Where are the extractive industries heading?

Architectural Grid

The last decade kicked off in the aftermath of the 2008 financial crisis with the Arab Spring and the fall of Gaddafi; $100+ oil; the Euro crisis; the Fukushima nuclear accident; and the death of Kim Jong-Il. As the decade progressed, it witnessed increasingly intense hurricanes and extreme heat events; the ascent of Xi Jinping in a newly assertive China; Brexit; the Trump administration; #MeToo; #BLM; and Covid-19.

From the perspective of late 2021, we see growing widespread acceptance of the reality of anthropogenic climate change pushing decarbonisation faster and further than anticipated ten years – or even five years – ago.

Unfolding events and trends like these are both indicators and drivers of major changes in the business environment. If some of these events had happened differently or not happened at all, the world of 2021 would probably be very different from the one we now inhabit. Most probably, it would not be one we would have considered in our long-term strategic planning.

All industries have therefore needed to become increasingly agile and adaptable. And mining and petroleum corporate strategies have responded to the drivers of change in ways that have highlighted the similarities and differences between the two industries.

Mining and Upstream Petroleum Business Models

The mining and upstream petroleum sectors have a largely shared business model, based on the extraction of mineral resources typically with capital-intensive, long-duration projects, usually in remote, environmentally-sensitive places and often in developing countries.

This commonality makes both sectors subject to many of the same risks, such as: changes to the fiscal and regulatory regime; uncertainties over asset ownership between the companies and host governments; deterioration in community relations; increases in the costs of licence to operate; fluctuating sales volumes and unpredictability in the realised price of production; and escalating Capex and Opex per unit of production as richer and the more accessible deposits are exhausted.

Both sectors have needed to adapt to take advantage of new opportunities and respond to risks that threaten their profitability or even their very existence.

Miners and petroleum companies have welcomed the increased demand and better prices for many of their products as the world slowly recovers from the pandemic and returns to business as usual.

But this return is attended by increasingly onerous environmental and societal obligations and costs, underpinned by the emerging global consensus on the urgency of combating environmental degradation and climate change.

The drive towards decarbonisation is at the forefront.

Decarbonisation is the strongest driver of change for the petroleum industry.

There is a widely-shared expectation that the world is very close to peak oil production. Reasons include: increasing public acceptance of the need to reduce CO2 emissions from fossil fuels; the anticipation of declining demand for liquid motor fuels as electric vehicles (EVs) benefit from advances in AI, battery technology, and the charging infrastructure; the growth of the hydrogen economy; and incentives to switch to greener energy for uses such as home heating. Geopolitical factors have also contributed to price instability in all fossil fuels.

These changes have led to a decline in investment in fossil fuel production both in absolute terms and as a proportion of sales, which has contributed to further price instability.

It is worth noting, however, that consumption of natural gas will almost certainly decline less rapidly than oil, as gas will continue to be a key source of energy throughout the transition to a net-zero global economy.

As the world economy makes this transition, we should expect demand for fossil fuels to show a highly volatile pattern superimposed on long term decline. This pattern will arise because renewable energy networks, whether wind-, solar- or hydrogen-based, will only gradually become adept at matching generation, storage and distribution capacities to fluctuating local energy demands.

Price spikes in fossil fuels will be characteristic of the transition until the supply of renewable energy is as cheap, flexible and aligned to demand as is fossil fuel supply and is capable of entirely replacing it.

The supply and demand pattern of energy will also change, for example, in response to the widespread adoption of vehicle-to-grid technology or the substitution of natural gas by electricity or hydrogen.

The impact of this on petroleum companies will be two-fold.

  1. On the one hand, analysts expect the majors to continue consolidating around their core holdings, de-risk their portfolios, and so become more attractive to institutional investors with ESG goals to achieve.

    Upstream, they are seeking to concentrate holdings in areas where geological and political risks are better understood: to monetise the potential of speculative exploration reserves that are likely to decline in value in future; and to divest their non-core or higher-cost late-life properties and avoid decommissioning costs where feasible.

    Downstream they are modifying their operations to serve the growing market for EVs and eventually hydrogen fuels.
  2. On the other hand, there is a class of smaller, more agile companies with a greater appetite for risk than the majors. They are more active acquirers of divested assets because they believe they can wring more value out of them than their larger competitors.

