“Physical and economic realities must not only be considered but controlling. Wishing and hoping for change is not a successful business strategy, and the past few years have awakened BP management to that reality.”
“Leaning in” is a phrase BP plc CEO Bernard Looney likes to use to describe how his company is embracing the energy transition. BP is transitioning from an “international oil company” to an “international energy company,” according to Looney. This means more renewable energy and less oil and gas. Looney invoked “leaning in” in February 2020 when he introduced new strategic aims for BP to reach “net zero carbon emissions on an absolute basis by 2050 or sooner.”
In Looney’s presentation, “Reimagining energy, reinventing BP,” he said BP needed to reinvent itself as a clean-energy producer because climate change demanded it. The company needed to be part of the solution and no longer part of the problem. Looney said not only did the public demand such a shift but so too did BP investors and employees. Some observers wondered if this would be a redo of the late 1990s failed rebranding of BP as Beyond Petroleum.
Looney cited his first workday as CEO when he saw the company’s office surrounded by climate activist protestors forcing its closure. This, to Looney, demonstrated the urgency for the strategic shift. In his presentation, Looney only vaguely set forth the key aspects of the new plan – less oil and gas and more investment in “growth transition engines” – while promising specifics in the fall. At the same time, he warned investors and BP pensioners that dividend growth might be at risk given the lower returns of renewable energy investments, but their steadier returns would counter the cyclicality of oil and gas returns.
As Looney was speaking in mid-February 2020, the pandemic was just emerging and beginning its surge across the globe. The economic lockdown medicine for fighting Covid nearly destroyed the petroleum industry, making BP’s new business plan a possible winner. Since then, global economies have reopened and recovered. With the recovery has come more oil and gas consumption. Last year, additional oil and gas stimulus came from Russia’s invasion of Ukraine, which upset world energy markets and created a push for Europe to end reliance on cheap Russian fossil fuels. Oil, gas, coal, and electricity prices soared across the continent and in the U.K. Suddenly energy security became the most important consideration, wiping away concerns over affordability and decarbonization.
Walking Back the Plan
Recently, BP announced its 2022 earnings – record results like every Big Oil competitor. Overshadowing BP’s earnings and dividend hike announcements was Looney’s modifications to his earlier grand “reinventing” strategy. In 2020, management set plans to dispose of petroleum assets, reduce capital investment in the petroleum business, step up investment in its GTEs, and cut its future oil production. A cornerstone of the new plans was reducing oil output by 40 percent from 2019’s level by 2030. This plan was in sharp contrast with the company’s earlier target to boost oil production by 20 percent between 2018 and 2030.
When BP reported its earnings on February 7, management announced major adjustments to its “reinventing BP” plan. Now, BP plans to shrink production by roughly 12 percent by 2025 from 2019’s adjusted output and lower it by 25 percent by 2030 rather than the planned 40 percent cut. More oil and gas mean more carbon emissions, further tamping down BP’s 2020 expectations.
BP also plans to increase its capital investment program, adding $8 billion for each of its oil and gas and growth transition engines (GTEs) businesses. The increased investment will be funded by significantly higher projected cash flows partly from higher oil prices. BP now sees a 2030 real oil price of $70 a barrel, up from its prior $60 estimate. The higher oil price forecast means an additional $4-$6 billion of earnings before interest, depreciation, and amortization (EBITDA) in 2030.
By boosting capital investment, BP projects its GTEs can generate an additional $1 billion of EBITDA by 2025 and $2 billion by 2030. The $8 billion in incremental capital committed to oil and gas should add an additional $2 billion to 2025’s EBITDA and $3-$4 billion in 2030. Note petroleum’s higher return on investment than from its GTEs. That is at the heart of BP’s energy transition problem.
Low Returns from Renewables
At the recent introduction of the “BP Energy Outlook,” an audience member posed a question: With oil and gas returns in the 15-20 percent range and renewables at 6-8 percent, can the latter be raised, or do investors need to lower their expectations? The panel of BP’s chief economist, the head of the International Renewable Energy Agency, and the leader of Columbia University’s energy program did not have an answer. The question was answered when BP released its earnings – slow the rush into renewable energy while sharing the spoils of higher oil prices through higher dividends and stock buybacks.
A week before BP’s release, U.K.-based Shell plc reported record earnings while also adjusting its green energy transition plan. So now, both BP and Shell have decided to slow down and reorient their push into renewable energy. At the same time, they have increased their commitments to their traditional oil and gas businesses that post consistently higher returns.
The low returns from renewable energy are well-known. So well-known that BP’s Looney warned of the potential risk to the company’s dividend growth and its share price from the accelerated investment in renewable energy. He pledged to protect the dividend, which was later cut due to the financial repercussions of the Covid economic disruption.
BP’s share price has lagged behind its American counterparts since 2005 when a refinery accident cost the lives of 15 workers and sent the company into a defensive posture. That accident was followed five years later by the Gulf of Mexico’s Macondo well blowout, unleashing the largest oil spill in U.S. history and jeopardizing the future of BP.
More telling, however, has been BP’s share performance since the early 2020 industry collapse. Since then, ExxonMobil’s share price has increased fourfold while BP’s shares have merely doubled. Shell and French oil company TotalEnergies SE. have posted similar underperformance. Such results tell us that investors have been less impressed with the strategic response to climate change by the European-based oil giants, which is hurting investor returns. Until European oil companies develop answers for renewable energy’s low returns, investors will vote with their feet.
On Bloomberg TV’s London business show the day of BP’s earnings release, the anchors asked: Do you buy the BP pivot? Buying the pivot could be asking whether investors thought BP was serious about shifting away from its GTEs and recommitting to oil and gas in catering to investor demands. If so, investors concerned with Environmental, Social, and Governance issues would avoid the stock. Or should investors buy BP’s stock because future returns would improve given the strategic pivot?
BP’s share price rose 8 percent on the day of the earnings release and 3.4 percent the next day. Investors were “buying the pivot” because they saw better capital stewardship and greater earnings and dividends in the future.
The lesson of the latest Big Oil earnings and business strategy adjustments is that leaning into the “energy transition” means going much slower–or even transitioning back to consumer friendly, taxpayer neutral energies. Energy affordability and reliability from energy density checks magical thinking about renewables.
Physical and economic realities must not only be considered but controlling. Wishing and hoping for change is not a successful business strategy, and the past few years have awakened BP management to that reality.