Summary: Europe’s prominent Oil & Gas groups (BP, Eni, Repsol, Shell and Total) made major announcements in the field of climate change slightly before and after the Covid-19 crisis broke out. Such announcements suggest a gradual change of paradigm among European majors not only on sustainability issues but also on the scope of assets deemed relevant amid rising climate change awareness and uncertainties on oil demand fundamentals. Such change of paradigm is likely to accelerate European majors’ shift towards electric utilities’ business models, which has been evidenced thus far through continuous expansion of renewable capacities, increased footprint in the electricity retail market and development of low carbon mobility infrastructure. How fast European majors will go in that direction (increased organic effort and/or large scale M&A involving prominent European utilities or renewable development specialists?) is difficult to determine at this stage, for the swiftness of such shift will be contingent on a set of largely exogeneous factors (speed of oil price and demand recovery, general political/societal background around the extraction and use of fossil fuels).
In the field of climate action, the past few months have been marked by major statements by Europe’s largest integrated Oil & Gas groups (BP, Eni, Repsol, Shell and Total). From Repsol last December to Total last month, European majors have unveiled a series of additional actions to substantially reduce their carbon footprint, in particular through accelerated development of renewable energy and other low-carbon assets. What’s more, with the exception of Eni, all these players have announced their ambition to reach a certain form of carbon neutrality by 2050, this with a view to aligning their business with the 2015 Paris agreement on climate change. Although these net-zero ambitions are set to materialize in various ways the table below summarizes, this series of announcements evidence mounting climate awareness within the industry. Also striking is the fact that the bulk of these new strategies were announced before (cases of Repsol, BP and Eni) the Covid-19 crisis broke out.
Recent European major's announcements in the fiels of climate change
Sources: Oddo BHF Securities, TPI
Such timing is worth highlighting, given the deep impacts the ongoing sanitary crisis has had thus far on the oil industry, not only through a slump in Brent prices, but also through an unprecedented lockdown-induced oil demand destruction phenomenon.
Interestingly, upon announcement of a major step in the development of the group’s renewable capacity (51% stake acquisition in Seagreen 1, Scotland’s biggest offshore wind project), Total CEO Patrick Pouyanné raised the issue of the sector’s going concern amid electricity gradually taking over the role of oil as the world’s premier source of energy. Also of note is Eni announcing on 4 June 2020 a new business structure consisting of a Natural Resources division focused on oil & gas portfolio and of an Energy Evolution division dedicated to power generation, product transformation and marketing from fossil to bio, blue and green.
These various announcements suggest a gradual change of paradigm among European majors not only on sustainability issues but also on the scope of assets deemed relevant amid rising climate change awareness and uncertainties on oil demand fundamentals.
1/ European majors’ Q1-20 results evidence the early impacts of the Covid-19 crisis as well as the higher resilience of their utilities-like activities
The past three months have seen an unprecedented deterioration of oil sector’s fundamentals as evidenced by:
i/ Brent prices now standing at roughly 50%-60% of their end-2019 levels ($30-$40/bbl vs. $66/bbl at 31/12/2019) after bottoming out at $19/bbl last 21 April, and
ii/ Worldwide oil demand plummeting in March-April 2020 due to the lockdown measures implemented all across the Globe in response to the pandemic. As a result, the IEA expects world oil demand to dip in 2020 to about 91 million barrels a day, to compare with a level of nearly 100 million barrels a day of oil seen on average in 2019.
Noteworthy is the abovementioned oil price slump no being fully tied to the pandemic, for Brent fell below the $50 threshold last 6 March slightly ahead of the lockdown measures announcements in Europe and in the US, after the OPEC+ (OPEC and Russia) failed to agree on production cuts to cope with already deteriorated demand fundamentals.
