Oil, Gas and the Transition to Renewables 2024

Pent-up M&A demand and stable commodity prices led to a wave of large-scale energy M&A in the second half of 2023 and early 2024. This period of “Mega-Mergers” was kick-started by ExxonMobil with its USD4.9 billion acquisition of Denbury Resources in July 2023 and its USD60 billion acquisition of Pioneer Natural Resources in October 2023. Two weeks after ExxonMobil announced its transaction with Pioneer, Chevron announced its USD53 billion acquisition of Hess Corporation.

The ExxonMobil and Chevron transactions have since been followed by:

• Occidental Petroleum’s USD12 billion acquisition of CrownRock;
• APA Corp’s USD4.5 billion acquisition of Callon Petroleum;
• Chesapeake Energy and Southwestern Energy’s USD7.4 billion merger;
• California Resources Corporation’s USD2.1 billion acquisition of Aera Energy;
• Diamondback Energy’s USD26 billion acquisition of Endeavor Energy Resources;
• Chord Energy and Enerplus Corporation’s USD11 billion merger; and
• ConocoPhillips’s USD22.5 billion acquisition of Marathon Oil.

In last year’s introduction, the authors discussed that many oil and gas companies had been able to generate significant free cash flow that was being used to shore up balance sheets and return cash to investors. However, it was also noted that shareholder pressure was preventing oil and gas companies from investing heavily in funding exploratory, long-term development to increase production. This lack of investment in future development was beginning to create pressure on oil and gas companies to explain where future production would come from.   

These “Mega-Mergers” have been a solution to this problem by allowing companies to add future development opportunities through mergers while maintaining capital discipline.

Additionally, these “Mega-Mergers” are allowing companies to capitalise on operational synergies and benefit by gaining size and scale in the marketplace.

Given oil and gas’s significance to the global economy, many of these transactions have come under the watchful eye of the US and foreign governments. In the US, the Federal Trade Commission (FTC) has taken many of these transactions to second review under the Hart-Scott-Rodino Act of 1976. And while the FTC has yet to sue to block any of these transactions, it has deeply scrutinised them, including in the case of the ExxonMobil and Pioneer transaction, making a criminal referral of Pioneer’s CEO to the Department of Justice. 

Despite this scrutiny, it is expected that oil and gas companies will continue to look to synergistic and opportunistic acquisition and consolidation opportunities in the near future. It is also expected that oil and gas companies will continue to maintain a disciplined approach to spending and returning capital to investors.

And while it is unlikely that global demand for oil and gas will decline any time soon (indeed, it is likely that it will continue to increase for years to come), energy companies will no doubt continue to participate in the ongoing energy transition by investing in alternative energy sources.

Short-Term Trends

Commodity price uncertainty

Ask five economists for their predictions on the economic and commodity price outlook for the remainder of 2024 and you will get five different predictions. The only consistent answer you will receive from the economists is that no one will guarantee their prediction.

Concerns over inflation (including high interest rates being used to combat inflation) continue to weigh on oil and gas prices. However, the resilience of the global economy has led to optimism of a soft landing. The result thus far has been relatively strong and stable commodity prices.

If prices remain strong and stable, this should lead to greater investment in oil and gas and future production, as well as continued consolidation and M&A activity.

Supply v demand

While no one disagrees that global demand for energy will dramatically increase over the coming years, there is great disagreement on what will fuel that demand. Energy is necessary to bring billions of people across the planet out of poverty. It is needed for basic services like electricity, clean water, heating and cooling, cooking, medical care and transportation. It is also needed to power data centres and the technological revolutions occurring in the developing world, including the energy-intensive advances expected in generative artificial intelligence. 

According to the IEA (International Energy Agency) – a group mostly supported by Western countries – growth in global demand for oil will slow in the coming years (peaking by 2029), and the world will face a massive surplus of oil. The IEA is projecting a fast transition to renewable energy. Under its projections, global oil capacity will rise to 114 million barrels per day by 2030, but global demand will only be 106 million barrels per day at this time.

OPEC (Organization of the Petroleum Exporting Countries) has a starkly different view. According to OPEC’s Secretary General Haitham Al Ghais, global oil demand will increase by 25 million barrels per day in the developing world through to 2045, but global supplies will not rise nearly this fast. OPEC is warning that, without material investment in global oil supplies, the world will suffer energy shortfalls and increased price volatility.

