Open Season for The Energy Market

Dan Loeb’s Third Point Management activist investor firm’s stake in Royal Dutch Shell revealed this week may reveal more about how energy giants balance business models in the future to hold on to higher returns. Loeb’s plan is straightforward: break up the corporation. Put the oil and gas assets in a separate company focused on returning cash to shareholders while establishing an independent renewable energy company. In his investor letter, Loeb’s comments on Shell were vague on how many firms would form by splitting units. These include renewables, liquefied natural gas, and marketing from heritage exploration and production. However, he argued that Shell’s current “doing it all” approach makes it more challenging to attract shareholders.

Shell stated that it “welcomes open conversation with all shareholders, including Third Point”. It does this due to an earnings miss published on Thursday morning.

Later that day, during a conference call with the media, Shell’s CFO stated that the company has communicated with Third Point on several occasions during the past year. The converse may be true: integrating the cash flow of oil and gas assets under the same corporate roof as high growth, investment-intensive renewable energy business.

The $7 Billion Shell Decision Explains a Lot

Shell’s recent sale of profitable oil and gas assets in the Permian Basin underscores the problem.

The sale to ConocoPhillips was worth $9 billion, so where did the money go? A total of $7 billion was returned to shareholders. An undetermined portion of the remaining funds goes toward overall spending and programs such as energy transformation.

At the time of the acquisition, Shell informed CNBC. It said that most of the deal proceeds would be returned to shareholders rather than invested in renewable energy. However, she referred to a thorny problem with investor returns: “We are consistent on disciplined capital allocation and going after projects that would have the maximum value and returns.”

The legacy fossil fuels business generates the highest profits, especially now that oil prices have returned to a decade high.

Renewable Energy Returns Aren’t High

The Norse energy giant Equinor has been at the vanguard of the renewables revolution. This summer, it has reduced its estimated rate of return from its offshore wind projects from 6% to 10% to 4% to 8%. Moreover, it anticipates an internal rate of return of 30% for oil and gas. Nonetheless, the business has stated that it will increase its renewables and carbon capture spending. The increase will equal more than 50% by 2030, up from 5% last year.

High costs paid in recent years for renewable projects are one of the reasons return expectations have fallen. The $7 billion that Shell just returned to shareholders from the $9 billion Permian transactions was not a large sum of money in the context of its business and shareholder expectations. Annual levels of pre-pandemic shareholder return, for example, were as high as $19 billion in 2019. An oil business must continue to return money to shareholders. This will deter them from shifting to other sectors or peers within the energy market. She believes it is a wise strategy from the standpoint of just obtaining liquidity and retaining investors for the next few years.