Trend in oil (Brent) and gas (Netherlands-based TTF) prices since January 2016
Such developments had almost immediate impacts on the industry as evidenced by European majors nearly all reporting double-digit contractions on their operating result generation in Q1-20 relative to Q4-19. Unsurprisingly, save for specific instances (i.e. case of Repsol’s refining business), European majors took the hit through their Upstream and Downstream operations. Such two-fold impact proved relatively new to largely integrated oil & gas players: under ‘’normal’’ circumstances, any oil price downturn tends to be mitigated through vertical integration, with cheaper oil not only improving refining margins but also boosting demand for petroleum products.
Against such backdrop, the assets cushioning the unprecedented deterioration of sector fundamentals were those contiguous with Utilities’ traditional or new activities, namely renewable energy production, LNG (liquified natural gas) supply, gas and power sales in the retail market. These activities offering genuine resilience and even continuing to grow (as seen with Eni’s and Total’s) comes as no surprise: they tend to be operated under protective contracted frameworks as opposed to upstream oil and gas activities where volumes are sold spot either internally (abovementioned vertical integration case) or externally. In the case of renewable energy assets, volumes are sold at prices which are either ‘’regulated’’ (through feed-in tariffs/premiums) or ‘’contracted’’ (through corporate PPA-type arrangements). Concerning LNG sales, the underlying logistics chain is so capital-intensive that the whole business is structured around long-term contracts, with take-or-pay clauses between the supplier (typically an international Oil & Gas company) and the end-user (typically a ‘’national’’ gas utility). It should be added though that global LNG fundamentals have deteriorated further through the second quarter, with Total, Shell and BP reported to have cancelled LNG cargos at US export terminals, electing to pay fixed liquefaction fees rather than lifting gas.
European majors’ Q1-20 operating performance
2/ Oil & Gas groups have swiftly responded to deteriorated sector fundamentals by slashing capex budgets while sparring renewable and low carbon spend
As all sectoral players, European majors swiftly responded to the new price and volume environment, with a set of measures mimicking those implemented in 2014-15 during the previous oil price downturn, namely:
i/ Operating efficiency measures (Opex cuts);
ii/ Revised shareholders’ remuneration schemes (end of share buyback programs and in some instances – notable case of Shell - dividend cuts) and
iii/ Substantially reduced 2020 Capex budgets (circa -25%/-30% on average in our sample). The table below summarizes the various investment cuts announced during the Q1-20 reporting season. Unsurprisingly, in light of the deteriorated price and volume environment sectoral players face, the bulk of the capex adjustments primarily concern oil-exposed activity, namely Upstream and Refining activities. In the same time, while slashing overall capex budgets, European majors sparred their planned spend in low carbon/renewable activities.
European majors’ revised 2020 investment plans
Sources: companies, Natixis
Low carbon/renewables spending being sparred amid massive Capex cuts is consistent with the increased sustainability targets announced before or after the Covid-19 broke out. Interestingly, looking in detail at European majors’ investment plans and key decarbonization pillars, apart from the development of carbon offsetting projects through reforestation and carbon capture and storage (CCS), ones sees converging efforts towards the expansion of electric utilities-like assets/activities, namely:
i/ Low carbon electricity generation; which includes renewable assets as well as (more questionably – see above) state-of-the-art natural gas-fired plants;
ii/ Retail electricity and gas sales;
iii/ Charging infrastructure for low carbon mobility (electric and fuel-cells vehicles)
European majors’ targeted renewable capacity development
Sources: companies, Natixis
3/ In the European utility sector, Q1-20 results and updated 2020 guidance showcase higher resilience from renewables-centric players
By contrast, the European utilities sector looked like a safe haven in Q1-20, with most players displaying very resilient performance and providing reassuring EBITDA guidance for the rest of the year. As the table below shows, from an EBITDA generation perspective, save for specific instances (in the case of EDF mostly generating electricity from nuclear sources in France, see below), the sector should be moderately affected by the pandemic and the expected slump of Eurozone GDP in 2020 (-8.8% according to the current estimations of Natixis’ economic research).