Long-Term Trends

Social and government pressures

Concerns regarding the potential climate effects of conventional sources of energy have become more embedded and widespread, and there is an increasingly negative focus on hydrocarbons. Government regulation and political pressure continue to mount against oil and gas companies. Increased climate awareness and the accompanying heightened scrutiny of environmental impact have also affected traditional energy financing, as certain investors shift away from investment in this sector. Conversely, government subsidies supporting the energy transition continue to expand, leading to economic headwinds for traditional energy sources.

However, the supply disruptions precipitated by the war in Ukraine and the resulting commodity price spikes have resulted in a greater appreciation of the significance of traditional sources of energy and our reliance on them.

In the short term, efforts have centred around bolstering and diversifying sources of conventional energy, as well as some enhanced efficiency measures in more acutely impacted jurisdictions. This reflects an acknowledgement of the superior scalability and infrastructure compatibility of oil and gas compared to renewables, given current technologies and infrastructure build-out.

In the long term, social and government pressures and concerns over climate change will continue to drive energy transition, but the supply disruptions and commodity price spikes may cause governments to focus on a more balanced transition that continues to rely upon hydrocarbons as well as alternative energy sources.

Accelerating investment in energy transition

Although the capital deployment required in order to meaningfully impact aggregate hydrocarbon consumption is enormous (as much as USD9 trillion per year worldwide by 2030 v USD2 trillion for 2024), significant capital deployment into energy transition is underway, both on the electric power generation side and in terms of carbon capture, utilisation and storage (CCUS) technology. The Inflation Reduction Act of 2022 is also expected to accelerate investment in clean and renewable energy production and manufacturing in the US, through reformed energy tax incentives.

Energy player consolidation

As seen with the “Mega-Mergers”, pressure on public companies continues to drive consolidation, which is aimed at driving profitability through synergies and cost reductions. Public companies are also pursuing these mergers as a way to increase production without having capex. A number of private capital sources (private equity) have also retreated from traditional energy investments.

The public consolidation and the private capital retreat have meant fewer sources of capital for new investment. In the long term, this will have a negative impact on oil and gas production.

Access to capital

Larger oil and gas companies with investment grade balance sheets continue to have access to debt and equity financing that can be used to fund acquisitions and exploration and development. However, smaller oil and gas companies continue to face challenges in accessing financing. Traditional financing institutions have been reducing their lending exposure to smaller oil and gas companies, forcing these smaller companies to look for alternative financing. As a result, alternative financings, such as asset-backed securitisations, have become (and will continue to become) more prevalent in the oil and gas industry.

Higher interest rates have also negatively impacted the capital available for oil and gas investment. Not only have the higher interest rates increased borrowing costs for companies, but they have also made it more difficult for new exploratory projects to hit investment hurdles. The result has been fewer new investments in future production.

Global realignment

The wars in Ukraine and Israel/Gaza have accelerated a global energy realignment, with the United States and Europe on one side, and Russia and China on the other.

European countries have long relied on Russia for energy needs. Russia’s invasion of Ukraine and the resulting sanctions on Russia are a stark reminder of the fragility of the global energy infrastructure. Desperate for alternative hydrocarbon sources, European countries have been paying premiums to source hydrocarbons from the United States and the Middle East. This has had a dramatic effect on Russian exports and has caused Russia to increasingly sell its oil and natural gas into the Asian markets.

These shifts have also led to the acceleration of large-scale LNG projects in the United States (and LNG-receiving projects in Europe) as well as increased renewable investments across Europe. The Biden Administration issued a temporary pause on new LNG projects in the United States at the beginning of 2024. It remains to be seen how this pause will impact future LNG projects.

Political pressure and sanctions are also having an impact on investment. Political tensions between the United States and China have caused many state-owned Chinese companies to begin withdrawing from energy investments in the United States. Western investors, on the other hand, have swiftly pulled their investments out of Russia. As the world’s second-largest oil producer prior to the invasion of Ukraine, Russia received significant investments from a number of Western firms. The loss of this capital and know-how continues to have a negative impact on the Russian energy sector.

The long-term implications of this realignment remain to be seen.