Two Different Approaches to Greentech

The mining and petroleum sectors are increasingly diversifying into green technologies, but for different reasons and in different ways.

The fossil fuel sector faces a high-risk future of progressively lowering demand and highly volatile prices for its output as the energy transition bites. Many majors and service companies see the green economy as offering a new lease of life and a means of mitigating their portfolio risk through diversification.

They are attempting to transition to their own sustainable future by applying existing capabilities to the supply of renewable energy. Examples include offshore engineering in harsh environments for wind farms, pipeline engineering for hydrogen transport, and the use of their existing retail infrastructure for charging EVs.

Miners are likewise applying their specialist capabilities, especially in chemistry and materials processing, in fields such as batteries and recycling, to extend their reach down the value chain. Here the motivation is less about the existential threat and more a desire to mitigate risk and capture more downstream value by exploiting the growing demand for specific products from the push to decarbonisation.

Coal mining is left as something of an orphan. It is subject to the same forces of decarbonisation and lower demand as the petroleum industry, but without the latter’s expertise that can be widely applied in Greentech. Coal miners also face the same hostility as other miners due to the environmental damage wrought by their open-cast operations. Its main hope for an extension of profitable life relies on the commercialisation of carbon capture and storage technologies.

Changing the business models of extractive industries creates opportunities… and risks.

All this marks a significant adjustment in the extractive industries’ business models, from being strongly or exclusively project-based. With the introduction of Greentech elements, the new hybrid miners’ model may now include manufacturing. Equally, a new hybrid petroleum model may include green energy generation, storage and distribution, and even a move into forestry.

Of course, miners’ involvement in manufacturing and recycling could be seen as a logical extension of ore processing, smelting and refining. However, the fine tolerances often needed in manufactured products and the inclusion of B2B and even B2C marketing and sales functions would require new capabilities to secure the benefits of entering new business areas.

Similarly, the business model of integrated oil companies has always included specialised processing (refining and petrochemicals) and product wholesale and retail marketing and sales. But the move into parts of the value chain of regulated energy utilities introduces new opportunities and risks.

It remains to be seen whether these changes will engender hybrid vigour to allow revitalised and reshaped business models to flourish in new markets. Or will they lead to a diffusion of focus away from tried-and-tested approaches into areas where both opportunities and risks are unfamiliar to the incumbent management?

Will the opportunities or the risks weigh more with investors?

Have the lessons of the past been heeded?

This is not the first cycle of diversification with which the extractive industries have experimented. In the 1960s and 70s, diversification was high on the strategic agenda: some oil companies entered the coal and metals mining sectors. And miners returned the compliment and became involved in upstream petroleum.

Both parties felt that their existing capabilities were transferable to other sectors and that synergies were achievable by engaging in non-core but apparently similar businesses. The subsequent history of mining and petroleum companies’ divestment of businesses and assets shows how boardrooms realised that operational reality is not that simple.

First, there are the usual challenges of merging new businesses into organisational cultures established over generations, where intense conflicts of interest can arise. Secondly, many of these new Greentech businesses rely on emergent technologies and markets where success demands extraordinary levels of risk appetite and strategic agility – attributes in notoriously short supply in large corporations.

And thirdly, how much will the attempts to acquire green credentials improve an organisation’s attractiveness to investors?

Why, then, it is reasonable to ask, will there be different and better outcomes from the efforts of the current generation of diversifiers?

Today’s focus on extractive industries companies’ licences to operate and the planetary need for decarbonisation has created a paradigm difference between the present situation and that which prevailed in the 1960s and 70s.

Under powerful regulatory and societal impulses, greater respect for local communities and efforts to reduce or eliminate environmental degradation and CO2 emissions are becoming the norm. Failure to accept this now directly threatens executive careers, corporate profitability, share prices, and even a company’s very existence.

Just as there is no alternative to concerted action to avoid global climate change, there is no alternative to radical change for the extractive industries.

Welcome to the real “new normal”.

Image (c) Shutterstock | Olga Kashubin

Roger Simpson
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