I agree 100% that traditional energy companies will mostly fail in their new energy investments. It would be great to have a list of all the past failures. Starting in the late seventies, as I remember, with SLB buying Fairchild Semiconductor (the guys who left started Intel LOL) and Exxon office products (that were going to displace IBM and Xerox another LOL). Please big oil. Just focus on creating shareholder value doing stuff you know how to do!
Conventional E&P may be high fixed cost, low variable cost but shale’s high decline rates means that they are constantly drilling through very high cap-ex… it is high fixed cost, high variable cost. Sure, you can capitalize it, put it on the balance sheet and hope it goes away, but in a high interest rate environment, people eventually start to notice. Also, on renewable power generation, if you have a long term PPA backstopping a project, there is limited price volatility. An alternative power generation project is more similar to an LNG project than an oil field, high cap-ex, low variable cost, long term offtake agreement reducing exposure to price volatility, low financing cost. TOT is generating 10% ROIs on its renewables and many oil and gas investors are outraged… they gripe “why deploy capital for such low returns?” But are the full cycle returns really that low? What was the ROI on E&P cap-ex in shale from 2014 to 2022? What pure play shale operator has EVER generated a 10% ROIC over a 10 year period?
Thanks Nat. Just to be clear on the "high fixed cost, low variable cost" comment in my post, I was referring to refining, drilling rigs, and supply vessels. Oil sands and LNG should be added to that list. Shale I wouldn't have included. Regarding E&P returns, those cycle over 10-15 years...so yes, 2014-2020 was really poor, for top quartile companies, 15%-30% is the history.
One thing I learned the hard way in 2015 from managing private equity investments in offshore field services is that investing in a capital intensive businesses with a highly cyclical revenue stream can be a very dangerous game if you get the cycle wrong. Ouch.
I see alternative power generation as a bit different, as long term PPAs provide some level of protection against price volatility. My only point is that if TotalEnergies or Shell can manage a 10% ROIC across a porfolio of windfarms (a big if going forward, admittedly, with the inflation currently ripping through the sector - Orsted), it might be much lower than a good year in E&P, but it is lower volatility than E&P and probably a better return in a lower oil price environment. I think LNG is probably the right analogy... it is, after all, largely a power generation fuel.... So I am somewhat more comfortable that renewable power investments may have an appropriate place in the integrated portfolios of the big oil majors.
In work boats and drill rigs, the contract lengths are quite short and the oil majors just renegotiate the contracts they don't like anyway, so day rate pricing declines hit very quickly, so you get high fixed cost, low variable cost and rapidly falling revenue, resulting in very rapid asset impairment and a very bad day at the office.
The only other point I would make about oil and gas vs. renewable power generation is the massive valuation gap. NextEra energy is the leading generator of renewable power in the USA. It trades at a price/ cashflow of almost 17x. TotalEnergies, which has been perhaps the most aggressive oil company in terms of pushing into renewable power, trades at a bit over 4x. I am not so foolish to believe that Total will enjoy some massive re-rating in the short term based on its renewables portfolio, but it does seem to me that taking cash flow being generated in a part of the market that is heavily discounted and deploying it into a sector that trades at a massive premium is not inherently irrational. Also, once the portfolio gets scale, it could possible spin it into a standalone to capture the multiple arbitrage, no?
In any event, I do not mean to nitpick... IMO your work is some of the best oil and gas insight in the market, particularly on the ROIC trends, so thank you!
We knew that if you hung around Texas long enough, you would appreciate Outlaw Country. Waylon, Willie and the Boys. Coe's You never even called me by my name is the perfect country western song!
I was on a flight to Dubai probably circa 2008 and decided to watch "Walk The Line" movie. I was instantly hooked and couldn't believe I hadn't previously really heard much Cash. NJ upbringing will do that. Fell in love with Outlaw Country.
We talk about the traditional energy business being a high fixed cost, low variable cost business. I think you'd also agree that energy companies are price takers, in that they are subject to the commodity price and have virtually no influence on it.
