Historically, oil companies with surplus capital had two choices. They could spend it. Or they could return it to shareholders. The energy transition makes this more complex. Why? Because there’s more uncertainty over long-term hydrocarbon demand. And, more importantly, there’s greater accountability from oil company stakeholders to decarbonize, or face mounting existential risks.
As such, Citi Research analysts say they expect the energy transition creates the imperative for a third capital allocation bucket know as New Energy, which largely takes two forms: decarbonisation and diversification.
In Citi Research’s Energy Company Trilemma framework, which is illustrated below, companies will develop specific archetypes depending on the mix of spend among each of the three buckets.
Company Archetypes in the Energy Company Trilemma of Capital Allocation
As the energy transition intensifies, we expect company strategies will have to juggle a third pillar of surplus capital allocation: New Energy. A failure to do so would increase the existential risks facing the industry, such as access to capital and talent. Different archetypes can define each strategy.
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Source: Citi Research
How much spend is enough?
Beyond moral arguments, what is the right level of spend in New Energy to avoid the some of the existential threats laid out briefly later in this piece? Company management, equity, and other stakeholders in these businesses will ultimately need to determine the answer to this question by mid-decade, the authors say. Firm answers are some ways off, but here are some high-level thoughts from the team on this:
What happens if companies get their trilemma capital allocation wrong?
1. Existential risks…
In the absence of adequate investment in New Energy, existential risks will become more pronounced for several stakeholders, including:
2. …which leads to financial and valuation risks…
The analysts say it’s very difficult to determine the financial impacts from the existential risks coming to fruition. But some things that could happen in theory:
3. … which may lead to listing risks
The full report goes on to describe how remuneration is aligned with the trilemma and much more with a focus on Australian oil companies. To read it in full, if you are a Velocity subscriber, please see Australia Oil & Gas - The Energy Company Trilemma: Investing in the Transition, published on 27 June 2023.
Citi Global Insights (CGI) is Citi’s premier non-independent thought leadership curation. It is not investment research; however, it may contain thematic content previously expressed in an Independent Research report. For the full CGI disclosure, click here.