Interestingly, the players set to best withstand the crisis are those with the highest share of revenues from regulated/contracted activities (typically electricity and gas networks activities and renewable generation assets). In the power generation segment, holding all else equal, such players operating the highest proportion of renewable assets (PV solar and wind) resisted better than those running mostly conventional generation fleets (nuclear and gas/coal-fired assets). Such difference mainly comes from renewable assets generally enjoying priority dispatch in electricity grids due to the intermittent nature of the underlying wind and solar resources, making renewable generation variable, unpredictable as well as price insensitive. From an electricity system operation perspective, the main practical implication of such dispatch priority is that conventional generation assets end up satisfying “residual” demand (i.e. demand not already met by renewable sources). Such rule proved true during the lockdown period with massive electricity demand contraction affecting conventional generation fleets (primarily nuclear reactors and gas-fired plants), while sparring renewable assets, save for specific instances (negative power prices leading to negative premia). These operational issues accounts for energy utilities with a high share of renewable generation such as EDP, Enel and Iberdrola, showing greater resilience than those players such as EDF primarily running conventional generation assets.
Major European energy utilities’ Q1-20 results & 2020 EBITDA guidance
Sources: companies, Natixis
Such operational differences should not overshadow the main trends at play in the sector, namely the near complete focalization of European energy utilities on renewables and networks expansion through their growth capex budgets. Such joint focus on green generation assets and networks upgrade/expansion comes as no surprise: for EU to reach carbon neutrality by 2050, there is still much effort needed to decarbonize existing generation fleets, mainly through expansion of PV solar and wind asset bases, but also to make electricity networks ready to withstand the intermittent nature of renewable sources, through grid expansion and digitalization. The table below shows that major European utilities’ planned renewable capacity additions in 2020 fit into long-term, overarching sustainability targets, with a set of players directly targeting climate neutrality by 2050 (cases of EDF, Enel and Iberdrola) or earlier (case of RWE).
Major European energy utilities’ installed / targeted renewable capacity and main sustainability targets
Sources: companies, Natixis
4/ European major’s shift towards electric utilities’ business models likely to continue and even to intensify in the coming months/years
European majors lifting their sustainability ambitions comes at a time these players have to cope with an overall environment characterized by mounting political/societal/shareholder pressure on climate change action but also by mounting uncertainty on the extent of oil demand recovery after the end of the sanitary crisis, both sources of asset stranding risk.
To tackle these mounting challenges, European majors’ focus on electric utilities-like assets offers a series of benefits:
i/ It fits into the general trend of “electrify everything” through expansion of renewable capacities to reach carbon neutrality by 2050. A clear reflection of such trend under formation is to be found in the IEA’s 2019 World Energy Outlook: under IEA’s updated Sustainable Development Scenario (SDS - the agency’s most Paris agreement-aligned energy scenario, for it is constructed with the aim of not only reaching climate goals but also ensuring the achievement of several socio-economic and environmental development goals), the respective shares of oil and renewable sources in World primary energy mix would go from 31% and 10% in 2018 to 23% and 33% in 2040. Under this scenario, electricity would find increased uses in Industry, Transport and Building at the expense of fossil fuels and would accordingly reach 31% of final energy consumption by 2040 (vs. 19% in 2018), while incremental electricity demand would be mostly met by accelerated expansion of renewable energies;
ii/ It takes advantage of the traditional contiguity between the electricity sector on the one hand and the oil and gas sectors on the other hand. In the electricity sector, such contiguity is exemplified by former incumbent electric utilities’ now having established dual offering in the retail market (electricity and gas) to take advantage of their traditional client base as well as expanding household as well as industrial uses of natural gas. Besides, while making use of natural gas to run their CCGTs (see above), some electric utilities (case of EDF through Italian subsidiary Edison) have built vertically integrated positions along the natural gas value chain. On the other hand, former incumbent gas utilities such as Naturgy (ex Gas Natural) and to a lesser extent Engie (which was formed following the merger of multi-utility Suez and French incumbent gas utility Gaz de France) have developed dual vertically-integrated positioning along the gas and electricity value chains.
iii/ It increases European majors’ exposure to a set of activities offering higher cash flow visibility and predictability than traditional oil & gas activities, hereby improving these players’ business risk profile as well as their ability to withstand any further deterioration of the sectoral environment;
iv/ From a purely operational standpoint, while proving more capital-intensive and disruptive than other technologies such as CCS, expansion of renewable assets offers immediate as well as tangible climate impact. Although it offers the appealing prospect of potentially fully mitigating the carbon footprint of currently fossil fuel-centric economic systems without business disruption, CCS cannot at this stage be regarded as a large-scale commercially viable decarbonization option. Interestingly, save for Eni, no European major provides quantified targets of CCS-related offsetting mechanisms as part of their increased sustainability ambitions.
