Majors mull power puzzle
Financial and regulatory challenges are curbing the ambitions of major oil companies' ambitions to invest in the electricity supply sector
Industry and political posturing over the direction and speed of the global energy transition, which many hope will limit climate change and encourage carbon-neutral energy consumption, is pitting oil and gas firms against the electricity supply industry. Each sector seems to be encroaching on the other: some major oil companies are taking steps to enter the power sector, while utilities are taking aim at the transport fuels business.
But underlying the rhetoric is the reality that these steps are so far largely marginal; enormous technical, and commercial challenges face each sector as companies migrate from their traditional sectors. For the oil industry, the challenges are further complicated by widely differing regulatory approaches in major electricity markets.
"It is a discussion with many questions. There are no easy answers," says a senior analyst with a leading investment bank. "This is something that requires a policy direction," adds an oil industry consultant, noting that such direction is largely absent in the world's largest single oil market, the US. Despite trenchant public statements by oil and power companies and politicians, investors and industry officials seem unwilling to put their personal views on the record because the outcome of the energy transition is global, unclear and long-term, well beyond many investors' current horizons.
"People underestimate how large the current energy system is", and overestimate the proportion of oil company capital expenditure dedicated to changing it, says one analyst. Consultancy EY estimated in 2018 that, in the previous four years, 10 leading oil and gas companies it follows invested only about 6pc of their total capital expenditures of $350bn in "low-carbon or renewable sources of energy and clean technologies". A review of company statements indicates that Shell, despite its recent active investment in the power sector, only controls about 10GW of power generation, compared with 85GW claimed by the largest non-Chinese power generator, Italy's Enel, which suggests that Shell's indicated ambition of becoming the world's largest power company is a significant stretch.
At the majors level, clear differences are emerging between EU-based BP, Eni, Shell and Total; their US counterparts ExxonMobil and Chevron; and Chinese oil companies. While European concerns are integrating into electricity markets, encouraged by EU policy, US companies are more focused on technology development, and Chinese firms appear to be ceding the power sector to Chinese utilities. Worldwide, the influential financial sector seems to doubt that there is an attractive and sustainable balance between the traditionally high-risk, high-return oil sector and the historically lower-risk, low-return power sector.
Rapprochements between the oil and gas and power sectors are not new. In the privatising, deregulating late 1990s, utilities such as Germany's Eon and RWE, the UK's Centrica and Enel acquired upstream oil and gas assets, while US independent producer Hess entered the UK retail gas and power sector. In Finland, utility IVO merged with national oil company Neste, while Shell acquired a 50pc share in power generation developer Intergen.
Most such alliances failed as oil company and utility cultures proved difficult to meld. The Neste-IVO merger lasted only six years before being dissolved in 2003. Shell sold its interest in Intergen in 2005, after holding it for seven years.
Today, oil majors are expanding their upstream and midstream positions in natural gas, which is widely touted as a "transition" fuel, to an electrified future energy system based on renewable power. But such upstream positions are seldom matched by downstream power generation ambitions. BP and Shell are beefing up their interests in renewables and electric vehicle charging technologies, but their direct interest in gas-to-power operations outside of refinery units are limited to approximately 1GW each.
Total said in a presentation this February that it aims to increase its gas-fired power generation in Europe, targeting a 15pc share of the French and Belgian commercial markets, while growing a gas-to-power business in developing markets via floating storage and regasification units. But power industry officials note that, while ambitions such as Total's are laudable, when final investment decisions are taken, oil companies tend to limit their investments to fuel supply and shy away from equity in power stations.
Limited end-user supply
Overall, oil majors' investments in power generation seem small relative to their statements about ambitions. Based on their public statements, none of the world's six largest oil companies controls non-refinery generation capacity of over 10GW, a small fraction of the capacity controlled by many utilities; and while many oil companies are active in electricity markets, few operate supply businesses to end-users. Notable EU exceptions are Shell, which has rebranded its UK First Utility acquisition as Shell Energy Retail, and Repsol, which acquired 2.9GW of gas and renewables capacity from Viesgo and is aiming to supply about 5pc of the Spanish end-user market by 2025.
The clearest battleground between oil and gas companies and the electricity sector may be in downstream fuels, where oil companies are already challenged on several fronts, including emotive plastics recycling issues in chemicals and new specifications on marine fuels. The International Energy Agency (IEA) projects in its Global EV Outlook 2018 that growth in the electric vehicles park could reduce gasoline and diesel fuel demand worldwide by between 2.5mn and 4.7mn bl/d from projected levels by 2030.