Question: do you think that ESG policies in the West are creating economic moats around traditional energy, particularly coal, via regulation, by stopping new permits, new entrants, pipelines, infrastructure etc.? In other words, do you think that the formerly competitive business landscape in traditional energy is having a moat dug around it? Or would that be going too far, maybe the polices are just digging a shallow ditch? LOL. Or maybe there's no moat at all, we are just trying to time the cycle?
Regarding ESG-driven economic moats, I would say that all of the anti-oil & gas sentiment does contribute to supplies being tighter than might otherwise be the case. still, the poor track of profitability last decade I'd still say is the overwhelming reason non-ESG investors have been slow to come back along with the debate on the future of oil & gas demand growth (i.e., when will it peak, etc.).
100% about policies in countries like Australia and Colombia restricting coal production and therefore supporting coal prices. If you are interested to learn more, read The Coal Trader and Six Bravo on Substack, or follow the Koala (yellow lab capital) and Matt Warder on Twitter.
The term “energy transition” should be eliminated from our vocabulary. In the history of energy systems, new sources of energy have been added to legacy sources to improve the quality of life. It’s called progress. The idea that society can “transition” from an economy powered by hydrocarbons to wind, solar, and other renewables does not hold up to even the most simplistic analysis. Energy transition is a political term, along with “green energy”, “carbon”, “dirty energy” etc etc
100% Weston. It's why I use the quotes. it's simply what every calls it. But I do refuse to say "Clean Energy" or "Clean Tech", etc....just need a better term. Maybe it is "energy expansion" or "energy diversification".
Dwight Yoakum and the whole Bakersfield Beat, is where I’m at, not even gonna try a small town. Great work, Polymath level.
I agree 100% that traditional energy companies will mostly fail in their new energy investments. It would be great to have a list of all the past failures. Starting in the late seventies, as I remember, with SLB buying Fairchild Semiconductor (the guys who left started Intel LOL) and Exxon office products (that were going to displace IBM and Xerox another LOL). Please big oil. Just focus on creating shareholder value doing stuff you know how to do!
great idea to go back to the 70s versions of these strategies.
On the OG country side, go see Dwight Yoakam. You won't regret it
David Allen Coe does a version of Steve Goldman’s “perfect” country song. The last verse covers everything important to country songs.
“Well,I was drunk the day my mom got out of prison.
And I went to pick her up in the rain
But before I could pick her up at the station in my pickup truck
She got runned over by a damned old train”
That pretty much sums it up.
Thanks for another great article.
Conventional E&P may be high fixed cost, low variable cost but shale’s high decline rates means that they are constantly drilling through very high cap-ex… it is high fixed cost, high variable cost. Sure, you can capitalize it, put it on the balance sheet and hope it goes away, but in a high interest rate environment, people eventually start to notice. Also, on renewable power generation, if you have a long term PPA backstopping a project, there is limited price volatility. An alternative power generation project is more similar to an LNG project than an oil field, high cap-ex, low variable cost, long term offtake agreement reducing exposure to price volatility, low financing cost. TOT is generating 10% ROIs on its renewables and many oil and gas investors are outraged… they gripe “why deploy capital for such low returns?” But are the full cycle returns really that low? What was the ROI on E&P cap-ex in shale from 2014 to 2022? What pure play shale operator has EVER generated a 10% ROIC over a 10 year period?
Thanks Nat. Just to be clear on the "high fixed cost, low variable cost" comment in my post, I was referring to refining, drilling rigs, and supply vessels. Oil sands and LNG should be added to that list. Shale I wouldn't have included. Regarding E&P returns, those cycle over 10-15 years...so yes, 2014-2020 was really poor, for top quartile companies, 15%-30% is the history.
One thing I learned the hard way in 2015 from managing private equity investments in offshore field services is that investing in a capital intensive businesses with a highly cyclical revenue stream can be a very dangerous game if you get the cycle wrong. Ouch.
