ImpactAlpha, Nov. 24 – They were engines of growth for much of the past century. Now, some of the most iconic names of the fossil fuel era are breaking up, spinning off and otherwise restructuring themselves to hold off a new generation of sustainable juggernauts.
From Shell to Ford to General Motors, investors are clamoring for companies to spin off their high-growth green businesses from their stodgy legacy operations. The thesis: Such NewCo’s – or better yet, ReNewCo’s – will be able to reap the rich valuations and easy access to capital enjoyed by clean energy providers and electric vehicle makers at the forefront of the transition to a low-carbon economy. The OldCos can be milked for profits while they last.
Already, General Electric, the conglomerate assembled by Jack Welch, is breaking up into three units, including an energy company that will house its wind turbine business. That follows similar moves from its German competitor, Siemens AG.
On the heels of the insurgent board shakeup at Exxon led by activist investors Engine No. 1, hedge fund Third Point is pushing Shell to split in two. The Italian oil major Eni is spinning off its renewable energy, electric-vehicle charging and retail businesses into a separately traded company, Plentitude.
A growing chorus is demanding the same from automakers GM and Ford, which are worth less than pure-play EV makers Tesla and Rivian despite far higher sales.
Dynamics differ by company. GE’s conglomerate structure had grown unwieldy, for example. But a historic remaking of the economy has investors demanding, at a minimum, more visibility into companies’ ability to navigate the shift.
“The risk and return is totally different for the new business than the old business,” says UC San Diego’s David Victor, a professor of innovation and public policy. “The more the new businesses thrive, and the old businesses die, the more they must be managed distinctly.”
Nowhere is the disruption more stark than the auto industry, now rebranded as the ‘mobility sector.’ The days of the internal combustion engine are numbered. Today’s electric vehicles are ushering in a future of autonomous, self-driving vehicles. That requires a different skill set than the manufacturing prowess that built Detroit.
Incumbent automakers are stepping on the, er, gas. GM is investing $27 billion through 2025 to convert its fleet to all-electric by 2035. Ford, which is readying an electric version of its popular F-150 pickup, will spend $29 billion on EVs and autonomous vehicles through 2025.
Still, Tesla is valued at more than $1.1 trillion and newly public Rivian at more than $100 billion, eclipsing GM’s $91 billion market cap and Ford’s $81 billion. GM’s revenues through the first nine months of this year were $93.4 billion; Rivian’s: zero.
The disruptive shift to electric and autonomous vehicles will require a high-value currency for strategic investments and acquisitions. Traditional automakers are at a disadvantage compared to their pure-play EV rivals in accessing capital markets, says Datatrek’s Nicholas Cola. In a research note, he called for the breakup of GM and Ford. With their current stock prices, he said, “they will be bringing a penknife to a gunfight.”
Adds Morgan Stanely’s Adam Jonas: “The battle for capital and talent is likely to get significantly more challenging as start-up EVs attract large amounts of investor and consumer interest.”
Fossil fuel companies may be an even more urgent shake-up target, as they come under increasing pressure to decarbonize and turn around their flagging financial performance (a resurgent economy and higher oil and gas prices has lifted their shares this year).
The International Energy Agency and others have declared that there is no room for new fossil fuel expansion if the world is to achieve net zero emissions by midcentury. That could strand more than $3 trillion in oil and gas assets by 2050, including reserves that must be kept in the ground, according to the International Renewable Energy Agency.
At this month’s COP26 global climate summit, global leaders agreed to step up emissions reductions to keep warming to 1.5 degrees Celsius. In a side deal, more than 20 countries agreed to end direct public financing for unabated coal, oil, and gas by the end of 2022. The pledges fall short of an end to new fossil fuel production, but are one more signal of the coming end for fossil fuels. At least 10 countries, led by Denmark and Costa Rica, formed the Beyond and Oil and Gas Alliance to phase out fossil fuels.
But if incumbent automakers are scrambling to reinvent themselves, most fossil fuel companies are taking a leisurely stroll into the low-carbon future.
Climate laggards Exxon and Chevron have doubled down on oil and gas production, while allocating relatively small sums to unproven hydrogen and carbon capture and storage, which play to their traditional drilling and geological strengths.
Oil giants such as BP and Shell are making significant investments in wind and solar-powered energy, which require new skills and expertise. They are also investing in potential emissions-reduction technologies like hydrogen and carbon capture. Even so, they see a continuing role for oil and gas.
That’s put the oil majors in the crosshairs of policymakers, investors and activists.
“I think we are going to see a number of the big oil and gas companies starting to manage themselves as separate enterprises,” said UCSD’s Victor.
Next up could be Shell.
In a late October letter to investors announcing its stake in Shell, Third Point’s Daniel Loeb laid out the rationale for breaking up the more than 100-year old company. Some shareholders want Shell to move aggressively into renewable energy, he explained, while others want the company to prioritize the return of cash from oil and gas operations.
A standalone legacy energy business, Loeb wrote, could reduce spending, sell assets, and return cash to shareholders. A carved-off natural gas and renewables unit could “combine modest cash returns with aggressive investment in renewables and other carbon reduction technologies,” and benefit from a much lower cost of capital.
“Pursuing a bold strategy like this would likely lead to an acceleration of CO2 reduction as well as significantly increased returns for shareholders, a win for all stakeholders,” Loeb wrote.
Shell last month proposed simplifying its dual-share corporate structure by moving its headquarters to London from the Netherlands, where it is embroiled in a lawsuit over its emissions reductions. “Royal Dutch” would be dropped from its name.
Splitting fossil fuel companies into OldCo’s and ReNewCo’s poses its own risks. “If the sustainable business units are spun off and leave the legacy polluting activities under one roof, there is a danger that the intent is to cast off projects in need of expensive remediation,” warned Andrew Behar of the shareholder activist group As You Sow.
He cites Peabody Coal’s 2007 spin-off of Patriot Coal, which went on to declare bankruptcy and dump its most toxic assets on the public for remediation, in a model pioneered by mining giants Rio Tinto and BHP.
Already, fossil fuel companies have been selling off underperforming oil and gas operations to private companies. That just transfers emissions to another entity while making them harder to track, and potentially saddles taxpayers with future cleanup bills.
And companies such as Exxon that are eschewing renewable energy and focusing on “clean” technologies like carbon capture that draw on their traditional expertise may not be good candidates to split up.
There’s another option: a managed decline.
Victor envisions an organic winding down for oil majors like Exxon, where people, skills and capital gravitate into the low-carbon parts of the business over time, shifting the company from “a high carbon kind of extractive industry to a carbon management industry.”
BlackRock’s Larry Fink has similar ideas. At a side event during COP26, he floated a scenario in which oil and gas companies put a portion of their hydrocarbon businesses into a “declining trust.” The proceeds would be invested in green businesses; the legacy business would be managed down in a transparent way. Financial institutions did something similar in the Great Recession when they parked toxic assets in “bad banks.”
“We need to create these types of vehicles like we’ve done during the financial crisis with banks,” said Fink. “We need to create new vehicles, new thought processes.”