Electric vehicles still represent a very small slice of the market. While year-on-year growth is rapid, they do not yet represent even 1pc of the global passenger car fleet, according to the IEA. Nevertheless, major oil companies and national refiners in Europe are actively acquiring charging points and sites for EVs, often in collaboration with utilities. "The EV challenge is real," says a Scandinavian oil industry executive, commenting on the Norwegian market, the most active in the world, where EVs now exceed 40pc of new car sales.
Oil and power industry officials note that downstream integration of EV chargers into the market may no longer be up to the oil companies. Leading EU and US oil companies have sold large parts of their retail chains to specialist retail operators who may be restive about adding new infrastructure, particularly when they are already concerned about meeting growing demand for LNG as truck consumption for that fuel grows. "There will not be a single (oil) product: there will be a mix" in larger service stations, including oil products, LNG, LPG, and electricity, says the head of retail at an independent European oil company.
Regulation changes awaited
Regulations will need to evolve for many service station operators to offer EV charging, particularly the further they are from the core northwest European market. Charging infrastructure is not expensive, but "we cannot sell electricity to end-users" for lack of an electricity supply licence, says the executive. A temporary solution for some stations has been to charge a commission or ‘parking fee' to drivers charging their vehicles. In the absence of new EU and national regulations governing automotive electricity sales, such workarounds are likely to be commonplace but will also slow the growth in public EV charging infrastructure.
Oil companies may also find that, as most EV charging is expected to take place at home or at the workplace, fuel sales lost as the EV sector grows can only be recovered via broad electricity supply businesses, where utilities have an incumbent, and often regulatory, advantage. Meanwhile retailers, many of whose oil product sales in OECD countries only account for around half of total revenue, may have to adjust their "non-oil" retail offering to further compensate for a fall in income from automotive fuel sales.
Similar challenges also affect oil retailing in the US and China. According to a February report by Columbia University's SIPA Center on Global Energy Policy, Electric Vehicle Charging in China and the United States, neither the Chinese nor the US market has seen widespread installation of direct current fast charging at filling stations. In both cases, the principal obstacle appears to be regulatory. Chinese EV charging is undertaken by power rather than oil companies; and in the US, retail station operators, while partnering with charging network providers, "are unable to offer EV charging due to regulations that prevent resale of electricity".
Protected fuel niche
Meanwhile, US utilities such as New Jersey's Public Service Enterprise Group are gearing up to offer comprehensive charging services at sites including "multifamily buildings, businesses, fleet facilities, municipal facilities, and hotels and motels", as well as fast chargers along key highway corridors. By using their regulatory exclusivity in power supply, utilities in the US may be pre-empting future fuels markets from oil companies as the EV market grows. In the long term, this may enable utilities to regain power sales they had thought lost to energy efficiency and distributed renewables generation, while carving out a protected fuel niche at the expense of oil company gasoline sales.
But the growth of that niche is likely to be slow: the average age of the vehicular fleet in Europe and the US is over a decade, which suggests that even at an unrealistic one-to-one switch from internal combustion engine cars to EVs, it would take at least a decade for EVs to consolidate that transport niche. Meanwhile, growing long-distance truck traffic, which is less susceptible to substitution by electricity because of the heavier vehicles and longer distances, will continue to boost middle distillate and, in the longer term, LNG consumption, oil industry officials say.
Few in the oil and gas, utility, or finance sectors appear to believe that the challenges facing the oil and gas sector from the energy transition will be resolved in the short term. While European majors may broaden their acquisition of supply businesses and generation, they seem unlikely to be able to match incumbent utility suppliers in either sector. In the US, the regulatory divide between the oil downstream sector and the power supply sector is expected to deter cross-sectoral mergers. "It would change their risk profile," says a senior US utility executive.
In the short-to-medium term, a key challenge will be financial returns. One oil industry consultant points out that investors in all oil and gas industry sectors from wellhead to pump are now focused on shareholder returns rather than on growth. In this context, moving from upstream return targets of 20pc to returns of 8-12pc, as Shell suggests its power investments will bring, will be a major disincentive to investors.
Some industry observers suggest that, if governments fail to keep up the policy pressure to promote the energy transition, the real shift from internal combustion engines to EVs may occur away from major markets. "Where you are going to get an upturn in EVs is in developing markets", because they have not yet developed the energy infrastructure that more developed markets have, argues one oil consultant.