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Breaking up is hard to do: Energy majors and activist investors

© Supplied by Kris Miller/DCT MediSSE Renewables' meet the buyer event at Apex Dundee as they prepare to construct Scotland's biggest offshore windfarm. Thursday, 7th November, 2019.
SSE Renewables' meet the buyer event at Apex Dundee as they prepare to construct Scotland's biggest offshore windfarm. Thursday, 7th November, 2019.

Activist investors have grabbed headlines in recent months with calls to break up major energy players – but will this help or hinder their energy transition efforts?

Whether it’s Equinor, a newly rebranded TotalEnergies or a power generator such as RWE, large, integrated energy companies have positioned themselves at the centre of the energy transition. Their argument is that their diverse experience and large balance sheets can help fund and deliver the massive overhaul of the global energy system required to reduce emissions and meet net zero targets.

Counter to that narrative however, some investors have argued that greater strength lies in spinning off clean energy and transition businesses, simplifying their offering.

In September, hedge fund Elliott Management acquired a stake in generator and network operator SSE, prompting reports it was pressuring SSE to spin off its renewables business into a separate entity.

Though the suggestion was brushed off by leadership at the London-listed group, the fund doubled down in December, publishing a letter alleging that SSE’s networks and renewables business would be worth £21 per share, and could unlock “£5bn of value” through separate listing.

“A separation would resolve the long-term funding challenges that have hindered SSE’s growth historically,” it argued, and demanded the company explore other strategic initiatives.

Meanwhile, October saw activist investor Third Point lodge a similar demand of Shell, having built up a $750m stake in the listed supermajor, equivalent to about 0.4% of the company.

In a letter to investors ahead of the company’s quarterly results, founder and CEO Dan Loeb said the company would benefit from breaking off its liquefied natural gas (LNG), renewables and marketing businesses into a standalone unit, separate from its refining, upstream and chemicals business.

He argued that in efforts to fund both fossil-fuel activities and the energy transition, Shell couldn’t please all investors, leading to “an incoherent, conflicting set of strategies attempt to appease multiple interests but satisfying none.”

In response, both companies have argued that splitting up their respective businesses would increase costs and reduce their ability to back major renewables and energy transition projects.

Shell CEO Ben van Beurden hit back, detailing the company’s “incredibly coherent strategy,” and adding that “a very significant part of this energy transition is going to be funded by the legacy business,” while CFO Jessica Uhl said that a spin-off business “sounds really interesting from a financial perspective — it’s a pure play, it’s got one cost of capital”, but the suggestion “breaks down” when it came to enacting real solutions.

SSE’s chief executive Alistair Phillips-Davies took a similar stand in response to Elliott’s approach, stating: “Scale is very important… if you’re half the size, you’ll only get half the funding.”

© Supplied by Bloomberg
Ben van Beurden, chief executive officer of Royal Dutch Shell Plc, speaks during a session on day two of the Web Summit in Lisbon, Portugal, on Tuesday, Nov. 2, 2021.

Pure advantage?

That’s not to say such spin-offs couldn’t happen. There are of course precedents for this type of transaction, such as the Uniper/E.ON split seen in the European power sector, and the transformation of Denmark’s DONG Energy into Ørsted.

“From an investor’s point of view, conventional financial theory suggests that pure plays are better as this allows individual investors to assemble their preferred exposure. Reality is more complicated,” a spokesperson for strategic advisory group Gneiss Energy explained.

“The various parts of these businesses have different costs of capital and cash flow profiles. Part of Shell’s argument is that the cash flow from its conventional business can help to fund the growth into cleaner energy.

“The counterargument is that the green business perpetuates the underlying core oil and gas business – and only time will tell,” they added.

In Shell’s case, financial think tank Carbon Tracker argues that Third Point’s proposal is “unlikely to enhance shareholder value in the long term, to lower the cost of capital or to stimulate more investments in decarbonisation.”

It adds that even if there was greater investment in a new pure-play renewables unit, the role of LNG in that new entity would be questionable. “Meanwhile, the rump business might become less inclined to decarbonise.”

Moreover, it prompts the question of who should deliver major energy transition projects, if not larger, integrated businesses like these.

“If the likes of Shell and SSE are not in charge of these projects, it will be left to overseas or private companies that do not have the same skills, balance sheets and accountability,” noted Ashley Kelty, a senior research analyst for oil and gas at investment bank Panmure Gordon.

“The majors, as publicly listed companies, can be scrutinised and held accountable for their emissions – surely a good thing?”

‘Foolish and short-sighted’

Gneiss’ spokesperson also noted the existing advantages of integration from an ESG perspective, given many investors are permitted to hold stakes in oil and gas business under their responsible investment commitments because of the attached green businesses.

“In a break-up scenario, they might be required to divest the oil and gas portion and lose a significant part of their portfolio,” Gneiss explained.

It cites ESG funds, such as Blackrock iShares Core FTSE 100 UCITS ETF which includes both BP and Shell in its top holdings. “If they were to spin off their greener businesses, funds like this would only be able to hold the green portion,” they added.

The current focus on energy de-mergers may therefore be as much about finance trends as a supposed belief in driving the energy transition. “Calls to combine and/or break-up, like so much in the financial markets, go in cycles,” Gneiss’ spokesperson said, drawing comparisons with similar calls for integrated businesses in other sectors, such as Johnson & Johnson, GE and Toshiba.

Carbon Tracker suggests that this recent drive may be emblematic of “polarisation” in the asset management sector, highlighting tensions between investors comfortable with long-term transition and those who may be “impatient” with the time and cost required to get there – not to mention some short-term opportunists.

Gneiss also alluded to this, noting the “very specific dynamics” of energy transition investments. “Hedge funds’ time horizons suit a short-term rerating and may not value the longer-term ability to deliver the multi-billion-dollar projects over coming decades that are required to meet climate objectives,” its spokesperson said.

“There will be success stories among those that break up, but it is far from certain.”

Mr Kelty was even firmer: “In short, breaking up the majors is foolish and short sighted. It will not create value for shareholders in the long term and will hamper the chance of reaching the net zero goal in time.”

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