Eni Aims To Grow Overall Energy Production, Including Hydrocarbons, in Energy Transition 

Strategist

Allen Good

Eni’s latest strategy to achieve carbon neutrality in 2050 mirrors that of many peers as it seeks to invest in new low-carbon businesses. However, as with others its legacy hydrocarbon business will remain the primary earnings driver during the next decade and command the majority of investment. 

It plans to grow production at 3%-4% CAGR through 2026 from 1.61 mmboe/d in 2022 while reducing its portfolio break-even level to about $20/bbl on average through 2026 and earning returns of 25% on new projects. Hydrocarbon production and investment post-2026 remain uncertain and market dependent, though management plans for natural gas to compose 60% of its production in 2030 and over 90% of what will likely be a much smaller portfolio by 2050.

Its decarbonization efforts rest on the use of carbon offsets and investment in carbon capture and storage projects, with an aim to offset 15 mtpa and capture 10 mtpa by 2030. While reducing Eni’s net emissions, the economics of these projects vary and will ultimately be reliant on some carbon tax and improved costs. 

For diversification Eni plans to produce greater amounts of energy from decarbonized sources. In refining this means replacing part of its refined product with biofuels. By 2025, it expects bio-refining and marketing will produce over half the segment’s earnings as bio-refining capacity rises to over 3 mtpa from 1.1 mtpa in 2020. Its chemical segment will rely on bio/recycled products to reduce exposure to oil price volatility and lift returns, while reducing carbon intensity.

Like peers, it is also investing in renewable power generation and distribution, using leverage to boost mid-single-digit returns. It aims to grow its capacity from an expected over 3 GW in 2023 to over 7 GW in 2026 and over 15 GW by 2030. In its retail gas and power business, it plans to increase its customer base to 15 million by 2030 from about 10 million in 2023 as it transitions them to renewable products. 

The combined renewable, retail and e-mobility businesses are expected to generate EUR 1.8 billion in EBITDA in 2026 compared with over EUR 600 million in 2022. Named Plenitude, Eni plans to publicly list this business at some point.

Business Strategy & Outlook

Eni does not earn an economic moat, in our opinion, as its asset base is not capable of delivering durable excess returns at our long-term oil price assumption of $60/bbl. 

Although Eni’s upstream portfolio has delivered strong returns in recent years, it fails to qualify for a moat, given its history of uneven returns. We also do not think it can deliver returns on capital employed above 10% at our midcycle price. This compares to return on capital employed of 15% from 2010 to 2014, when oil prices were much higher. While Eni’s production costs are low relative to peers, largely thanks to production from North Africa, it also realizes higher tax rates that weigh on margins and returns. While we expect Eni to increase production from higher-margin assets and grow its LNG portfolio, which will improve returns, we do not think these efforts will prove sufficient to deliver maintainable excess returns for the upstream segment. 

Eni’s downstream segment will also likely prove to be an obstacle to delivering excess returns. Although the segment has registered losses in five out of the past 10 years, we expect modest improvement going forward. Eni has diversified its European refining assets with the addition of capacity in the Middle East through its 20% ownership in ADNOC refining, which operates refining capacity of 922 mbd. It has also grown its high-return marketing earnings which should compose about 40% of downstream earnings in 2023. Meanwhile, it is converting its lower quality European refineries to biofuel facilities which have a more attractive demand and margin outlook, thanks in part to government support. Eni plans to double biorefining capacity to 3 MT by 2025 and to 5 MT by 2030, while increasing share of cost advantaged waste products and residues as feedstock to 80% of total processed volumes in 2025 compared with only 20% in 2020.

We do not see these efforts collectively carving out maintainable competitive advantages as others are doing the same, but they should result in improved returns. 

Eni also has a large gas and power segment that holds assets we would normally consider worthy of a moat. However, poor contract structures and rising gas supply prices have resulted in losses and poor returns. We expect Eni’s recent efforts will improve profitability and returns for the segment but do not anticipate the contribution to be enough to offset the other segment’s performance and deliver a moat for the firm.

Eni is exposed to several environmental, social, and governance-related, or ESG-related, risks, but these do not influence its moat rating in our view given their long-term impact on the company and that they are neither probable nor material enough risk to cause material value destruction. Eni’s primary ESG risk stems from carbon emissions in its operations and use of its products, emissions, effluents, and waste generated in operations such as oil spills and poor community relations. 

The risk from carbon emissions is most likely to materialize through a carbon tax, which increases the price of end products to consumers, reducing demand over time and threatening Eni’s core business. We expect carbon taxes to gain greater adoption over time, but think the impact on hydrocarbon demand remains more than a decade away. 

