Back to Petroleum?

August 13, 2009

by David L. Levy

BP and Shell, the two giant British (and British-Dutch) oil companies, are both making a major strategic retreat from alternative energy and refocusing on their core oil and gas businesses. Ed Crooks has recently provided an insightful analysis of BP’s Back to Petroleum strategy in the Financial Times (also see also The Guardian and New York Times). This is big news indeed. A global transition to a low-carbon economy requires the large scale mobilization of financial, technological, and organizational resources that are concentrated in the hands of multinational corporations like BP and Shell. The nine largest integrated oil majors made a record $128 billion in profits in 2007 on revenues of $1.6 trillion, according to this Congressional report. BP alone will invest $20 billion in capital spending in 2009, though less than 5% of this is designated for renewables. Shell’s capital spending is budgeted at $31 billion for 2009, also largely for oil and gas. By comparison, total venture capital investments in clean tech reached only about $8 billion globally in 2008, up from $6 billion in 2007.

If we want to leverage business resources to address climate change, then it’s essential to understand the thinking and decision processes behind corporate strategy. We need to know why some companies are willing to invest billions of dollars to develop new low-carbon technologies and markets, while others invest in the status quo, protecting their core products while engaging in political strategies to block carbon regulation. About ten years ago, as BP began breaking from the climate-denial position of the industry, I became intrigued by the divergence in climate strategies between the more proactive European oil majors and their more conservative US counterparts.

Many people think that business strategy is a rational, objective affair based on calculation and modeling, yet the trans-Atlantic divide had no simple explanation based on the economics of the industry; in fact, the oil majors on both sides of the “pond” had similar global profiles in terms of their oil and gas mix and their regional presence. Together with my colleague Dr. Ans Kolk from the University of Amsterdam Business School, we interviewed senior managers from four oil companies to try to understand what was going on. The insights we uncovered on the behavioral nature of strategy are highly relevant today as BP heads Back to Petroleum, and might just help policymakers figure out how to nudge companies in the right direction (see our academic paper on this).

In July 2000, the British oil company BP launched its famous Beyond Petroleum rebranding and advertising campaign, with a commitment to invest substantial sums in solar and wind energy. This was not just an exercise in public relations; BP had been demonstrating leadership on climate change for several years before that. In a landmark speech in May 1997, BP’s CEO John Browne became the first chief executive of a major oil company to acknowledge the case for precautionary action on climate change, despite scientific uncertainty. The same year, BP left the Global Climate Coalition, the major industry association at the time opposing greenhouse emission controls, initiating a splintering of what had been a rock solid industry coalition. In 1997 BP also established a partnership with Environmental Defense to develop an internal carbon trading scheme and joined the Pew Center for Global Climate Change, which advocates for early action on the issue. In 1998 the company committed to reduce internal emissions by 10% by 2010, even while output was expected to grow 50%. BP followed through with substantial investments in low-carbon energy, creating a separate alternative energy division in 2005 with investments in wind, solar, biofuels, and carbon capture and storage (CCS) rising to a peak of $1.4 billion in 2008.

Exxon, by contrast, has been the standard-bearer of the US oil industry’s fidelity to hydrocarbons. During the late 1990s, Exxon led the industry charge against the mandatory emission controls required by the Kyoto Protocol, culminating in President Bush’s withdrawal from the treaty in March 2001. Exxon, often working through industry associations and think tanks, aggressively challenged the science of climate change and warned against the dire economic consequences of regulating carbon. At the same time, Exxon invested heavily to enhance its technological leadership in oil exploration and extraction and to secure its position as the lowest cost producer. It has also invested modestly in operational energy efficiency, fuel cells, and CCS.

In our interviews with oil industry executives, we found that though European and American oil companies faced similar global market conditions, they viewed the market through very different lenses; the futures they perceived were powerfully shaped by their experiences and national context. Business strategy involves charting a course through an uncertain future, and at the turn of the millennium, climate change presented a host of uncertainties regarding the unfolding state of climate science, the regulatory response, technological developments, public pressures, and competitor reactions. These uncertainties served to expand the “gray zone” of strategic scenarios; will fossil-fuel based businesses go the way of horse-powered transportation? Or will fears of global warming fade as quickly as earlier concerns of a new ice age?

