On June 27th, 2019, the UK became the first major world economy to pass legislation to reduce the UK’s net emissions of greenhouse gases by 100% relative to 1990 levels by 2050. In recent years oil giants have battled with the growing pressure to abandon oil and gas, given their history of significant contributions to climate change. So what sort of challenge does this pose for oil giants? These mounting pressures have already begun to take an economic toll on these companies. In 2019, energy was the worst performing sector on the S&P 500 index, accounting for only 5% of the index’s value as compared to 28% in 1980. This trend is expected to continue with recent projections suggesting that the demand for oil could peak and fall within coming decades, perhaps as soon as 2025. As oil giants grapple with the existential challenges posed by climate change, a stricter regulatory environment, and declining demand, they are left with no choice but to find alternatives to oil, with many turning to offshore wind farms as their investment of choice.
The world’s oil giants, such as British Petroleum (BP), Shell and Exxon Mobil, are no stranger to UK waters, with over 170 active rigs in the North Sea alone. Given their familiarity with off-shore energy installation in these areas, these oil companies are able to transfer this knowledge to install offshore wind farms in the same area. Many oil giants see offshore wind as facilities that are capable of providing clean power for millions of homes, as well as advancing their commitment of reducing their contributions to climate change, given the heightened regulatory environment. In addition, big oil companies are used to $10 billion or more on energy projects, so the price of this investment aligns with their previous business models and therefore does not put an economic strain on these firms. For example, earlier this year, BP along with a German partner Energie Baden-Württemberg, made a record-breaking bid for the rights of two tracts to build wind farms in the Irish Sea, by offering to pay the Crown Estate $2.5 billion over the course of four years. BP and Energie Baden-Württemberg were not the sole bidders, with Total SE, another supermajor oil company becoming the top bidder for a large tract in the southern North Sea. For BP and Energie Baden-Württemberg, they expect to be in the planning and permissions phase for approximately four years, and are only expected to begin generating power after seven years. BP itself hopes to increase its portfolio of renewable energy to 50GW by 2050.
But why did these oil giants specifically choose offshore wind farms as opposed to other renewables as their asset class of choice? According to Mark Lewis, the chief sustainability strategist at BNP Paribas Asset Management and a major investor in renewable energy, “Big Oil’s big spending on offshore wind is an investment in their long term future.” Furthermore, oil giants have noticed that stock market listed companies with a strong portfolio of renewable energy projects are able to reach high market valuations many times the size of their annual earnings. These high valuations are attributed to increased investor confidence coupled with reduced costs that come with more advanced renewable energy technologies. In terms of offshore wind farms, oil companies believe that the skills needed for off-shore oil rigs and off-shore wind are easily transferable. For instance, the engineering proposition is very similar between offshore wind farms and offshore oil rigs, allowing oil companies to reduce costs by avoiding new hiring cycles. Furthermore, oil giants are already familiar with the structure of these sea beds, allowing them to economize time within the planning stage. Similarly, oil giants have experience in planning and executing large infrastructure projects, further facilitating their transition into the renewable energy sector.
However, there are still potential risks that remain, even for experienced oil companies, when reallocating production at this scale. According to Lydia Rainforth, an oil and equity analyst at Barclays, each seabed license has different characteristics, which can ultimately affect the economic aspect of a wind farm. One key issue that oil giants are currently grappling with, is the profitability of this reallocation of assets. Despite the relatively small upfront costs faced by the multinational oil companies, the rate of the return on investment remains fairly unknown. Currently, forecasts sit at a rate of approximately 8-10%, but remains unproven. There is also the potential for marine environment damage, if the transition speed becomes a determining factor for the oil giants.
Additionally, given the novelty of wind farms, there is currently no price set for the electricity that the wind farms will eventually generate, meaning the oil companies’ return on their investment will be unknown for several years. In order for the big oil companies to be able to profit from their shift in investments, the transition needs to be smooth. There is the potential for excessive costs to arise due to heightened seabed risks. This would, in effect lead to unsustainable financial returns for developers as well as higher energy costs to future energy consumers. Oil giants are also new players within the renewables’ realm, and therefore must be able to compete with established renewable energy firms.
However, for many of these major oil companies, this shift in investments is not purely a choice but rather the only possibility for oil giants to survive going forward. Within the past five years, there have been several spikes and volatility within the oil and gas market, which has led to the generation of negative returns and the loss of investor confidence within the oil industry. In order to avoid decapitalization risk and regain investor confidence, these oil giants must prove that they are able to adjust their business models given the heightened climate risk. Oil companies within the UK know two things for sure: they must reduce the emissions from its operations, and they need to find alternatives to oil for its future growth. For these oil giants, this opportunity comes in the form of offshore wind, which has proven to be a great growth market in recent years and provides the opportunity for a smooth transition into the renewables market.
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Mathis, W., & Hurst, L. (2021, February 8). Big oil takes over next generation of U.K. offshore wind. Bloomberg. Retrieved February 26, 2021, from https://www.bloomberg.com/news/articles/2021-02-08/big-oil-takes-over-next-generation-of-u-k-offshore-wind
Reed, S. (2021, February 8). Oil giants win offshore wind leases in Britain. The New York Times. Retrieved February 26, 2021, from https://www.nytimes.com/2021/02/08/business/oil-companies-offshore-wind-britain.html