sound interesting from a financial perspective” but when considered from a strategic or operational perspective it “breaks down.”
The concept of splitting out different business lines is not foreign to European integrated companies. Italy's Eni and Spain's Repsol have already flagged plans to sell small stakes in their renewables businesses to help finance their transitions to offering more lower-carbon products. But the selldown would be small, at perhaps 10% of equity. This would open up new funding options but fundamentally the units would remain part of the parent company.
Europe has also seen major upheaval in a related sector — power — in recent years, highlighted by the 2016 spinoff of E.On’s fossil fuel assets into Uniper. Utilities like EDF, Iberdrola and Enel split their fossil and renewable businesses more than a decade ago but ultimately repurchased their renewables divisions when it became clear they were the more viable industry.
Strategic differences could dictate whether spinoffs make sense for each oil company. Importantly, achieving the ambitious net-zero targets set by many firms — while continuing to grow — is dependent upon selling more low-carbon energy, such as renewable power or charging services. Even for those companies where splitting could work, it's not clear it will be a long-term trend.
As oil majors build new energy businesses, many stand-alone competitors in sectors such as renewable power generation, batteries and vehicle charging are trading at much higher multiples in stock markets, allowing them to achieve low capital costs that enhance their returns.
But spinoffs may not be so simple for majors. Cash flow from traditional businesses are funding their investments in the transition. And they say synergies between things like refining and hydrogen or natural gas trading and renewable power sales are necessary to maximize returns and minimize risk. Instead, they hope that better visibility into their new energy operations and returns could help investors start ascribing more value to them — even if they sit within these majors’ broader portfolios.
TotalEnergies CEO Patrick Pouyanne indicated that Total’s board was willing to be patient, expecting the company’s shares to rerate as investors better appreciate the synergies between its different business lines. Shell CEO Ben van Beurden acknowledged that the market might not give full value to each individual business but also emphasizes the importance of synergies. “The whole idea that [at the] moment we’ve built something nice that we hive it off because then someone else can do something better with it, I don’t think that logic works for me,” he said recently.
Assuming Third Point is seeking complete separation of Shell’s traditional and transition business, its proposal would go far beyond anything considered by oil companies and what was pursued by most European utilities. But if investors determine that legacy oil companies do not add any value to the transition and are dragging on majors' valuations, the sector could be in for a dramatic shake-up.
Spinning out attractive low-carbon businesses would leave legacy oil companies with only few options but to enter wind-down mode. While previously unthinkable, more investors seem open to such a path. Almost 20% of Woodside shareholders voted in favor of a wind-down strategy earlier this year. BP’s transition strategy already implies a 40% reduction in its upstream production by 2030.
However, US fund managers told Energy Intelligence that US majors may not feel the same pressure because renewable power is not at the center of their transition strategies. US majors’ focus on carbon capture and storage, biofuels and hydrogen build more directly on their existing oil and gas operations, they say. But that might not guarantee growth in a world where oil and gas demand is set to shrink.
The original version of this article appeared in Petroleum Intelligence Weekly.