The imagined future in which BP and Shell plotted their strategy was one in which mandatory emission controls were inevitable, carbon would carry a price-tag, and renewables would grow rapidly. Shell was sensitized to the power of public pressure following the Brent Spar incident in 1991 and its controversial involvement in the conflict in the oil-rich Niger delta of Nigeria. This concern fed directly into Shell’s elaborate planning process, which encouraged diverse perspectives; one long-term scenarios was labeled ‘People Power’. BP managers also expressed sensitivity to the growing environmental awareness of the European public, exemplified by the mad-cow scare of the late 1990s and the resolve of policymakers to take strong precautionary action against genetically modified foods in the face of unknown risks.

Exxon’s strategy was crafted for a very different future, one in which fossil fuels continued to power the global economy, mandatory emission controls were stuck in political quagmire, and the public demanded cheap fuels rather than worry about the environment. Exxon’s strategy certainly made sense from the perspective of the mostly American managers who staffed the corporate offices in Texas and New York, just as BP and Shell’s strategy made sense to the European managers based in London and The Hague. Yet these companies were operating in the same global markets.

Until I actually visited Exxon and interviewed their managers, I had assumed that the company’s campaign against the dominant IPCC interpretation of climate science was purely strategic – a means to defeat regulations that they saw hurting the company’s interests. After the interviews (and many others with other companies), I became convinced that the managers really believed the position that climate science was not yet sufficiently convincing to put the fossil fuel industry, and indeed, the American way of life, at risk. Partly this illustrates the psychological phenomenon of minimizing cognitive dissonance: people (and organizations) shape their perceptions of reality to reduce internal conflicts. But personal and organizational factors are also important at Exxon. Brian Flannery, a respected atmospheric scientist and himself a climate skeptic, led Exxon’s climate strategy team. Moreover, Exxon’s strategy process was highly centralized, leaving little room for consideration of alternative scenarios. Shell and BP, by contrast, lacked internal expertise in climate science, and so relied on outside scientists who tended to be closer to the mainstream IPCC view.

Exxon also took to heart the key lesson of business strategy taught in every MBA program: stick to your “core competencies”, those things you do better than competitors. The company had lost money when it had tried to diversify in the first energy crisis in the 1970s. One manager said “we have learnt from the experiment with diversification that businesses such as office products, with rapid product cycles and very different technologies, require competencies that Exxon lacks.” Exxon understood that its core expertise lay in geology, hydrocarbon chemistry, extraction technologies, and distribution, and it has invested to enhance its capacity in these technologies. Though Exxon eschewed biofuels for many years, in July 2009 it announced a $600 million algae biofuels project with biotech company Synthetic Genomics. Biofuels clearly represent a better strategic fit than solar or wind, and promise to extend the age of liquid hydrocarbon fuels.

BP and Shell managers were not ignorant of the principles of strategy, but saw the risks differently. They appreciated that companies cannot reinvent themselves overnight. If the they had deep pockets and several decades to adjust to a low-carbon future, then it was better to begin investing now to build the necessary expertise organically, over time. They intended to remain focused on their core oil and gas business for many years, so these modest investments in alternatives were something of a hedging strategy. The risks of doing nothing, in technological and political terms, seemed greater. In any case, strategy is more art than science; plenty of companies have successfully transformed themselves, from film to digital photography, and from transistor radios to high-definition televisions, though many have certainly failed. Perhaps the question is one of execution.

Even as we were trying to explain these divergent strategies, we sensed that there was likely to be convergence within the oil industry. The oil companies were rapidly internationalizing their senior management teams, broadening the perspectives brought to the climate strategy process. Their managers were also interacting more frequently at climate-related conferences and industry associations, leading to the emergence of shared perspectives on the climate issue. Notably, senior managers realized that climate change was not such a mortal threat after all; coal might be doomed, but liquid fuels for transportation would be hard to replace and natural gas for power would boom in the coming decades. Rapidly growing demand in developing countries would offset the impact of energy efficiency and alternative fuels. Crucially, the emerging international regime to control GHG emissions is looking weak, with carbon prices too low to have much impact on the oil industry. Prices above $30/ton CO2, equivalent to about 30 cents per gallon of gasoline, are politically implausible in the US for the foreseeable future.

