You can tell what an oil company will do by the R&D it does

We heard a joke the other day about an exhausted father and chief executive who is on the verge of a complete breakdown and goes to the doctor for an assessment. The doctor calls the wife in to have a private word, and tells her that her husband must have complete relaxation, no arguments, no stress, and plenty of comfort food and physical comfort and sex, or he may indeed die.

The wife leaves the doctor and gets into the car with her husband, and he says “What did he say?” and she turns to him and says, “I’m very sorry, but the doctor says you’re going to die.” The oil industry is in a similar position.

Oil is measure by investors by how much oil it has in reserve, but soon it will be impossible to use what the oil company has. Its investors will desert it. If an oil company embraces renewables, its 25% plus margin is replaced by an 8% or 9% margin, and it can only grow by hard work. Its investors leave it for a renewables company that is further down that path. In the end it is perhaps simply better for the oil company, like the executive, to carry on without knowing that it is doomed to die.

A report out this week from a group of Oxford academics makes this point clearly. It says that one way of telling what activities an oil company is focused on, is to take a look at its patent filings. The paper from an independent group The Oxford Institute for Energy Studies, whose members include both oil companies and oil-consuming nations, uses the graph below to demonstrate that oil companies are investing in all the wrong things, and ignoring renewables like they are not there.

Basically if an oil company does not have a large yellow slice of patents at the top, then it is way behind on the transition of the energy markets away from fossil fuels and is likely for the scrap heap.

The report notes that some $6 trillion of investments have agreed to divest of oil and fossil fuel assets, mostly because there is a chance of a huge number of stranded, yet still indebted, assets. The report says that the pace of change at oil companies is seen by investors, shareholders, governments, and society in general to be very slow and not enough to confront what some have identified to be ‘the great existential challenge of our times.’

Another fear is that escalating costs for each technology when compared with renewable energy and it provides another diagram as evidence with coal likely to have a 25% cost escalation and oil megaprojects and deepwater oil, less inflated, but enough extra cost to make them far less profitable.

There have been concerns about shale gas from some of its founders this week (see separate story) and it shows a concern of 5% increase in its capital cost.

This is a report that sets the transition speed as “slow” over 50 years, beyond 2050, and yet still worries that many oil companies are going to find themselves unprepared to make any kind of transition. Rethink Energy is of the firm opinion that the transition “accelerates,” and does not proceed at anything like the current rate of renewables, which this report points out would take 180 years to turn 100% renewable. It’s just that while it knows it will accelerate, it cannot put a precise rate on future transition speed – it is just faster than now.

So this is a guess that everyone takes – on the one hand oil and gas “assume” they will still be in business by 2050, but climate change scientists are clear that the entire world will be in upheaval and trade, civil society and civilization will all have given way to climate catastrophe, with billions dead or starving, and war imminent. Under those circumstances there is little need for the global petroleum market except to fuel military tanks, ships and warplanes. Both positions cannot be right, and the continued belief among oil communities that “everything will be just fine” is totally out of touch with either of these realities.

Either we will have managed to achieve zero emissions, or we will be at war with billions starving. Every other outcomes is denial.

And it looks to Rethink Energy that oil companies are in denial over the rise of renewables. We have seen something similar in the rise of video delivered over the internet, in that traditional companies like Disney have moved far too late, and now find themselves left behind by companies like Netflix. This is certainly going to happen in oil and this paper merely highlights this, and asks the question, so what should investors/oil companies do about it?

But from our experience in other markets, what begins as a slow drip feed of change, becomes an avalanche quite rapidly. In the end the Sony Walkman gave way entirely to streamed music in under ten years by way of the iPhone. This is certainly how consumer markets change.

But for that to happen, broadband lines had to go from under 5% of society to over 50% in a single decade of acceleration. As smartphones began to offer broadband too, the entire globe got used to data speeds that enabled many entirely new experiences. Tapes, DVDs and TV channels gave way to streaming. And so it will go with renewables.

Initially governments get involved to subsidize renewable energy, then consumers become aware of what oil companies are up to, and then China releases 60 different EV models, and virtually over a single car cycle, typically they last 15 years, we go from transport reliant on gasoline, to one where gasoline cannot be sold, and it becomes worthless. About 5 years into the cycle the outcome will become obvious and it will all go into the price of the oil companies. The tipping point for this is when all countries reach a point of “parity” between renewables and thermal energy, expected 2022/3. By 2028 this could be all over.

This paper makes the point that even if you assume that this is stretched out over a longer period, it STILL shows how poorly prepared oil companies are.

It points out that Carbon Tracker predicts global demand for fossil fuels to peak in 2023 posing a significant risk to the financial system as trillions of dollars’ worth of oil, coal and gas assets could become worthless.

