Energy Crisis Raises Doubts About Energy Transition Strategies

The Ukraine war is pushing energy security to the top of the agenda for the West, prioritizing oil and natural gas production over climate change and environmental activism for the first time in decades.

That is good news in the long run since it will ensure a smoother and more viable energy transition – one that doesn’t abruptly abandon traditional fossil fuels for renewables not yet ready for prime time.

That is true even in Europe, where the transition to green energy is most advanced. There is a recognition in Brussels and capitals across the continent that the most immediate concern is finding alternative oil and natural gas supplies to complete the transition off of piped Russian energy supplies.

The implications for international oil companies are immense.

Before the war in Ukraine, Europe’s oil companies were under tremendous pressure from investors to cut their “Scope 3” greenhouse gas emissions. Scope 3 refers to emissions from consumers of fossil fuels.

The idea of holding producers responsible for the emissions of consumers was always pure folly. After all, oil and gas companies are only meeting consumer demand for these fuels. If societies want to switch their economies to low- or zero-carbon sources, it’s up to their governments to make that happen through policy and legislation, not forcing private companies to bear the burden.

Nevertheless, Europe’s top oil companies like Shell, BP, and TotalEnergies in recent years found themselves under fire from shareholders and broader society for failing to address Scope 3 emissions. And they responded by setting targets to reduce the intensity of their Scope 3 emissions.

This meant in practical terms, that Europe’s biggest oil and gas producers vowed to curb growth rates or even reduce their oil and gas production in coming years. Indeed, reducing Scope 3 emissions became code for cutting production.

This situation was most pronounced at BP. The UK energy major promised to cut oil production by a staggering 40% by 2030 to satisfy investor demands that it address Scope 3 emissions. Never mind that BP planned to achieve this by selling oil-producing assets to other companies – most likely ones not facing the same climate pressures to exit the fossil fuel sector.

The whole exercise was ridiculous, and Europe found this out the hard way after Russia invaded Ukraine last year, prompting an energy crisis.

Over the past year, investors have eased the climate change pressure on European oil companies – even if some governments like the UK continue to make a mockery of energy security with policies like windfall profit taxes.

The Scope 3 pressure has eased in financial markets, providing European oil companies more freedom to deal with the political realities of the moment.

BP has since rethought its energy transition strategy, realigning for a post-Ukraine world. The company has prolonged plans to shed producing assets, now promising to reduce them by 25% by 2030 while vowing to invest an extra $1 billion a year in upstream oil and gas production.

The investor response has been stellar. BP’s stock price has risen 17% since the announcement last month.

It’s no surprise the new CEO of Shell, Wael Sawan, is reviewing his company’s plan to cut oil production by up to 2% each year this decade.

Also unsurprising is that Shell recently weighed a plan to delist its shares from the UK stock market and move them to the United States

European oil companies trade at a steep discount to their U.S. peers – a reality they are understandably frustrated with.

Activist investors in Europe have pushed radical transition strategies on oil companies there, prompting them to make big investments in low-return renewable electricity. Euro majors’ valuations have suffered as a result.

U.S.-based majors like ExxonMobilXOM
, ChevronCVX
, ConocoPhillipsCOP
, and Occidental have enjoyed better stock evaluations than their European competitors because they’ve been more resistant to social pressures to change their business model.

U.S. investors have preferred oil and gas companies to do what they do best – produce oil and gas at the lowest cost with the lowest carbon footprint possible. U.S.-based majors have focused on decarbonizing their operations where feasible and reducing Scope 1 and Scope 2 emissions – which they have direct control over – not consumer emissions – which they do not have control over. U.S. majors have invested in new businesses complementary to their existing operations in oil and gas production, refining, and petrochemical operations. These include carbon capture and storage (CCS), biofuels, hydrogen, and other advanced technologies that improve the environmental performance of fossil fuels.

That’s been ExxonMobil’s strategy all along – and one shouldn’t blame them for wanting to be the best oil company in the world. It’s also why you won’t find many U.S. oil companies buying solar farms or putting up wind turbines. It’s simply not what they do best.

Equity markets are sending a clear signal to oil companies – and policymakers – that the U.S. model is the preferred energy transition strategy. I’d argue that it’s the most viable, too. The Europeans are starting to understand this. Unfortunately, it took a war and an energy crisis to reach them.