Why European oil companies face a valuation gap when compared with US peers

While players in Europe have been trying to boost their low-carbon businesses, those in the US have concentrated on their core petroleum businesses

In May 2021, a Dutch court ruled Shell should cut its greenhouse gas emissions 45 per cent by 2030 in line with global climate targets. AP

The company formerly known as Royal Dutch Shell — simply Shell from January last year — has a proud European heritage. But the continent’s investors don’t love it, or its fellow oil companies, even while Americans rediscover the charms of petroleum stocks.

The big European oil companies, BP, Shell, TotalEnergies and Eni, trade at about five times their forward earnings; the leading Americans, ExxonMobil and Chevron, at 10 to 11 times.

All have done well with rising oil and gas prices. But while Shell’s share price has gained 78 per cent since the start of 2021, ExxonMobil's is up 165 per cent.

The European corporations nearly closed the valuation gap with their US peers after the 2008-2009 global financial crisis, but it ballooned again.

The Europeans have been trying to boost their low-carbon businesses, investing in offshore wind, solar power, electric vehicle charging and batteries.

Shell and BP both recently paid billions of dollars to acquire bio-gas companies. They still have to demonstrate that they can run non-fossil businesses as well as specialist competitors do, and as well as their own petroleum assets.

The Americans, by contrast, have concentrated on their core petroleum businesses. They are developing carbon capture and storage (CCS), which fits well. Otherwise, their major purchases have been of shale oil and deepwater exploration companies. This may be short-sighted given the ever-increasing imperative of climate policy, but for now, it has paid off.

The European regulatory and public environment is not friendly to oil companies, to say the least. In May 2021, a Dutch court ruled Shell should cut its greenhouse gas emissions by 45 per cent by 2030 in line with global climate targets — including the emissions caused by customers, anywhere in the world, who burn the oil and gas they purchase.

Following Russia's invasion of Ukraine, as oil prices rose, the UK and EU both imposed windfall taxes on what they called energy companies’ excess profits.

Such a levy was debated in the US but not implemented. Instead, the Joe Biden administration’s Inflation Reduction Act includes subsidies (or “incentives”), both for renewables and for oil company-adjacent biofuels, hydrogen and CCS.

Last week, the White House also approved a significant new oilfield development in Alaska, despite environmentalist opposition.

In December 2021, Shell consolidated its headquarters and listing in the UK, dropping the Royal Dutch part it had held since its 1907 merger. This was primarily to make share buybacks easier and avoid the Netherlands’ dividend withholding tax which had been a persistent irritant. Still, environmental groups suspected the court ruling on emissions was another motive.

That year, the company reportedly also considered shifting to the US. But it was not clear that such a move would suddenly have seen it enjoy the valuation multiples of ExxonMobil or Chevron. Some of its core shareholders would have opposed the idea, and the US levies a dividend withholding tax on foreign non-residents.

BP and Shell have shifted their focus recently. Higher oil and gas prices since the post-2014 slump, and the need to replace Russian supply, make upstream investment in hydrocarbon exploration and production more enticing.

“2022 taught us that too much focus on the decarbonisation agenda led to a mismatch between supply and demand,” BP’s chief economist, Michael Cohen, said last week.

In February, chief executive Bernard Looney revealed plans to cut oil and gas output to a more moderate 20 per cent to 30 per cent, from an earlier estimate of 35 per cent to 40 per cent. Within four days, BP's stock gained more than 30 per cent.

Patrick Pouyanne, TotalEnergies’ chief executive, notably said in February 2021: “I’m proud to be black [oil] and green, because if I don’t have the black part, which is delivering cashflows, I don’t have the green part.”

New Shell chief executive Wael Sawan took the top job after leading the gas and renewables business, which some took to indicate he would lead the company in a lower-carbon direction.

But before this, he ran the upstream division, and before that Shell’s US upstream, and its successful global deepwater business.

As a Lebanese-Canadian who grew up in Dubai, he brings a different perspective from the previous run of Dutch, Swiss and British chiefs. Now, he is demanding that the low-carbon businesses pull their weight and earn returns commensurate with those in oil and gas.

What can the European oil companies do to counter the valuation gap with their American peers?

They could spend more on oil and gas development. As noted, Mr Looney and Mr Sawan have made partial moves in that direction. Shell and TotalEnergies have hugely promising new finds in Namibia, which could be the growth engine for them that Guyana’s oil has been for ExxonMobil.

But pressure from environmentalists, the general public, the law, shareholders and even their own employees in Europe makes it impossible to go unashamedly “back to petroleum”.

The European majors could go big in renewables, making a really major acquisition — more like $50-100 billion than the few billions of bolt-on deals so far — to build the scale and skills they need. But they have to accept that most low-carbon businesses are inherently lower-return — though less volatile — than upstream.

CCS will look more like sewage treatment than buccaneering frontier exploration. And today’s low valuation multiples make big share-based acquisitions unfeasible.

They can be bought by the Americans — a politically controversial Transatlantic move, and likely to be impossible in the case of TotalEnergies. They could sell their upstream assets piecemeal or en bloc. BP and Shell could merge, but that would be a purely defensive move unless accompanied by a radical shake-up of strategy. Or could they find another buyer, perhaps an epochal tie-up with a Gulf company?

If they are to continue as independent entities, there is no easy way round the fundamental contradiction: European stakeholders demand energy transition but aren’t willing to value it as oil company investors.

The situation won’t change until the European chief executives articulate and deliver compelling pathways to high returns with low carbon.

Robin M. Mills is chief executive of Qamar Energy and author of The Myth of the Oil Crisis