After nearly a century of elevating global living standards, oil and gas companies are beginning to consider some of the negative externalities of their products and business models. A combination of regulatory, economic, and social pressures has forced the world's largest oil producers to consider an exit strategy -- even if it takes decades to play out. While most are making multibillion-dollar investments to reduce carbon emissions and create cash flow-positive businesses in renewable technologies, the road maps can vary.
The different approaches of ExxonMobil (NYSE: XOM) and Royal Dutch Shell (NYSE: RDS-A) (NYSE: RDS-B) are a great example. The former is currently going all-in on a strategy that's unique among its peers, one that looks to leverage its global refining and logistics infrastructure by bringing next-generation renewable fuels into the mainstream. The latter has a clean energy strategy that looks more similar to peers': a focus on natural gas investments today while slowly building renewable energy power generation and electricity distribution businesses.
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As far as investors are concerned, which oil stock is the better buy when it comes to renewable energy strategy?
Seeing it through
Although many oil majors had a renewable fuels strategy in the mid-2000s, pretty much all of them abandoned the idea years ago to focus on market-ready technologies. But not ExxonMobil. In 2009, the energy giant announced a $600 million pact with synthetic biology leader Synthetic Genomics to chase one of the most elusive technologies in biotech: low-cost algae fuels and chemicals.
The goal is to genetically engineer a certain species of algae to efficiently produce oil compounds using only sunlight, carbon dioxide, and several added nutrients. After being grown in large outdoor facilities, the biomass would be harvested, processed by ExxonMobil in its refinery network (the oil is contained within each individual algae cell), and distributed in its global logistics network.
Despite some early hiccups, the pair haven't wavered in their commitment -- and it's paid off so far. A genetic engineering breakthrough in 2017 nearly doubled the amount of oil produced in the partnership's algae strain without significantly slowing the growth rate. That allowed ExxonMobil to announce the next leg in the ambitious project.
By 2025, the companies want to demonstrate the technical ability to produce 10,000 barrels per day of next-generation algae fuel, which works out to a facility with an annual capacity of about 130 million gallons. While "technical ability" is not the same as "this thing will be built by that date," hitting the milestone could be a true energy breakthrough.
That's because if the technology hits similar targets to past outdoor algae projects, then it might be efficient enough to produce three times as much oil as the Permian Basin with half of the footprint. In other words, ExxonMobil could produce all of America's fuel requirements with "just" 40,000 square miles of production facilities. It's worth a shot, anyway.
From liquid fuels to watts?
Royal Dutch Shell was one of the big energy producers that abandoned its ambitious, moonshot approach in renewable fuels (the idea was to turn any source of biomass into drop-in renewable fuels and chemicals). Today, it's focusing on building out a portfolio of cash flow-contributing businesses in electric and gas utility infrastructure, wind power, solar power, and energy storage.
Earlier this year, the Dutch oil major acquired a 44% stake in American solar developer Silicon Ranch, which has 880 megawatts of active projects and at least another 1,000 megawatts in the order backlog. It's part of Royal Dutch Shell's plan to invest up to $2 billion in what it calls "new energies" during the three-year period ending in 2020. While that's only 7% to 8% of the total capital investment, it should help to build a solid foundation in renewable energy.
For instance, the equity stake in Silicon Ranch provides the option to integrate solar energy into the budding electric utility business. Last year, Royal Dutch Shell acquired U.K.-based electric utility First Utility, as well as U.S.-based MP2 Energy. The latter owns a natural gas distribution network and provides services for distributed solar.
The strategy to build an electric utility and power generation business mirrors that of peer Total (and maybe a dash of Equinor if investors include its offshore wind strategy). It's also an obvious hedge against both future climate regulations and emerging transportation technologies, such as electric vehicles. After all, if Royal Dutch Shell becomes a major global electric utility, then it still has a shot of retaining business in fueling transportation -- just with watts instead of liquid hydrocarbons.
One big consideration for investors
Of course, both ExxonMobil and Royal Dutch will continue to be almost completely dependent on oil and (especially) gas in the next decade or two. Neither expects to generate a significant portion of business from renewables in the near future. But that's also one of the biggest differences to consider.
That is, ExxonMobil knows that next-generation renewable fuels from outdoor algae cultivation is a moonshot and has no expectation that the project will contribute to the business anytime soon. Royal Dutch Shell, however, demands certain rates of return on capital investments made in "new energies." For instance, the utility businesses acquired in 2017 are profitable today.
That's a huge consideration for individual investors, who prioritize building wealth, not role-playing the part of a venture capitalist. That gives Royal Dutch Shell the better renewable energy strategy, hands-down. The numbers also favor the Dutch energy giant over ExxonMobil for long-term-minded investors.
The better buy is...
A lower-risk long-term strategy in renewable energy and more attractive valuation metrics make Royal Dutch Shell the better buy in this matchup. Both are supported by the company's energy transition strategy, which focuses more heavily on natural gas and liquefied natural gas in the next decade or so. That will then provide the option to deploy cash flow generated from those activities into the continued -- and likely accelerated -- build out of the renewable energy portfolio. That creates a sweet opportunity for investors to own a great business today and sit back for the long haul.
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