For this set of reasons, we see this trend towards electric utilities-like assets likely to gain momentum in the coming months/years. Its magnitude remains nonetheless contingent on a series of mostly exogeneous factors (speed of oil price and demand recovery, general political/societal background around the extraction and use of fossil fuels) and it is still unclear at this stage whether European majors will undertake such asset base reshuffling organically or through large-scale M&A transactions potentially involving European utilities (Iberdrola? EDP? Orsted?) or independent renewable development specialists (Neon? Voltalia?).
 Oil & Gas groups generally set renewables and natural gas-centric activities (LNG trading, power generation from combined cycle power plants - CCGTs) apart in their reporting, flagging them as ‘’low-carbon’’ activities. Let’s recall that upon combustion, natural gas is 35% and 55% less carbon intensive than oil and coal, respectively.
 The concept of carbon neutrality takes many forms in the corporate world. The corporate perception of their carbon “neutrality” often does not include all three scopes of greenhouse gas emissions.
 With a total installed capacity of 1,140 MW due to be commissioned in 2022.
 Being mostly domestic, Repsol’s refining business remained heathy in Q1-20.
 Power purchase agreement.
 Capital expenditures
 Operating expenditures
 Combined cycle power plants (CCGTs).
 Hydrogen vehicles.
 We exclude large hydro assets which are have been run in European for about a century and do not enjoy priority dispatch.
 With electricity demand contracting in the magnitude of -15%/-20% in April in countries such as France, Italy and Spain.
 In France, through the system of negative prices, electricity injected into the grid cannot benefit from an energy premium when production exceeds consumption, leading to negative wholesale prices.
 Despite the decarbonization effort undertaken over the past two decades, the electricity sector still accounted for 28% of EU’s total CO2 emissions in 2017.
 German electric utility recently voiced its ambition to reach climate neutrality by 2040, grounding such ambition on i/ the nearly-full focalization of expansion capex on renewable energies for the coming years, ii/ the impact of the coal phase out in Germany, which implies that all domestic coal and lignite-fired plants will have to cease operation by 2038 at the latest, and iii/ the potential retrofit of existing gas-fired plants for the use of hydrogen as combustion fuel, which would make the residual conventional generation fleet carbon-free.
 Structural oil demand destruction issues arising from lastingly hard-hit sectors such as air transportation (8% of worldwide oil demand in 2019) but also from the potentially disruptive dimension of recovery plans across the globe (case of the recently-announced EU Green deal with joint focus on renewable energy and hydrogen to decarbonize hard-to-abate sectors such as mobility).
 As exemplified by the various options followed in the EU Taxonomy under formation.
 Including hydro assets which nonetheless enjoy limited incremental development potential across the Globe.
 Although Edison recently divested its E&P portfolio to Energean.
 As various observers highlight, current challenges associated with large-scale use of CCS are mainly twofold: first, processes currently developed “only” reach a 90% efficiency rate, which entails specific treatment costs for the remaining 10%. Second, use of CCS implies tailor-made work to adapt the process to the specific features of concerned industrial facilities. For this reason, CCS remains hard to industrialize at this stage of technology development.
 Among European majors, ENI is exemplary in terms of communicating the expected contribution from the offset mechanisms it wants to put in place to achieve its decarbonisation targets (40 MtCO²e per year, with 10 for CCS and 30 with reforestation projects by 2050).
 We nonetheless note Orsted is still 50.1% owned by the Danish government.