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Pivot to renewables opens up opportunities in oil and gas

Renewables are attracting investors and delivering spectacular returns—but private equity funds still see opportunities in oil

While investors are increasingly vocal about their concerns over environment, social and governance criteria, market data from the last decade reveals that investment in decarbonisation could have been made for entirely mercenary reasons.

Historically, returns from oil companies have been far superior to those available in the renewables sector. But over the last decade—and especially this year as oil demand and prices have fallen—renewables have offered far better volatility-adjusted returns.

According to research by the IEA and Imperial College London’s Centre for Climate Finance & Investment, a stock market-listed US fossil fuel portfolio delivered 97.2pc over ten years with 25.4pc volatility. Meanwhile, a US renewables portfolio delivered more than double the returns with very similar volatility, at 192.3pc and 28.6pc respectively.

“Investors are flooding into the story of ‘the new economy’. There are spectacular returns from these investments” Bond, Carbon Tracker

Unsurprisingly, this divergence has strengthened more recently. Over the past five years—which has seen a fall-off in oil prices and stronger investment in renewables—the same fossil fuel portfolio returned -9.6pc with 28.3pc volatility, while renewables delivered 65.6pc with 26.7pc volatility.

Cliff Vrielink, energy partner at law firm Sidley who advises private equity and energy clients on investing and fundraising, says the landscape has dramatically shifted and made investing in oil and gas companies more challenging. 

“The industry has several serious headwinds. The commodity price collapse has made it very hard for a lot of investors who made their investments based on certain price expectations,” says Vrielink. “All of a sudden, their base-case analysis no longer reflects reality, which is extremely challenging, and there have been a lot of bankruptcy filings across the entire industry.”

Investor caution

The recent fall in demand, especially if we are past peak oil as many mainstream consultants now suggest, has also led investors to become concerned that oil pipelines and infrastructure are overbuilt. If production falls, overcapacity and underutilisation could impact profitability.

Energy-focused investment managers are facing a highly unusual outlook in which to place capital and seek out opportunities. A common quandary is whether to invest in oil companies and encourage them to cut costs and streamline operations, or exit investments and pivot to renewables companies.

“A few private equity funds that have historically been oil-based are moving more into renewables such as wind and solar. That is largely being driven by their institutional investors who are asking for that exposure,” says Vrielink.  

“Battery storage has become a really interesting part of the [investment] mix because there are all kinds of reasons why it really complements what else is going on in the transition to renewables. 

Bent Erik Bakken, senior principal specialist at standards agency DNV GL, painted a bleak picture for the oil and gas sector on a TEDxCarbonTracker webinar last week. “[The] fossil fuel use peak is behind us and will never recover. Demand will be flat for the next ten years and then will gradually decline. Gas will peak in 2035 and there will be significant decline thereafter to 2050.”

Kingsmill Bond, energy strategist at thinktank Carbon Tracker, says: “For the first time, there is competition right across the energy system from new energy technologies with falling [energy] prices. Investors are flooding into the story of ‘the new economy’. There are spectacular returns from these investments.”

Oil resurgence

However, in terms of absolute market penetration, renewables remain a very small percentage. “It is a crowded landscape—there is a small number of projects and a lot of capital to invest in them,” he says.

192.3pc – Investment returns from a US renewables portfolio over ten years

If investors continue to exit oil and gas and allocate to renewables, the clean energy market will become more crowded and see returns diminish.

Vrielink adds that there can still be a case for investing in oil and gas, because although wind and solar can be an important part of the mix, multiple fuel sources—notably including gas—will continue to have a major role.

“A lot of private equity funds that have capital allocated to the oil and gas sector are thinking, because there is less focus on the sector and will not be as crowded, there will be some opportunities where they can really add value.”

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