The surprise win earlier this year by activist firm Engine No. 1 of board seats at Exxon Mobil was a watershed event in Big Oil’s ability to control the climate narrative as investors push for change. But the stake revealed this week in Royal Dutch Shell by Dan Loeb’s Third Point Management activist investor firm may say more about how energy giants balance business models in the future to hang on to higher return, cash-generating legacy fossil fuel projects while investing in renewable energy.

Loeb’s idea is simple: just break up the company. Put the oil and gas assets into a separate firm focused on returning cash to shareholders while setting up a renewable energy company to succeed on its own.

Is the sum of the parts going to be worth more than the whole in the future of the oil and gas business?

Loeb’s investor letter comments on Shell were not highly specific on how many companies would result from separating units like renewables, liquified natural gas and marketing from legacy exploration and production. But he made the case that Shell’s current approach of “do it all” ends up making it more difficult to attract shareholders.

In an earnings miss reported on Thursday morning, Shell said it, “welcomes open dialogue with all shareholders, including Third Point.”

Climate investing experts say this turn in the activist attention to oil is big.

“This is a significant development, because it will force Shell to answer a question that has been on the minds of investors for some time: do legacy oil companies like Shell actually add any value to the low-carbon transition? Is Shell becoming like an old-style conglomerate, where the whole is worth less than the sum of the parts?” said Andrew Logan, senior director, oil and gas, at climate shareholder advocacy group Ceres.

The opposite may be proven true: combining the cash flow of oil and gas assets under the same corporate roof as a high growth, investment intensive clean energy business Shell is actually building a stronger business than either of the two standing alone.

But no one knows the answer and at least Loeb has posed it.

“If nothing else, the move by Third Point signals that Shell has not convinced the investment community that there is value in keeping all of these businesses in house,” Logan said.

A recent sale by Shell of lucrative oil and gas assets in the Permian Basin highlights the issue.

The sale to ConocoPhillips fetched $9 billion — and where did the proceeds go? About $7 billion was returned to shareholders and an undisclosed part of the remainder would be included in overall spending and initiatives that include energy transition.

Shell told CNBC at the time of the deal that investors should not read too much into the majority of the deal proceeds going back to shareholders rather than into renewable energy. “This sale was a one-off event and thus the decision on proceeds was also treated as such,” a Shell spokeswoman stated in an email. And she stressed that the company has outlined a capital spending plan that increases focus on its renewable energy business. But she also alluded to an issue about investor returns that remains tricky: “We are steadfast on disciplined capital deployment and going after investments that will have the highest value and returns.” 

To date, and especially with oil prices rising back to a decade-high, it’s the legacy fossil fuels business which generates the highest returns. 

It was not long ago that headlines in the press highlighted the market cap of utility company NextEra Energy, which has aggressively invested in renewables, surpassing that of ExxonMobil. With the oil cycle turning back to a boom, that’s no longer the case.

“Throwing money right away into the alts space may not be the right answer for Shell,” said Peter McNally, global sector lead covering energy at Third Bridge.

Energy in the future will be a much broader potential business model than the narrow model of exploring for liquid fuels and producing them, but delivering energy in the power sector is a different business than fossil fuels. 

This past summer, Norse energy giant Equinor, which has been at the forefront of the transition to renewables, lowered its expected rate of return from its offshore wind projects from between 6% and 10% to between 4% and 8%, while projecting an internal rate of return of 30% for oil and gas. Still, the company has said it will reach over 50% of spending on renewables and carbon capture by 2030, up from 5% last year.

“Today, the outlook is more money in hydrocarbons than in renewables,” McNally said. ” It’s the Exxon argument. You still make more money, whether you like it or not, than selling power from wind.”

A recent survey of investors by Reuters showed that as oil prices have risen sharply, investors have said, “drill, baby, drill” rather than spend on wind and solar.  

“Returns for low carbon businesses may not be that good in the next five to ten years,” said Axel Dalman, associate analyst on oil, gas and mining at Carbon Tracker. “BP has said don’t expect strong returns until 2030 and that’s a bitter pill to swallow for some investors,” even if longer term, the big risk is a stranded asset and losing a lot more if energy transition isn’t successful.

Former BP CEO John Browne said at the CNBC ESG Impact summit on Thursday that society will need to spend over $2 trillion more per year to reach carbon reduction goals. And for the oil and gas companies, he said it is a difficult “balancing act” to satisfy all shareholder interests, though he also said the plans announced to date to reduce carbon don’t “really have meaning.”

