2019 was a bumper year for equity markets around the world, one that that provided a fitting close to one of the best decades for the stock market. The only exception was Oil and Gas, which sat at the bottom of the list of 11 sectors covered in the S&P. The sector now represents less than 5% of the US equity market compared to three times that at the start of the decade. The industry’s underperformance reminds us of another close analogue – the coal industry. Even though demand for coal has remained nearly unchanged over the past decade, the market cap of the top US coal producers have plummeted. By 91% to be exact.1 Is it that while the Oil and Gas industry has been debating when peak demand will happen, peak value has arrived?
It’s apt to say that the industry is facing compressive disruption, a type of disruption that is insidious and if unattended fatal. Earnings have fallen by more than a third since 2011. And growth rates have fallen by nearly as much (10% to 31% for upstream players).2 Unfortunately, industry projections don’t look healthy. Per capita oil consumption is expected to fall by more than 20% over the next 20 years.3 Some scenarios suggest that hydrocarbons’ share of the energy mix can drop from 80% today to just 50% by 2060.4 Even if we take cheerier projections, the growth trajectory of the industry tapers off in the next decade or two. What then?
Oil and gas companies have no choice but to reimagine how they’ll make money – every company will have to find more efficient ways to extract an abundant resource, and most will have to find either new ways to monetize the molecules or identify alternate growth pathways within the expanding and changing energy system. As we describe in From Oil Producers To Power Players: A Smart Move? the power sector presents one such pathway.
Beginning this decade, we’ll see global demand growth for oil start to slow and eventually fall.5 That won’t be the case with energy. Over the next 20 years, demand for electricity is expected to grow by nearly 50%. In fact, global electric power consumption will represent approximately two-thirds of primary energy demand growth by 2040.6 We’re already catching a glimpse of how this might play out. Over the past five years, utilities outperformed oil and gas companies in terms of market capitalization (+21% versus -18%). And even though utilities’ market cap growth lags that of other sectors, they’ve provided the stability that oil and gas investors value.7
No sure bets
While the power sector might be enticing, it comes with its own challenges. One is profitability. Compared to oil and gas players, power companies’ returns are typically lower, but more stable. Tradeoffs will have to be made. Another is disruption. Power players are nearly as vulnerable to disruption as their oil and gas peers. A global move to energy efficiency, along with advances in storage, distributed generation, electric vehicles and renewables, will likely shrink profit pools even further. And then there’s market access and scalability. The fragmented, concentrated and highly regulated power industry makes it tough for players to leave their mark on a global scale.
This is not to say that oil and gas companies need to have everything figured out. Amid the disruptions roiling both energy and power sectors, what is critical is asking three broad questions to get a potential move into power: Where are we going? What paths can get us there? And how fast should we go?
Oil and gas companies considering a move to power must, therefore, proceed with caution. They need to understand those areas of the power value chain where they might have the greatest success—and where they are more likely to fail. They need to evaluate the profitability tradeoffs (higher, volatile returns in oil and gas versus lower, annuity like returns in power), unique assets and capabilities required for each business, their appetite for risk (higher capital commitments in power though at much lower cost of capital), and their ambition to decarbonize to maintain their social license to operate. They do need an ambitious vision, but one that is tethered to a realistic plan.
5 power paths
For oil and gas companies that would consider a move into power, five distinct roles, explained in greater detail in our report, hold particular potential.
- Scale generators. These will be literal powerhouses, staking their claim in power generation. Clean generation holds particular appeal. While wind and solar power generation projects produce lower returns on invested capital, they come with less risk and a relatively low cost of capital.
- Resource monetizer. Another option for oil and gas companies involves boosting gas-fired generation capacity and monetizing hydrocarbon resources along the way. Upstream players, for example, can monetize “stranded” gas by building gas-by-wire capabilities to augment existing pipeline transmissions. The economic potential of such a move is enormous. It can nearly double the return on traditional gas power.
- Consumer disruptor. Two sets of customer-facing solutions—one for business and one for residential consumers—give oil and gas companies another chance to capture more revenue, as well as customer loyalty. Smart home services, distributed generation solutions and integrated eMobility infrastructures are few examples of disruptive service offerings that would change the game.
- Growth hunter. Larger oil and gas companies have the chance to expand their reach in developing markets. Such moves—ranging from regasification infrastructure development and power generation to consumer service delivery—could create a lot of value. But those rewards come with significant risk.
- Market facilitator. Building integrated resource-to-power trading capabilities and ecosystems can yield attractive results, and would build on the long history of trading among many oil and gas companies.
Surge or Wait?
Oil and gas companies should be preparing today to go “all in” with one or two of the large-scale power plays described above if they are going to “move the needle” by playing in power. In making their decisions, leaders will need to consider multiple factors - the viability, risks and potential rewards of each new business model.
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Of course, oil and gas companies need to be careful. But I think they can also be hopeful. Oil and gas companies have shown they know how to deal with disruption and, in the process, lead the world toward its energy future. I see no reason to think they will stop now.
1 Accenture Strategy, Energy analysis, 2020.
3 Ibid; World Energy Council, World Energy Scenarios 2019.
4 World Energy Council, World Energy Scenarios 2019.
6 International Energy Agency, World Energy Outlook 2019.
7 Accenture Strategy, Energy: analysis, 2019.