And there is a growing awareness that at some point putting carbon into the atmosphere will become illegal – selling oil may end up being banned in key, leading countries.

On the one hand oil companies should have the money and clout to buy their way into renewables late in the day. But on the other hand success is far from guaranteed especially if decentralized, small-scale solutions like solar panels and homes batteries are what is required. In almost every case even if an oil company gets its investment strategy right, it is sure to lower their profitability and this would be punished by their shareholders.

Oil companies then are between a rock and a hard place, damned if they invest in renewables and damned if they don’t. “I’m very sorry, but the doctor says you’re going to die.”

And it points out that during periods of rapid change a VC fund can move faster, more flexibly, and more cheaply than traditional R&D to help a firm respond to changes in technologies and business models. So being an oil company is the wrong place to start from.

We can see plenty of “arms-length” investments in renewables, with a cluster of VC style assets run by an investment arm of an oil company, but they have been prone in the past to panic and sell off the renewables, and go back to their knitting. How many companies have sold their new business because it was not as profitable as the old, to then watch the old business go sour?

One piece of advice is to invest into a market that is an overlap from where they have come from to where the future is going – cars or more clearly the charging of EVs. But for every company that had a 10% market share in oil, to make the same amount of money, it will need a 40% market share in recharge points. Few CAN be successful, and fewer still WILL be, because some companies from other markets will win the day.

Shell acquired companies such as, Ionity, Greenlots and NewMotion and an electricity company, First Utility, which has since been re-named Shell Energy.

BP invested in ChargeMaster and StoreDot. Total paid $1.7 billion for Direct Energie in 2018. Electrification helps drive the energy transition.

But if a $4.5 trillion petroleum markets becomes a $1 trillion add on to electricity markets, these are only slim pickings.

So far the oil companies have been able to keep all this at bay, and keep the right plates spinning in the air – gas gives off less CO2 than gasoline, which gives off less CO2 than coal – but this can only get the world to around 40% reduction in CO2, it is not a strategy that can see it through to zero emissions.

The Oxford Institute for Energy Studies asks if perhaps the oil companies can invent the next generation of renewable energy. For instance it is well known that the wind at 300 meters high, has twice the power than at 80 meters and there is a green-tech industry is dedicated to find such an improvement, in “airborne wind” where drones transmit power back down to ground level via a tether. The academic literature estimates costs per-kW could be 10-50% the level of conventional wind turbines.

ExxonMobil has filed patents to deploy similar tethered kites offshore, “opening up a resource system which is four times greater than the electrical generation capacity of the entire United States”. In February Shell signed up with a company in partnership on this and will test the concept offshore in Norway this year.

Other oil companies have invested in improving solar technologies, and the Oxford team reviewed 37 distinct solar patents filed across oil companies in 2018 and three leaders stood out, with Equinor investing in Oxford PV, which is developing Perovskite Solar Cells. But only a few can win here.

And then there is the subject of Carbon, Capture, Utilization and Storage (CCUS) and an awareness that this is the way out for oil companies. If we could capture enough carbon right out of the air, the oil companies can carry on without change. This is of course a myth.

The real advantage of EVs is that they have so few moving parts they can dramatically lower the cost of making cars, and so EVs are now going to happen, with or without CO2 emissions – at the expense of gasoline.

But cost of CCUS have proved astronomical, and the energy effort of mounting such efforts is larger than the energy they save.

Current technologies for separating CO2 cost >$50 per ton (closer to $200 per ton for direct air capture) and incur a 15% to 30% energy penalty and have other operational drawbacks. But the oil companies may indeed have an edge here. Shell is currently commercializing new solvents, which remove 25% more CO2, for 30% less energy and ExxonMobil has filed over 30 patents improving processes.

Next-generation technologies include Chemical Looping Combustion, which burns fuel in a slurry of metal oxide, yielding energy, metal, water and CO2, which can immediately be sequestered. With this the cost is supposed to fall to $20 per ton and a mere 10% energy penalty. But the first real demonstration plant will go up in China from Total in 2023, rather too late we feel.

There are other areas of progress. But eventually these technologies will require fuel, which has the costs of being taken out of the ground, paid for, and transported, and then burning, and finally carbon capture and sequestration, multiple cost components, when renewables have free sun and free wind, and no requirement to eliminate CO2 from their processes, because they don’t have any. Renewables will eventually ruin these ideas simply by being simpler and of course cheaper. The same is true for decarbonizing gas before it is burned, which perhaps leaves some R&D around Green Hydrogen, which of course has safety issues, which still need to be overcome. Which brings us back to “I’m very sorry, but the doctor says you’re going to die.”