Majors' capital allocation in a stuttering energy transition

Judging the pace of the energy transition has been perhaps the biggest strategic conundrum for oil and gas companies since the Paris Agreement almost 10 years ago. European Majors have led the way, early movers in allocating capital away from oil and gas into low-carbon opportunities.

BP’s decision this week to slash its investment in low carbon confirms what’s been evident in the last three years as the energy transition has hit headwinds: the risk/reward ratio doesn’t make sense for oil and gas investors. Luke Parker, Greig Aitken and Tom Ellacott of our Corporate Analysis team shared their thoughts with me.

First, current project economics heavily favour investment in upstream over low carbon (see chart)

Some low-carbon technologies are investable – solar and onshore wind, for example, after two decades of massive cost reductions. The returns, though, are comparatively modest. BP’s planned offloading of its entire renewables business – selling US onshore wind, moving offshore wind and solar into ring-fenced JVs – speaks volumes of the oil Majors’ priorities.

Emerging technologies including blue and green hydrogen and carbon capture and storage are all at a much earlier stage of development. Most require years of investment and innovation to replicate solar’s downward cost trend, plus heavy subsidies until they achieve stand-alone commerciality in the mid-2030s.

Governments – consumed by more urgent priorities, including defence and the cost-of-living crisis – are struggling to justify the scale and duration of the subsidies these emerging technologies need. On the other side of the equation, companies seeking to invest cite a lack of visibility on subsidies as a blocker to progress.

Some Euro Majors adopted low-carbon strategies that embraced multiple technologies. While there is an argument for spreading risk, it’s led to perceptions of a lack of focus.

Upstream projects, in contrast, can look highly attractive in the current environment. The slow pace of the transition implies stronger-for-longer oil and gas demand and the prospect of firm oil and gas prices. That combination underpins double-digit returns for Wood Mackenzie’s pipeline of pre-FID projects.

The financial framework for the Euro Majors, as with the US Majors, is still bound by strict capital discipline – capital will only be allocated to the opportunities with the highest risk-adjusted returns. With most of these in upstream, spend on low carbon and renewables is being squeezed.

Second, the global outlook for investment in energy supply also reflects a softening enthusiasm to invest in low-carbon
opportunities

Investment in power and renewables, upstream oil and gas and critical metals for the transition continues to rise. We forecast a 6% increase this year, lifting spend to a record US$1.5 trillion. Low carbon’s share of the total jumped from 32% in 2015 to 50% in 2021 but has stalled since and won’t increase on our forecasts until the end of the decade. It needs to be 60% higher than the current US$0.7 trillion a year by 2030 to meet the goals of the Paris Agreement on our estimates.

The Euro Majors’ cutbacks in low-carbon investment broadly mirror the global trend. After diverging for years, US and Euro Majors’ spend on low carbon is now converging. The Euro Majors had committed an average of 30% of total investment to lowcarbon projects in 2024, but Shell, Equinor and now BP are rebasing around 15% to 20%. ExxonMobil and Chevron, going in the opposite direction, are now 15% and 10%, respectively.

Third, the Euro Majors’ tilt back to upstream is ultimately pragmatic

Upstream will be in business for much longer than they anticipated in the post-Paris Agreement strategic reset, and there’s still money to be made.

The pivot, though, won’t happen overnight. We still expect the Euro Majors’ to focus on driving up cash flow and dividends to boost stock market ratings. This will increase the financial optionality for large-scale deal-making in 2026. In the meantime, imaginative business development can strengthen the portfolio incrementally as BP’s recent Kirkuk deal in Iraq shows.

Finally, national oil companies’ budgets for low-carbon projects had already eclipsed the Majors in 2024

Collectively, Saudi Aramco, ADNOC, Petrobras, Petronas, PetroChina, CNOOC and ONGC plan to invest over US$20 billion a year through 2030 – albeit for many of these industry giants it’s a much smaller proportion of free cash flow. The scale of the NOCs’ cash generation, overarching national targets to decarbonise and aspirations to diversify their economies away from oil and gas suggest NOCs will carry the low-carbon torch for the oil industry in the next stage of the energy transition.

The global push to a low-carbon world hasn’t stopped; it’s just slowed. It’s possible, even probable, that in a few years’ time, the relative returns will reverse and the Majors ramp up low-carbon investment once again.

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