The Empire Strikes Back: Return of Oil and Gas Dominance for U.S. Integrated Energy

Introduction

Earlier this year, European oil majors BP and Shell announced that they would roll back their energy transition plans and keep oil and gas as relatively large parts of their portfolio. In October 2023, their American counterparts Exxon Mobil and Chevron doubled down on a collective $115 billion bet on fossil fuels. Exxon Mobil announced their intent to acquire Pioneer Natural Resources in a $60 billion all-stock transaction, greatly expanding their presence in the coveted Permian Basin, while Chevron’s $55 billion similar all-stock acquisition of Hess gives them a strong foothold in offshore Guyana, another hot spot for oil production. These E&P (exploration and production) acquisitions mark Exxon’s second-largest acquisition, and Chevron’s largest deal, despite pressure from governments and activist investors to wean off fossil fuels. Why, then, would these companies spend tens of billions on oil and gas assets?

Profitability and Demand

Two factors ultimately appear to govern capital allocation for energy investment: profitability and demand. The issue of profitability is straightforward—right now, fossil fuels make more money than renewables. BP, for example, targets a 6-8% internal rate of return on renewables versus 10-20% generally seen in oil and gas.^1,2 While hydrogen and biogases offer somewhat higher returns (around 15%), this dilemma has made oil majors reluctant to switch course.

While growth in renewable energy over time is undeniable, companies are betting fossil fuels will still play a key role for years to come. While the International Energy Agency (IEA) recently predicted oil and gas demand will peak by 2030, “everybody that produces oil and gas disagrees” with this forecast, according to Pioneer’s CEO Scott Sheffield.³ In part, as Sheffield explained to the New York Times, the lack of viable alternatives for jet fuel and petrochemicals will leave fossil fuels with a key role in the global economy.

Moreover, in the United States, consensus on future energy demand is anything but unanimous. According to Pew Research, while 74% of Americans support international efforts to reduce climate change, only about half are seriously purchasing alternative energy technologies such as electric vehicles, solar panels, or electric water heaters.⁴ In other words, while most Americans talk about wanting a greener future, fewer have plans to spend to do so. In addition to consumer demand, geopolitical tensions may push the U.S. government to support domestic oil production, particularly when trade tensions hinder clean energy development. In October 2023, China restricted the export of graphite, a key element required for electric vehicle batteries, threatening a major aspect of the energy transition. China is also a dominant force in solar energy, with over 80% share in solar panel manufacturing.⁵  Meanwhile, domestic oil production has allowed the United States to be a net producer of energy since 2019⁶, which helps mute price spikes caused by shocks like the Russia-Ukraine war. Although the passage of the Inflation Reduction Act shows continued support for the energy transition, domestic production of oil and gas may provide a hedge to geopolitical risk, which may fend off regulators a little while longer.

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Where Does This Leave Oil Producers?

Given this, can oil and gas producers continue to produce fossil fuels while paving a path towards net-zero emissions? There appear to be five ways oil producers may be able to reduce their emissions:

1. Produce oil from newer or updated wells which have relatively lower emissions for an equal level of production.
2. Similarly, they could dispose of aged, less-productive assets. All else equal, this would reduce emissions while also helping to improve profitability and efficiency.
3. Increase the amount of gas and LNG in the production mix. Natural gas is considered a “stopgap fuel” because it emits less CO₂ than oil and gas, while offering relatively higher returns versus other renewables sources.
4. Invest in and scale carbon capture technologies to help offset emissions. Though this could justify at least some O&G production, scaling this technology is difficult and expensive.
5. Pivot toward alternative energy sources such as biofuels, hydrogen, wind, solar, etc., and eventually reduce oil and gas output.

Option #5—increasing renewables mix— is what many think of regarding the energy transition, but this carries the highest financial burden. However, none of the other options alone will accomplish carbon neutrality by 2050. Moreover, increasing production volumes may undo any of these effects. As a result, integrated energy companies will likely continue to use a combination of all these factors to reduce emissions. Near-term, energy companies will likely go after the low-hanging fruit, prioritizing increased efficiency of legacy operations, disposing of older, less efficient assets, and continuing to invest in low carbon businesses, though at levels less than their mainstay businesses. As low carbon businesses become more cost efficient and demand shifts, investment should increase further. Until then, oil and gas will likely continue to be significant in the global energy mix. It should be noted, however, that these companies, like all energy companies, continue to face significant exposure and risks to the energy transition. As a result, they should continue to invest in reducing their emissions, including low carbon businesses, and changes in regulation should be closely monitored.

¹ https://www.bp.com/content/dam/bp/business-sites/en/global/corporate/pdfs/investors/bp-annual-report-and-form-20f-2022.pdf

²https://www.reuters.com/business/energy/shell-pivots-back-oil-win-over-investors-sources-2023-06-09/

³ https://www.nytimes.com/2023/10/25/business/energy-environment/exxon-chevron-oil-mergers-peak.html

⁴ https://www.pewresearch.org/science/2023/06/28/majorities-of-americans-prioritize-renewable-energy-back-steps-to-address-climate-change/

⁵ https://www.iea.org/reports/solar-pv-global-supply-chains/executive-summary

⁶ https://www.eia.gov/energyexplained/us-energy-facts/imports-and-exports.php