I see alternative power generation as a bit different, as long term PPAs provide some level of protection against price volatility. My only point is that if TotalEnergies or Shell can manage a 10% ROIC across a porfolio of windfarms (a big if going forward, admittedly, with the inflation currently ripping through the sector - Orsted), it might be much lower than a good year in E&P, but it is lower volatility than E&P and probably a better return in a lower oil price environment. I think LNG is probably the right analogy... it is, after all, largely a power generation fuel.... So I am somewhat more comfortable that renewable power investments may have an appropriate place in the integrated portfolios of the big oil majors.
In work boats and drill rigs, the contract lengths are quite short and the oil majors just renegotiate the contracts they don't like anyway, so day rate pricing declines hit very quickly, so you get high fixed cost, low variable cost and rapidly falling revenue, resulting in very rapid asset impairment and a very bad day at the office.
The only other point I would make about oil and gas vs. renewable power generation is the massive valuation gap. NextEra energy is the leading generator of renewable power in the USA. It trades at a price/ cashflow of almost 17x. TotalEnergies, which has been perhaps the most aggressive oil company in terms of pushing into renewable power, trades at a bit over 4x. I am not so foolish to believe that Total will enjoy some massive re-rating in the short term based on its renewables portfolio, but it does seem to me that taking cash flow being generated in a part of the market that is heavily discounted and deploying it into a sector that trades at a massive premium is not inherently irrational. Also, once the portfolio gets scale, it could possible spin it into a standalone to capture the multiple arbitrage, no?
In any event, I do not mean to nitpick... IMO your work is some of the best oil and gas insight in the market, particularly on the ROIC trends, so thank you!
Thank you for the post Arjun. Can’t wait to read about the Energy CEO Hall of Fame!
We knew that if you hung around Texas long enough, you would appreciate Outlaw Country. Waylon, Willie and the Boys. Coe's You never even called me by my name is the perfect country western song!
I was on a flight to Dubai probably circa 2008 and decided to watch "Walk The Line" movie. I was instantly hooked and couldn't believe I hadn't previously really heard much Cash. NJ upbringing will do that. Fell in love with Outlaw Country.
Hello Arjun,
We talk about the traditional energy business being a high fixed cost, low variable cost business. I think you'd also agree that energy companies are price takers, in that they are subject to the commodity price and have virtually no influence on it.
Question: do you think that ESG policies in the West are creating economic moats around traditional energy, particularly coal, via regulation, by stopping new permits, new entrants, pipelines, infrastructure etc.? In other words, do you think that the formerly competitive business landscape in traditional energy is having a moat dug around it? Or would that be going too far, maybe the polices are just digging a shallow ditch? LOL. Or maybe there's no moat at all, we are just trying to time the cycle?
Thanks again,
J
Regarding ESG-driven economic moats, I would say that all of the anti-oil & gas sentiment does contribute to supplies being tighter than might otherwise be the case. still, the poor track of profitability last decade I'd still say is the overwhelming reason non-ESG investors have been slow to come back along with the debate on the future of oil & gas demand growth (i.e., when will it peak, etc.).
100% about policies in countries like Australia and Colombia restricting coal production and therefore supporting coal prices. If you are interested to learn more, read The Coal Trader and Six Bravo on Substack, or follow the Koala (yellow lab capital) and Matt Warder on Twitter.
Thanks Arjun. Always a Saturday morning treat to read what is on your mind.
thank you Martin!
The term “energy transition” should be eliminated from our vocabulary. In the history of energy systems, new sources of energy have been added to legacy sources to improve the quality of life. It’s called progress. The idea that society can “transition” from an economy powered by hydrocarbons to wind, solar, and other renewables does not hold up to even the most simplistic analysis. Energy transition is a political term, along with “green energy”, “carbon”, “dirty energy” etc etc
100% Weston. It's why I use the quotes. it's simply what every calls it. But I do refuse to say "Clean Energy" or "Clean Tech", etc....just need a better term. Maybe it is "energy expansion" or "energy diversification".
Energy evolution?
Implies survival of the fittest ...
Yeah, that probably works best.
I try to get people to use “energy addition”. We need more energy to advance global social progress. Not just different energy.