Oil and Gas and Creosote

Oil Companies will not lead a hydrocarbon transition. 

In business school studies they teach the cautionary tale of the creosote bush. In the 1990s the chipmaker Intel grew rapidly as the PC market exploded: its share price increased by a factor of 100 to make it one of the largest corporations in America, and it became synonymous with most PCs bought in US and Europe.

But even at its zenith, its two forceful leaders Andy Grove and Craig Barrett noted a problem. Barrett used an analogy based on the creosote bush, a plant he was familiar with and which he even brought to management meetings. The plant grows in desert conditions, and has evolved to ooze an oily secretion on the ground around it as it matures. This ooze snuffs out the potential development of any other plants, ensuring the creosote bush maintains access to the limited water and other nutrients in the desert soil, and so continues to grow.

Barrett noted that Intel’s primary money-making division, the microprocessor unit vital to all PCs, was “a dream business with wonderful margins and a wonderful market position. How could anything else compete for resources and profitability?” He recognized early on that even so the division was Intel’s own creosote bush and would probably hinder the development of any other profit-making line.

Since its all time share price high in 2000, Intel has tried to move into other businesses adjacent to its core microprocessor unit. It was an early pioneer in smartphones, tablets and even cloud-computing – but none of these alternate product lines could compete effectively for management time and money with the core PC division. So they withered, and Intel has largely exited these business extensions.

As a result, Intel’s size is less than half its peak, and it still heavily relies on microprocessor revenue, even though rapid growth is long gone and margins far from wonderful. The key point is: even though Intel’s chief executives knew this would likely happen, and tried to overcome the creosote bush problem, they were unable to balance their investments to allow smaller units to thrive, while still feeding their dominant product line to safeguard their core. The industry structure and competition, the internal culture and processes and the management will to change all needs to be carefully handled to mitigate the core business dominance – and it did not happen.

Herein lies the cautionary element – the power of this phenomenon is that it occurs precisely because companies act rationally and diligently, attempting to satisfy their main stakeholders in reasonable and efficient ways by delivering consistent profits and growth from doing what they know best. They spend capital wisely, and avoid risky bets on adjacent but subtlely different markets.

In sum, the leader of a given industry market is unlikely to be the front-runner who spearheads the development of its ultimate competitor – even when its obvious the competitive market will ultimately dominate the old business.

Unlikely, but not impossible.

The Energy Business and the Paris 2degC Challenge

The energy consultancy Critical Resources have produced a useful document called “The Heat is On”. It identifies a key problem with Oil and Gas companies leading the transition to a less fossil-fuel intensive energy future. In their five-point assessment, and especially in Figure 9 on the report, they indicate several important examples where the industry is reactive and tactical – long on words, short on actions.

• 2degC business development strategy – negligible or even within the cited BHP Billiton report, focused on portfolio impact rather than portfolio adaptation
• Carbon Capture and Storage – $10bn invested in 2007-12, less than 0.5% of the industry capital expenditure in that period.
• Lower carbon energy supply – advisory activities only, reactive to governmental policy
• Carbon pricing – slow progress on an active market solution

All of the above are clear symptoms of the oil and gas business’s very own creosote bush problem. Others have also labeled it the industry’s Kodak moment – another example of a dominant business model curtailing the development of an alternate one until a substitute arrives from elsewhere. And the industry has to take it seriously – for Intel it halted business growth significantly, but for Kodak it was fatal.

But here is where the oil industry creosote bush phenomenon adds a different dimension. For intel and Kodak, it was primarily a problem for the companies themselves – the general rise of cloud computing and digital film was not hampered by their conservatism. And their product did not have a direct impact on a vital externality such as climate stability. But when the whole oil industry limits its transition agenda, it potentially stalls the development of an alternate energy universe. And remember – each oil company is acting rationally, fulfilling its current stakeholder needs – a powerful and natural-feeling incentive to continue as before.

The core oil and gas upstream and downstream business divisions define oil companies – so their problem is just as acute, if not more so, than Intel’s or Kodak’s. Without the revenue from oil and gas production to feed capital-intensive development of new oil fields, to thus create more revenue, the oil industry’s magic circle is broken. As oil companies grow bigger, the intensity of investment increases just to stand still. Many IOCs have tried to move into renewables – but almost all have retrenched back to the main business after sell-offs, or by keeping investment at a low level for optical benefit (see CCS data). In my experience, as in Intel, all our processes, systems, management focus and investment criteria are honed in on more efficient production of the principal product – even more so in the current oil price context.

Being large, most IOCs also have eloquent and intelligent staffers who can write stylish reports and attend industry networks on the transition to 2degC. But in the background the oil wells still inexorably produce less hydrocarbon and more water, and decommissioning costs grow on the horizon. More oil and gas must, quickly, be found. Hence the apparent, and growing, disconnect noted in the report between industry positive-leaning statements and their very limited transition-based achievements.

To state the obvious, it is not clear what the solution is to the creosote bush problem the oil industry faces. Intel and Kodak tried and failed to solve their particular dilemma, and that may be its fate too. But the report has identified a deep truth about the transition to a lower carbon future – the oil industry is not leading it, and I predict it will continue to struggle to do so.

To get to an answer however, we first need to admit the problem is there. So we are going to need much more uncomfortable analysis such as The Heat is On to provoke more honest and detailed debate about the industry’s dilemma. Reluctant gradualism, and minor investment in shop-front renewable projects will not work. If IOCs do not lead the transformation, an alternative leadership cohort outside the main industry will have to emerge.

There is a nucleus though in the current debate which may start to provide a route forward.

For example, the emphasis on win-win in the report is (always) a reasonable model – but a nuanced approach to this will be required: each actor needing to win over differing timeframes perhaps. In addition, the competing role of various stakeholders in the debate will be critical – how to balance the priorities of host governments and shareholders is an age-old industry issue which needs to be revisited. New joint ventures too may be a solution.

In all of the above, the role of more independent firms is important in shaping the debate to keep industry momentum moving in new directions. Inertia for proven business models will tend otherwise to keep them back.

More new voices are needed to develop a thoughtful framework for oil industry transition. Otherwise the dominant declarations will come from the likes of Rex Tillerson, CEO of Exxonmobil at the company AGM in May 2015 on the company’s lack of renewable energy investment – “We choose not to lose money on purpose.”

Powerful words, like creosote oil, prevent alternatives from flourishing.

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The Heat is On – Critical Resource, Nov 2015.

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One Response to Oil and Gas and Creosote

  1. Pingback: 2 + 2 = 4: The Energy Industry is now a battle between Technology and Ideology | dollarsperbbl

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