The world is on track to surpass the 1.5-degree target set out by the Paris Agreement within the next decade, indicating the need for a significant acceleration in low-carbon solutions. To ensure emission reduction by 2030 and reach net zero by 2050, companies and countries alike are setting and aiming to achieve ambitious targets. The large European energy companies are diversifying themselves in this regard through the adoption of various solutions, such as clean electricity, bioenergy, carbon capture and storage, electric vehicle charging and overall reduced energy intensity.
An equity research report published by Barclays (LSE:BARC, Financial) (BCS, Financial) on April 14, entitled “European Integrated Energy,” by analyst Lydia Rainforth explored the large European energy companies' targets and strategies for reducing emissions, evolving their spending plans and achieving their low-carbon ambitions.
The report compared BP PLC (BP, Financial), Shell PLC (SHEL, Financial), TotalEnergies SE (TTE, Financial), Eni SpA (E, Financial), Equinor ASA (EQNR, Financial), Repsol SA (XMAD:REP, Financial), OMV AG (WBO:OMV, Financial) and Galp Energis SGPS SA (XLIS:GALP, Financial).
The report discussed the differences in definitions of net-zero emissions, including both carbon intensity reduction consistent with the Paris accord or emissions on an absolute basis. European energy companies have embraced the challenge of net zero by 2050, with an average reduction in carbon intensity of 2.7% per year between now and 2030. Post 2030, the most rapid points of change are between 5% and 6% per year as all companies have set targets of 100% carbon intensity reduction by 2050. The report also highlighted the planned reductions in scope 1 and 2 emissions (operated emissions only), with Eni leading the way with its ambitious net-zero aim, according to Rainforth.
To achieve these plans, companies are evolving their spending plans with intentions of investing more into both upstream and renewable assets. Given that oil and gas is likely to still be part of the energy mix into 2030 and beyond, energy companies intend to maintain their legacy assets over this decade to enable the generation of strong cash flow, which can then be invested back into low-carbon solutions. The report showed that companies' revised capital expenditure plans both near and long term, with the key takeaway that by 2030, renewables capital expenditure will be close to 20%.
The large European energy companies are expanding their low-carbon divisions quickly. This poses a challenge for investors as we need to evaluate the worth of these businesses that are designed to generate value after 2030. The Barclays report suggests the market should recognize and reward these efforts, not only to reflect the value they bring, but also to encourage further investments. There are instances, such as in biofuels, where early investment was undervalued in terms of the value it created for several years. The low-carbon businesses typically account for 20% of Barclays’ net asset value-based valuations, and Barclays argues this is not being recognized by the market.
The report discussed the minimum expected returns in renewables businesses, with most of the companies looking for a 10% return or greater. The critical question for the investment case in this sector is evidence that these returns are achievable. Companies are moving away from talking about standalone renewables to more integrated renewables, where returns are often higher thanks to leverage and value add through power trading capabilities. One increasing area of differentiation for the companies is the ratio of electricity sales to electricity production. For example, TotalEnergies is aiming to match electricity sales with its own production, whereas BP and Shell, mimicking their strategy in oil products, will sell four or five times the amount of electricity they produce, utilizing their significant trading and distribution abilities to create value.
The report also explored the companies' renewables ambitions, with most of the focus on low-carbon solutions of European energy companies in wind and solar, yet most of the renewable pipeline is yet to be built. Strategies vary across companies. At present, Shell has the largest renewables pipeline of 45 gigawatts, although it has not set a specific target for future years. Equinor's ambitions relative to scale appear smaller, with a greater focus on offshore wind projects.
The key takeaways from the report were:
- 2030 is the point where European energy companies accelerate their decarbonization strategies.
- Capital expenditure in “low-carbon” businesses should step up as projects become real.
- There will be multiple pillars for the European energy names to decarbonize. They are reduced energy intensity, clean electricity, hydrogen, bioenergy and carbon capture and storage.
- Low-carbon strategies should eventually reap rewards (in the opinion of Barclays).
- Avoided emissions will likely increasingly become a focus for investors.
In conclusion, the report highlighted the growing focus on setting and achieving targets for companies and countries alike, not only for reaching net zero by 2050, but also interim targets to ensure emission reduction by 2030. Barclays thinks European energy companies are leading the way in embracing the challenge of net-zero emissions and have set ambitious targets and strategies for reducing emissions, evolving their spending plans and achieving their low-carbon ambitions.
My own opinion is that any large energy company will have to be very careful if it wants to become an “integrated energy” company. An integrated energy company playing in every energy market is really a conglomerate with an energy story linking the various divisions. Financial theory tells us that conglomerates should trade at a significant discount to the sum of their parts, due to the complexity of understanding and valuing the business and the risks involved when one management team tries to do too much. This means, in my view, as we get closer to 2030, we will hear more calls to break up big energy companies, like those coming from Daniel Loeb (Trades, Portfolio) now who is campaigning to break Shell up into an oil and gas business and a renewables business.