Furthermore, a key element of Eni’s strategy is reducing emissions, even Scope 3, which leaves it well positioned in an environment with higher carbon costs. However, its efforts are largely in areas we do not see it being able to carve out a competitive advantage. So while its actions should help mitigate carbon costs, they do not contribute to a competitive advantage necessary for a moat. Also, any efforts to reduce Scope 3 emissions will do little to impact final product prices and mitigate demand impact, which is the true purpose of a carbon tax. 

Eni’s plans to grow its renewable power generation installed capacity to over 7 GW by 2026, over 15 GW by 2030, and over 60 GW by 2050 from about 2 GW in 2022. We typically consider renewable generation, particularly solar, where Eni is focusing its efforts (60% of renewable generation) not to be moat worthy since it holds little opportunity for competitive advantages while returns are typically low, as well. Although Eni aims to increase typical renewable power generation returns of 5%-6% to 8%-10% through leverage, this remains relatively low. Also, other firms plan to do the same and power rates might compress with more firms moving into the space. Eni might be able to leverage its experience gained from offshore oil and gas developments to carve out a cost advantage in offshore wind, but that remains to be seen as it will likely remain a relatively small player that lacks the scale for a cost advantage. 

Eni’s other efforts to reduce its carbon intensity are unlikely to result in a maintainable competitive advantage either. Eni plans to ramp up carbon capture to 50 mtpa by 2050, with an intermediate target of 10 mtpa in 2030. However, details on specific projects are unknown while carbon capture economics remain questionable at this point. It also plans to invest in natural carbon sinks—natural reservoirs that absorb more emissions from the atmosphere than they emit like forests, oceans, soil and permafrost—to offset emissions to the tune of 25 mtpa by 2050, with intermittent targets of 15 mtpa by 2030 and 20 mtpa by 2040. In addition to question cost-effectiveness of natural carbon sinks, these projects are available to anyone willing to invest and holds no competitive advantage. 

With the recent 100% acquisition of Be Power, Eni has also entered the EV charging segment and plans to ramp up charging points from 5,000 currently to more than 30,000 by 2026. Eni’s EV charging business is part of the retail and renewables segment and will likely be part of an IPO in the future. We do not see EV charging as a moaty business given lack of switching costs and ability of EV owners to charge at multiple locations, including home. 

Additionally, Eni started producing maintainable aviation fuel in October 2021 from residues to further contribute to decarbonization targets. Eni has made some forays into blue and green hydrogen and magnetic fusion, though material contributions from these projects remains at least a decade away and project economics remain uncertain to date. 

Oil spills are an ever-present risk for oil companies operating offshore and can be devastating to firm value as BP’s Macondo incident in the Gulf of Mexico shows. While oil companies regularly cause spills, most are immaterial in size and associated fines and cleanup costs are manageable. Meanwhile, large sills such as Macondo are very rare and do not factor into any of our scenario modeling. 

Lastly, global oil companies such as Eni often operate in frontier areas such as Mozambique where oil and gas development can cause friction with local communities. In which case, poor community relations can potentially cause development delays, higher costs or concession disputes. In more mature areas such as Nigeria, Eni has experienced social unrest that resulted in disrupted operations. These risks come with the territory, however, and are manageable in our view. A delay or disruption of any one project is unlikely to materially affect the value of a firm of Eni’s size.

None

Economic Moat

Eni SpA Sponsored ADR

Eni SpA engages in the exploration, production, refining, and sale of oil, gas, electricity, and chemicals. It operates through the following segments: Exploration and Production, Global Gas and LNG Portfolio, Refining & Marketing and Chemicals, Power & Renewables, and Corporate and Other Activities. The Exploration and Production segment engages in research, development and production of oil, condensates and natural gas, forestry conservation (REDD+) and CO2 capture and storage projects. The Global Gas and LNG Portfolio segment refers to the supply and sale of wholesale natural gas by pipeline, international transport and purchase and marketing of LNG, which includes gas trading activities finalized to hedging and stabilizing the trade margins, as well as optimizing the gas asset portfolio. The Refining & Marketing and Chemicals segment engages in supply, processing, distribution, and marketing of fuels and chemicals. The Corporate and Other Activities segment includes the main business support functions in particular holding, central treasury, IT, human resources, real estate services, captive insurance activities, research and development, new technologies, business digitalization, and environmental activities. The company was founded on February 10, 1953 and is headquartered in Rome, Italy.

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