Tag: Diversification

Diversification strategies in Energy Transition

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Diversification, in the context of the global energy transition, is the broadening of the core fossil fuel business of oil and gas companies into new low-carbon energy products and markets.  At present, there are limited low-carbon diversification options available to invest in, and the options are in industries that are themselves nascent or require a huge amount of R&D investment to improve profitability.  

Each option comes with some opportunities and some downside risks.  The challenge is to select the optimal option, given firm-level capabilities, economic, social, and political conditions, to effectively diversify away from a fast- disappearing value source, whilst managing the risks and opportunities.

Oil and gas companies, through this diversification, are seeking to develop a viable, sustainable, and profitable business model that meets the environmental, regulatory, and financial criteria set by climate change actions.  However, the companies have differing views of the impact of the climate change on their business models and product demand, as implied by their responses underpinned by their varying future scenarios and forecast models used for business planning.  

This results in a broad spectrum of diversification strategies. At one end of the spectrum are those companies who plan to stay firmly within the fossil fuel business, diversifying as little as possible, at the other end are those who aim to transform completely into pure players in a new industry.  Across the spectrum are companies aiming for varying degrees of diversification, in the short-term at least, from product diversification within existing fossil fuel markets to diversification into various low carbon and renewable technologies.

A quick skim through of the various diversification initiatives in the industry shows that there are three main strategies which are adopted.

  • The resources specialist strategy is betting on a future that promises significant demand for hydrocarbons for another 30 to 50 years. The hypothesis is that fossil fuels will continue to be a key component in the foreseeable future whilst energy transition evolves globally
  • The integrated energy player strategy is looking to retain the profitable core, while also capturing some of the large global opportunities now emerging in low-carbon markets, including renewable power, bioenergy, next-generation mobility, energy services and hydrogen
  • The low-carbon pure play strategy is betting heavily on building future-proof, low-carbon businesses while divesting themselves of legacy, high-carbon portfolios that could create management distractions and present investment propositions that are too mixed for both equity and debt investors

Energy Transition and its economic rationale has been long recognised by the corporate world. However, as stated above its not a one-size-fits all transition strategy adopted in the industry.  The choice depends a lot on the priorities outlined by senior decision makers of the company and the direction given by investors.  And these are expected to further evolve based on the early outcomes of the diverse strategies.

Energy Transition and the diversification of Oil and Gas business

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To keep global warming to below 1.5 degrees C this century, the global energy system needs to be transformed from being largely based on fossil fuels to being largely based on renewable energy. This global energy transition shifts the production and consumption away from non-renewable fossil fuels towards the use of low carbon and renewable energy solutions. 

The International Renewable Energy Agency (IRENA) in its Global Renewables Outlook: Energy Transformation 2050 sets out an ambitious outlook to cut 70% of the world’s energy-related carbon dioxide (CO2) emissions by 2050. Over 90% of this reduction would be achieved through renewables and energy efficiency measures.  IRENA estimates that around 260GW of renewable energy capacity was added globally in 2020, beating previous record by almost 50%.

In the context of this fast-progressing energy transition, Oil and gas companies are faced with the existential challenge of how to diversify away from their current reliance on fossil fuels without losing the value and cash generating potential of their current business.  The expected decrease in demand for fossil fuels and concerns over damage from climate change is creating business risks for oil and gas companies and could result in a significant number of stranded assets and loss of value. In the long run, this could also lead to the transformation for some of the major oil and gas companies into completely new businesses.

Diversification, in the context of the global energy transition, is to broaden the core business of oil and gas companies into new low-carbon energy products and markets.  At present,

there are limited low-carbon diversification options available to invest in, and the options are in industries that are themselves nascent or require a huge amount of R&D investment to improve profitability.  Each option comes with some opportunities and some downside risks.  The challenge is to select the optimal option, given firm-level capabilities, economic, social, and political conditions, to effectively diversify away from a fast- disappearing value source, whilst managing the risks and opportunities.