In a major deal in the U.S. oil industry, ConocoPhillips has decided to purchase all of Royal Dutch Shell’s assets in the Permian basin.
The deal offers further consolidation in the U.S. shale industry, represents a big bet on shale, and also exemplifies two very different high-stakes strategies that oil majors are pursuing amidst the energy transition.
Conoco and Shell go different ways
The $9.5 billion deal makes ConocoPhillips the second largest oil producer in the contiguous United States, and a dominant force in the Permian basin in West Texas and New Mexico. Taking over Shell’s assets will add 200,000 barrels per day equivalent of oil production onto Conoco’s books, and bring overall production in the Lower 48 above that of Chevron, EQT, Occidental Petroleum and EOG Resources, according to the Wall Street Journal.
For its part, Shell gets to unload risky assets for a hefty sum and claim that it has cleaned up its portfolio.
The future is treacherous for the oil majors.
With oil and gas markets very much in turmoil as an escalating climate crisis turns finance and the policy world against the industry, the future is treacherous for the oil majors. A few years ago, their strategies for navigating the early stages of energy transition consisted of betting on different segments of the oil and gas industry – Shell made an enormous gamble on liquefied natural gas, ExxonMobil bet on LNG and petrochemicals, while ConocoPhillips left offshore drilling and focused on onshore shale. They all offered a modest twist on the same theme of hydrocarbon production growth.
Today, their corporate strategies have diverged. The European majors – Shell, BP, TotalEnergies, Eni – are attempting to slice off parts of their oil and gas businesses and use the proceeds to either hand back cash to shareholders or purchase new energy business lines, such as renewable energy or electric vehicle charging stations, for instance. This strategy ultimately amounts to presiding over a declining oil and gas portfolio while trying to pivot with the times.
On the other side of the Atlantic, the American oil majors are sticking with a well-worn strategy of…continuing to drill for oil and gas. Only, the difference these days is they have been forced to reckon with the prospect of climate change to some degree as investor pressure continues to mount.
In practice, that means a slower pace of drilling, some vague pledges to reduce emissions, and greenwashing PR on investments in future technologies such as hydrogen and carbon capture, but ultimately no major changes to their core business of extracting oil and gas. The oil industry no longer explicitly denies the existence of climate change, but their business strategies still decidedly do not comport with the climate science, which calls for a ratcheting down of production and consumption.
For ConocoPhillips, the takeover of Shell’s Permian assets means a doubling down on shale in a big way. The shale industry has burned through roughly $340 billion over the past decade, but cash flows started to improve this year on lower levels drilling (and spending) and higher oil prices. ConocoPhillips is betting that it can sustain those financial gains going forward.
But it is a big gamble. A temporary improvement in cash flow from shale is set against a dramatic slowdown in spending. But shale wells suffer from precipitous production declines, so at some point, the pace of drilling – and spending – will need to rise to offset eroding output.
That is the short-term problem. The medium- to long-term problem rests in the energy transition.
Moody’s Investors Service warned of increasing credit risk to the U.S. shale sector due to the unfolding energy transition. “Independent exploration and production (E&P) companies are particularly vulnerable to the growing risk of a weakened demand scenario over the long term,” said James Leaton, Senior Vice President at Moody’s Investors Service. “While integrated producers have greater scale and geographic diversity, their traditional focus on the largest, most complex projects increases their exposure to transition risks.”
Moody’s looked at 65 independent E&Ps and 34 integrated companies globally. E&Ps see higher risk. “Companies face daunting challenges in strengthening their resilience to a low carbon future, because doing so will require a capital-intensive diversification of their business to adapt to shifts in the energy system, and strategic cost management to ensure the economic viability of current and future assets,” Leaton said.
But even Shell’s strategy of divesting itself incrementally from fossil fuels raises questions. Shell will no doubt bill itself as a greener company, having removed 200,000 barrels per day of production from its books. A Dutch court decision from earlier this year essentially demanded some version of this strategy, ordering Shell to slash its greenhouse emissions. Shell’s sale to ConocoPhillips is one of multiple examples of Shell selling off assets.
But while Shell can claim progress, there will be no change in atmospheric emissions – the pollution will just shift to Conoco’s portfolio.
That underscores one of the great problems the world faces. A dramatic reshuffling of oil and gas assets is underway, with buyers picking up distressed or risky assets from more risk-averse entities. There is no shortage of headlines showing certain publicly-traded oil companies divesting themselves of costly and dirty assets. But those projects, for the most part, are not shut down.
As the FT reports, even in U.S. shale, while the publicly-traded companies – who are vulnerable to investor pressure – refrain from adding new drilling rigs into the field, private companies are ramping up drilling rates.
Ultimately, the climate solution calls for a phasing out of both consumption and production over time, and urgent government policy is needed to accelerate this transition. That means that all oil companies face existential risk.