Mixing oil with water
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Mixing oil with water
Renewable energy is not a natural pivot for most national oil companies
National oil companies face competing priorities of decarbonising their activities while sustaining oil and gas revenues that bankroll economic development and pay for basic social welfare services. Can NOCs in developing countries follow the example of Denmark’s Ørsted, which morphed from a small state oil and gas company into global renewables champion?
Ørsted is frequently held up as the poster-child of NOC diversification. The state-backed energy company, formerly known as Danish Oil and Gas (DONG), embarked on root-and-branches reform in 2006 that saw it divest upstream assets and invest heavily in renewables. The company today generates 95% of its pre-tax earnings from offshore wind.
This feat will prove tricky for other NOCs to pull off. Ørsted benefitted from first mover advantage, selling some fossil fuel assets into a comparatively healthy market for oil and gas M&A deals.
Publicly-traded oil companies and their financiers are now subject to a higher level of scrutiny of environmental, social and governance (ESG) metrics, and the long term outlook for hydrocarbon assets is more uncertain than it has ever been.
Moreover, any petrostate that orders its NOC to divest a producing oil field today would be depriving itself of fiscal revenues that pay for road repairs, schools and hospitals. And with projections of a ‘golden sunset’ for the oil industry gaining credibility, there is a strong incentive not to sell out too soon.
As Energy Flux previously reported, NOCs are well positioned to capitalise on the mounting ESG pressures weighing on international oil companies (IOCs) such as Shell and ExxonMobil. The prevailing wisdom is NOCs would be foolish to spurn inflated revenues from a structurally tight oil market in the mid-2020s, as this could be leveraged to finance their diversification efforts.
Ghana’s ‘Catch-22’
There are many other obstacles to NOCs contemplating a renewables pivot. Speaking at a recent webinar on the subject, Joe Amoako-Tuffour, secretary of the economic management team in the Office of the Vice President of Ghana, said Ghana National Petroleum Corporation is eager to diversify but finds itself “stuck between a rock and a hard place”.
Ghana is saddled by expensive legacy take-or-pay (TOP) contracts with 12 independent power producers (IPPs), whose generators are fuelled by a mix of heavy fuel oil, gas and hydro. The nature of these TOP contracts means Ghana pays whether it uses the power or not. Current utilisation of IPP capacity is at around 60%.
The cost burden of these contracts presents a strong incentive to switch to cheaper, cleaner sources – but doing so would reduce further the utilisation rate of the generators for which the Ghanaian state is obliged to pay, regardless of usage. So promoting renewables means shouldering an additional cost burden that cannot be offset against lower outgoings to IPPs.
The very high cost of grid power in Ghana is eroding the competitiveness of non-energy industries based there, such as pharmaceuticals and mining. Foreign companies are keen to establish their own sources of renewable power, which would be cheaper than buying from the state utility and also generate carbon credits that can be used in their home countries.
GNPC would like to play a role in facilitating or even investing in such projects, but this would deprive Ghana’s state power company of high-paying industrial clients, risking the financial stability of the electricity market.
This situation has generated institutional friction between the state utility and the NOC, and left Ghanaian officials “scratching their heads”, Amoako-Tuffour said. “We want to industrialise but the cost of energy is de-industrialising us. How can you promote industry under this circumstance?”
Help or hindrance?
This sort of Catch-22 is not unique to Ghana. Speaking at the same event, Aaron Sayne of the Natural Resources Governance Institute said any NOC contemplating diversification will inevitably face tricky trade-offs.
NOCs must consider whether their mandate – both on paper and in “political reality” – allow for investment outside of core oil and gas activities. Alluding to the golden sunset predicament, committing precious revenues into lower-yielding solar and wind projects makes little sense, Sayne said.
The lower margins from investing in renewable power projects would force NOCs to grapple with waste and corruption.
Some NOCs make “questionable and costly business decisions” under the duress of “heavy political interference”. These transgressions can be accommodated in a booming oil market – but the lower rents from wind and solar “don’t leave much room for waste in the power supply chain,” Sayne said.
There are also governance challenges. Do state oil companies have the institutional capacity and innovative culture to turn themselves into diversified national energy companies, and if not are they able to hire skilled personnel to make this happen?
Perhaps the toughest question facing NOCs, Sayne said, is this: What, ultimately, do NOCs bring to the table?
“What could inserting an NOC into a renewables project or ... company mean for project finance? Especially in developing countries, finance costs and availability are two of the main things that keep solar and wind projects working. Third party lenders can be really sensitive to issues of payment risk, credit risk, governance risk and reputational risk.”
Governments must therefore consider whether NOC involvement could make debt finance more expensive or less available, Sayne concluded. “Would its participation add value, or just headaches and challenges?”
First world, first mover
The event also heard from Devapriyo Das, senior communications advisor at Ørsted. While tacitly acknowledging that other NOCs face challenges that DONG managed to avoid, Das urged all players in the energy industry to step up their decarbonisation efforts:
“We are about nine years away from the 2030 target of halving carbon emissions to have a chance of staying within 1.5C of global warming. Fossil fuel consumption today contributes 73% of carbon emissions globally. If we don’t have the energy sector stepping up to play a big role I’m not really sure how we will [achieve the Paris climate] goal.”
Das said “innovation and scale” were key factors in Ørsted’s renewables success, and claimed the company has been “very good... at bringing down the cost of offshore wind” – which fell 66% between 2012 and 2020.
DONG benefitted from the Danish government’s integrated industrial policy that aligned Denmark’s heavily subsidised uptake of offshore wind power with proactive support for technological innovation and domestic manufacturing. This gave rise to Vestas – the world’s biggest wind turbine manufacturer.
Das alluded to this, saying building at scale requires “the right partnerships” with suppliers and equipment manufacturers and “the right financing frameworks as well”.
Ørsted has generated spectacular returns from taking on early-stage projects, de-risking them, building out turbines and then farming down big stakes in operational offshore wind farms to other investors.
“By doing that you recycle enough capital to invest in new renewables,” he said.
The Energy Flux view
GNPC and Ørsted are at opposite ends of the spectrum. Ørsted was rewarded handsomely for spearheading Denmark’s early adoption of renewables, seizing a profitable window of opportunity in the offshore wind industry’s early commercialisation and selling fossil assets into a buoyant oil market.
The wind industry and oil market are both different today, and Ghana faces institutional paralysis. Key actors are at loggerheads over how to navigate the country onto a more financially and environmentally sustainable footing.
While Ghana’s state institutions debate how to cut the Gordian knot in the power sector, the renewables space is growing ever more lean and competitive – just as the profitability of business-as-usual for NOCs is rising.
These factors deserve greater attention in the wider debate about the energy transition. There must be an element of realism in the expectations placed upon cumbersome NOCs that are still searching to identify what productive role, if any, they can play in a decarbonising world.
Seb Kennedy | Energy Flux | 10th June 2021