Making money in renewables is turning out to be difficult, despite the rapid growth of solar and wind markets (before the 2008 crash). The multiple competing solar technologies, from thin film to crystalline to organics, raise the risk of backing the wrong horse. Solar thermal is beginning to look like a better bet now than solar PV for grid scale power, though both are still far from commercial viability without subsidies or very high carbon prices. The leading global companies, such as Q-Cells in solar and Vestas in wind, are independent, innovative, and focused. Solar PV requires expertise in silicon semiconductors, so it’s not surprising electronics firms such as Sharp and Kyocera are among the top manufacturers. Wind energy demands expertise in materials science and aerofoil design, perhaps explaining GE’s strategic thinking in entering this market.

Now, in the summer of 2009, strategic convergence in the oil industry is almost complete. BP is shutting the Alternative Energy office it had set up in County Hall, London and merging the division back into its corporate HQ. It is cutting investment in alternative energy by 30-60% this year and has closed some of its solar PV facilities, moving production to Chinese subcontractors. Most tellingly, Vivienne Cox, who had headed the alternative energy business since 2004, left BP at the end of June. Shell has divested much of its solar capacity in the last couple of years and has pulled out of a major UK offshore wind project. Just last month, the company announced that it would freeze its research and spending on wind and solar. Both companies have invested heavily in oil from Canadian tar sands, and are focusing their alternative energy efforts, like Exxon, on biofuels. Meanwhile, Exxon is no longer campaigning against climate science and recently began pushing for a carbon tax in preference to a cap-and-trade system.

The oil industry appears to be converging on a strategy of “hydrocarbon neutrality” – it no longer needs to pay the political price of fighting mandatory emission controls, but neither is it running to embrace renewables. It is still too soon to say if this is the “correct” strategy from the companies’ point of view; climate change is not going away as a strategic driver, and longer term, renewables markets look more attractive than the mature oil industry. But whether or not this is good corporate strategy, it’s not good news for the earth. The industry is a powerful player in our societal response to climate change, and not just in terms of its political influence over states. The decisions private companies take about how to spend their vast technological, financial, and human resources have a profound impact on our planetary commons. Back to Peteroleum means that, for now, these resources are prolonging the fossil fuel age rather than fueling a systemic transition to a low-carbon future.

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Afterword:

My colleagues Andy Crane and Dirk Matten note in their excellent blog post that smaller companies will pick up the clean energy torch for now, but the big oil companies might jump back in and buy the successful ones later as the issue matures.

2 Responses to “Back to Petroleum?”

  1. A great piece, David, and the industry we studied together continues to be very interesting. Actually, recalling the evidence we found at the beginning of this century, the retreat of BP and Shell is not so surprising – they formed renewable business units but these needed to show profitability within 5 years or so. So now that this hasn’t worked out, and considering the overall economics (low oil price), it is back to (core) business, while reaping some reputational benefits and spreading (avoiding) risks of doing nothing. Apparently the cost of stopping now is smaller than that of sticking to it.
    Interestingly, wasn’t this what Exxon predicted in 2000 as well? That BP and Shell were in reality not so different in terms of core business, and that they were experimenting but if loss-making they would sell it?
    Not sure what conclusions to draw from this (e.g. about how to identify true strategic change), but it is indeed a convergence of both political and market strategies within the industry.

  2. It is not surprising to see companies doing ‘flip-flop’ on their business strategies. When oil was over $100, they were signing new initiatives for deep sea drilling, and then completely abandoned them once oil prices tanked below $50.

    But, I do agree that they will continue to focus on their core competencies and wait until a clear direction emerges in alternate energy sources. Wait and watch and buy smaller winning companies to build their own portfolio. Though I am seriously convinced that future will hold a major share for alternate energy