Despite Renewables Push, Equinor Remains a Way to Play Higher Oil and Gas Prices While Getting Paid

Director

Allen Good

Equinor is accelerating its push into renewable energy in pursuit of its 2050 net-zero goal. Central to its strategy is growth of its burgeoning offshore wind business. While net installed capacity only stands at 0.6 gigawatts at end-2022, Equinor plans to grow that to 12-16 GW by 2030, a target it previously set for 2035. To do so, it plans to increase renewable spending from 12% of total capital investment to over 50% by 2030, including a cumulative gross $23 billion over the next five years.

Capital will also go toward carbon transportation and storage, like its Northern Lights project, and clean hydrogen projects where Equinor plans to leverage its experience in each area to develop its pipeline of projects with the aim of becoming an industry leader. The strategy contrasts with many peers as it's more focused and related to existing operations than peers, which are pushing into all varieties of renewable power generation or distribution and low-carbon businesses.

Despite the growth in renewables, oil and gas will remain the cash flow and earnings driver for the foreseeable future. Wind power capacity growth should accelerate mid-decade and earnings won’t be material until the end of the decade. Equinor’s hydrocarbon strategy mimics peers as it is focused on investing in its highest-quality assets while divesting smaller, noncore areas. New projects coming on stream by 2030 break even at less than $35/barrel and payback in less than 2.5 years on average according to Equinor.

The Norwegian Continental Shelf, where Equinor has a wealth of operating experience, remains central to the company's strategy. Volumes are set to grow a 2% compound growth rate through 2026. Equinor also plans to further leverage existing infrastructure in the area to add future volumes at high returns. Meanwhile, the area figures into future decarbonization plans given the low carbon intensity of its production and opportunities for offshore wind, carbon storage and hydrogen projects.

Internationally, Equinor is prioritizing free cash flow from its operations by focusing on key projects in fewer offshore areas such as the Gulf of Mexico, Canada and Brazil where returns should exceed 20%.

Business Strategy & Outlook

Thanks to its dominant position on the NCS, Equinor holds some competitive advantages relative to peers. The focus on a single area allowed the firm to gain in-depth knowledge of the region relative to its rivals while building out significant infrastructure that lowered the capital cost of incremental production. However, given a high tax burden in Norway, Equinor has historically failed to match the aftertax upstream earnings margins or returns on capital of its higher quality peers. Given the uneven recent history of returns and the narrow forecast for excess returns at our midcycle price of $60/bb, we do not award Equinor an economic moat. 

That said, Equinor has made great progress on reducing capital spending, improving its cost structure, and bolstering the economics of projects under development or delaying higher-cost and lower-return projects. Also, thanks to recent discoveries, Equinor is reversing years of declining volumes on the NCS and developing projects that will leverage its expertise and existing infrastructure. New projects should add 700 mboe/d through 2026, resulting in a 2% compound annual growth rate. This should lead to the addition of higher-margin, lower-capital barrels, which will improve returns from recent levels. Discovered resources during the last two years have a break-even of $30/bbl while the company has identified 1.5 billion boe of volumes improved oil recovery techniques that leverage existing infrastructure and break even at $25/bbl. 

Similar progress has been made in Equinor’s international operations where it plans to only operate offshore projects and exit countries where it has smaller, lower-quality positions like Nicaragua, Mexico and Australia. Additional exits or divestments beyond those announced will likely occur, further narrowing the portfolio to the highest-quality areas. Equinor estimates its project portfolio, should deliver 30% returns at $70/bbl, suggesting low-cost incremental production. 

Foremost among its international growth options is Equinor’s Brazilian position which should deliver steady growth during the next decade as a string of projects with low-break-even levels come online. Producing about 50 mb/d currently, Brazil could contribute over 200 mb/d for Equinor by 2030. 

Although Equinor was an early mover into offshore wind and arguably has crossover capability and experience, particularly in the NCS, from its oil operations, we do not see it as having a competitive advantage in this business. Although, its experience and assets in Norway, combined with a large concentrated geographical footprint, might at some point carve out a cost advantage, it is uncertain at this point. 

Furthermore, we’ve seen a rush of competitors into the segment give its lack of barriers to entry that has compressed returns. As a result, in its most recent update Equinor lowered its nominal unleveraged return expectations to 6%-10% from 8%-12% previously. That said, Equinor expects to deliver higher equity returns of 12%-16% through leverage, farm downs and targeting higher rates in emerging markets. We expect competitors to do the same, however, which could ultimately pressure returns everywhere given the abundance of bids on new projects and availability of developed projects in the secondary market. 

Carbon capture and hydrogen production might also provide an opportunity to form a moat around cost and experience, but it remains far too early to determine winners in those sectors. 

Equinor is exposed to several environmental, social, and governance-related risks, but these have no bearing on our final moat rating as most are too long-term for moat consideration or are not probable or material enough risk to cause material value destruction. Equinor’s primary ESG risk stems from carbon emissions in its operations and use of its products and emissions, effluents and waste generated in operations such as oil spills. 

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 Equinor’s hydrocarbon 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, Equinor’s strategic plans call for a move away from hydrocarbons, which should insulate it to a greater degree than peers from any carbon tax. Also, its production has some of the lowest-carbon intensity in the sector and should fall further as Equinor targets reductions and invests in greater electrification of offshore fields. 

Oil spills are an ever-present risk for oil companies operating offshore and can be devastating to a firm's 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.

None

Economic Moat

Equinor

Equinor ASA engages in the exploration, production, transport, refining, and marketing of petroleum and petroleum-derived products. It operates through the following segments: Exploration and Production Norway, Exploration and Production International, Exploration and Production USA, Marketing, Midstream, and Processing, Renewables, and and Other. The Exploration and Production Norway segment includes the commercial development of oil and gas portfolios on the Norwegian continental shelf. The Exploration and Production International segment covers offshore and onshore activities in the USA, Mexico, and other operations worldwide. The Exploration and Production USA segment covers both onshore and offshore exploration, development, and Production of oil and gas in USA. The Marketing, Midstream, and Processing segment markets and trades of crude oil and condensate, natural gas, NGL and refined products. The Renewables segment focuses on offshore wind,and integrated solutions for onshore renewables. The Other segment includes projects, drilling and procurement, the business area technology, digital and innovation, and corporate staffs and support functions. The company was founded on September 18, 1972 and is headquartered in Stavanger, Norway.

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