The Edge

How will Covid-19 change corporate strategy?

The dilemma: focus on oil and gas versus diversify into new energy

1 minute read

Future energy demand may look very different after the Covid-19 pandemic. Our three scenarios – full recovery, go-it-alone and greener growth – aim to capture how policy and societal changes in the wake of the virus may alter expected trends in energy demand. Oil demand, in particular, is at risk in these scenarios. I asked Erik Mielke, Head of Corporate Research, how the increased uncertainty unleashed by the virus could influence corporate strategy in oil and gas.

How has the industry reacted to the crisis?

Almost no one makes money at US$35/bbl, so companies have been driven by short-term necessities – bolstering liquidity, cutting discretionary spend and shutting in uneconomic production. But the second price shock inside five years is resonating deeply, and the disruption caused by the coronavirus is an urgent reminder that oil and gas demand can’t be taken for granted forever.

Yet the global economy will rely on oil and gas for decades to come, and the industry needs to continue to invest to meet future demand. We expect the strategic response to the virus will be to intensify the present emphasis on building resilience and sustainability. Different companies will choose different paths to achieve this.

Diverging strategies: Big Oil, Big Energy, NOCs and niche players

Will companies decarbonise faster?

Yes, accelerating a trend that’s underway. European Majors lead the strategy to ‘diversify’ from Big Oil to Big Energy – BP, Shell and Total each just set ambitious new targets to meet Scope 3 carbon commitments in line with the Paris Agreement. Shell and Equinor’s dividend cuts early in May are a signal of shifting strategic priorities, cutting the umbilical cord with legacy cash flow while freeing up capital to invest in new energy.

Has the crisis made zero-carbon investment more attractive?

There are two angles. First, economics: the extreme volatility in oil price this year underscores the inherent risk in oil and gas investment. Returns from zero-carbon projects may be more modest but they are more predictable, and bankable. Second, there’s more growth in renewables, and growth prospects may be strengthened by policy choices post-crisis. The challenge for Big Oil diversifying will be to achieve sufficient scale organically. They’ll need acquisitions.

Will Big Energy appeal to investors?

Yes, from an ESG angle. Positioning as part of the solution as well as the problem increasingly resonates with investors, if the ambition is supported by clear targets and actions. What’s yet to be proven is the value proposition of green diversification. Will Big Energy be recognised by a re-rating of currently very depressed share prices?

Where do pure oil and gas businesses fit in?

Most companies will choose not to take on the risks of diversification, and instead focus on maximising value from the oil and gas business. We expect the US Majors, ExxonMobil and Chevron, and bigger independents like ConocoPhillips, to be among those which ‘focus’ and adopt a pure-play strategy.

Do pure plays need to change?

Yes, they’ll have to adapt to a challenging environment as the energy transition gains momentum. The pure plays’ focus will be about being the lowest cost and managing for margin. In upstream, that’s concentrating on advantaged positions – assets with economies of scale and high margins that are low carbon-intensive; and new investments that pay back quickly.

Downstream will be about advantaged feedstocks, proximity to growth markets and improving integration between upstream, refining and petrochemicals.

Assets through the value chain that don’t fit the bill – high cost, low margin, high carbon-intensity; or geographically peripheral – will be sold or spun off. Some pure plays will be aggregators – consolidation and related cost synergies have to be part of the playbook. There’s also a need to reset costs structurally and build a 21st-century platform around digitalisation, automation and artificial intelligence. The diversifying Europeans will follow much the same strategy as they milk the legacy cash cow to fund diversification.

The challenge for focused players will be to stay investable as ESG increasingly dominates the stakeholder agenda. We expect the pure oil and gas companies to limit emissions reductions to their own operations (Scope 1 and 2). Investors will want higher returns from the pure-play harvest model, which will be difficult to deliver without help from oil and gas prices.

Will NOCs diversify?

Unlikely, though it’s difficult to generalise – each NOC is shaped by its own government’s national priorities. Most will focus on deeper regional integration through the oil and gas value chain.

What about ‘Little Oil’?

Niche players will thrive in both upstream and downstream. Consolidation is inevitable, but there will be a smaller, stronger pool of higher quality E&Ps, and new independents will emerge. Privately owned companies unconstrained by ESG are likely buyers of carbon-intensive or environmentally challenged assets.

Find out more about corporate strategy in a post-coronavirus world 

In a recent report, “The world after Covid-19”, we ask how corporate strategy is likely to shift in a post-pandemic world. That report also looks at Covid-19’s impact on the long-term energy outlook and lays out three scenarios for a post-pandemic future. Fill in the form at the top of this page to get a complimentary extract.