Two current trends in the energy sector are giving the oil majors reason to reconsider the power option. The first is the rise of electric mobility as technical advances gain momentum. There are strong indications that plug-in hybrids and electric vehicles will be economically viable by 2020, even in major markets like the United States and China. This development has the potential to fundamentally change the game for the oil industry at large, because it could erode the overall demand for oil, and it should compel oil company leaders to review their position on refining and other downstream operations.
The second factor is climate change. The role of natural gas in power generation is gaining importance because gas emits less carbon per unit of electricity produced than does coal or oil. However, the value of the gas portfolios of oil companies has come under pressure of late, owing to downward pressure on gas prices caused by an oversupply in the global gas market. This glut was a result of several trends and events, including the collapse of energy demand during the recession, the continued construction of supply infrastructure, and the relatively sudden strong increase in the production of gas from shale and other unconventional sources in the United States. The oversupply in gas markets is expected to remain until at least 2015, if nothing else changes. Given the oil companies’ large exposure to gas markets, the implications are already becoming visible in their financial results, forcing executives to seek other ways to add value to their gas portfolios.
Rather than just selling natural gas in oversupplied markets, oil companies could capture three sources of value by integrating into gas-fired electric power generation. First, such integration would provide a captive market for part of the gas sales portfolio and could increase sales volume. Second, it would allow the companies to capture the “spark spread”: the difference between the sales price of electricity and the cost of the gas needed to produce it. Third, by having positions in both gas and power, the new energy majors could become more flexible and face less pressure when conditions are unfavorable for either of these markets. Oil companies may also be able to capture the growth in power demand from electric vehicle growth, replacing some of the value lost to utilities from declining hydrocarbon sales in the road transportation segment.
The Path to Power
Several paths will be available to the new, would-be super-energy majors should they decide to diversify into gas-fired power generation. Some companies already have the capabilities needed to make this shift. Others do not, but they could develop the necessary capabilities through either investments or partnerships.
For example, one option could be investing in the construction of new generation assets through so-called independent power producers. These investments are large and complex; however, they are exactly the type of investments the oil majors are good at making and managing. Opportunities are likely to abound. Power demand is expected to continue to grow, and a prolonged period of low natural gas prices may very well lead to strong growth in gas-fired power-generation capacity. Indeed, if current prices continue to prevail in the U.S. and Europe, gas should become the preferred feedstock for new fossil fuel–powered generation capacity. In Europe alone, an additional 20 gigawatts of gas-fired capacity could be the result.
Because direct investment in power generation is capital-intensive, the super-energy majors could also seek partnerships with suitable utilities. These could range from simple tolling agreements — whereby the utility contracts part of the capacity of a gas-fired power plant to an oil company — to more complex models in which the utility and the oil major combine and optimize their gas and power operations. These more complex partnerships could expand to include other assets, such as gas storage and wind-generation capacity. These partnerships might offer advantages to both sides: Oil companies would get exposure to power markets at lower capital requirements, as well as better scalability and more flexibility in their gas portfolios; utilities would get more advantaged access to fuel and increased utilization of their generation assets.