The energy business has always been cyclical and high oil prices today won’t necessarily remain that way, and while renewable energy projects may have lower internal rates of return, the exponential growth opportunity from the sector may be more attractive to many investors than the cash-generating core carbon legacy business of an oil and gas major. Few expect energy to ever overtake technology ever again in sector representation in the S&P 500, or even come close, though it has come up from its oil bear market low of 4% of the U.S. market, which some had taken as a permanent bottoming related to climate change.

The $7 billion that Shell recently returned to shareholders from the $9 billion Permian sale was not an enormous amount of money in the context of its business and shareholder expectations, according to Alisa Lukash, vice president of shale research at Rystad Energy. Pre-pandemic shareholder return annual levels, for example, were as high as $19 billion in 2019, and an oil company has to keep returning money to shareholders to keep them from turning to other sectors or other peers within the energy space. From the angle of purely getting some liquidity and maintaining investors for the next few years, she said that it’s a smart strategy.

But if the company’s stated strategy is energy transition, which it is in Shell’s case, “As an investor, you want to see them use the cash to reinvest and look for new business streams for cash generation,” such as solar. “Taking out $7 billion for investors, burning cash, that’s why that balance is important,” Lukash said. “Many investors would have preferred use of cash for decarbonization efforts and other aspects of environmental impact, like water impact.”

After an energy bear market and Covid year which saw oil companies cutting back on spending and shareholder reward programs, it is hard to make investors wait longer as the energy market soars.

But that approach becomes disconnected for a company claiming it wants to transition and become a new energy company which requires massive investments in new technology. “It’s perhaps a missed opportunity,” Dalman said. “Didn’t get the strong sense from Shell, didn’t give specific message of what they will spend for energy transition. … still a strong smell of business as usual here.”

The traditional ethos of the oil and gas investor is to hold the stock with the expectation that you will suffer through bad years in the cycle when oil prices are low but when things go back up you will be rewarded and compensated for the additional volatility risk. And because of that, “it’s hard to say we won’t be able to compensate you now, you have to be patient,” Dalman added.

Energy companies have so far failed to make the case — or at least try to make a detailed case — on project spending levels and returns from renewables.

“It’s hard to know if $1 billion or $2 billion or $3 billion makes a difference,” Lukash said. “It’s hard to say on decarbonization unless they tell us what projects and how much. For investors, it’s easier to say $7 billion, dividends and share repurchases.” 

Meanwhile, prices on legacy assets may not get better the longer these companies wait.

The $9 billion price tag on the recent Permian deal shows legacy assets can still generate high values, and shale is among the most exposed types of drilling to future stranded asset risk. That implies value for this type of asset will go down over time, and climate-minded investors can make the case that the capital raised today from sales is even more critical for transition investments. “Because in ten years when you try to sell you have to assume they will be fetching lower prices,” Dalman said. Selling oil and gas assets to a peer like ConocoPhillips, in the end, “It’s more barrels burned in the end,” Dalman added, in a world that needs less of the underlying product.

The history of activist investing, and its own motivations, are mixed. Spinoffs are nothing new in the energy sector or as an activist approach. Refiners have been spun off by both ConocoPhillips and Marathon Oil and Marathon Petroleum, and while an imperfect comparison to a new type of energy break-up involving renewables, the history does show that all the resulting companies don’t end up equal winners.

The easiest comparison is Conoco separating from Phillips 66 in mid-2012. Since that deal, ConocoPhillips stock is essentially flat, while Phillips 66 is up over 125%.

“At least on that one it’s pretty clear who won,” said Stewart Glickman, energy equity analyst at CFRA Research.

“It didn’t work out for the exploration and production companies,” McNally said.

But it is hard to generalize because most of that time period had been a crude oil price regime that has “ranged from mediocre to awful,” Glickman added.

In the future, it may not necessarily work out for the refiners, which are seen as being at high risk in the energy transition and which Shell has heavily divested from, a strategy that Loeb applauded in his investor letter.

There are benefits of being an integrated energy company with a big balance sheet, possibly even more so during the energy transition. With higher oil prices the situation is now very different than it was a year ago when investors and management thought there may not e enough money to invest in anything. “Now they’re debating what to do with all this money,” McNally said. 

For an activist like Third Point, Shell is a safe target in the sense that it is a big liquid stock and so even if the plan doesn’t work, there is an exit strategy that is not that many days of volume in Shell trading.

But an analysis of the benefits versus the risks of the proposed transaction is hard to make at this point, according to Maurizio Carulli, senior corporate research analyst at Carbon Tracker. Companies can benefit from being split up when it allows the management teams to truly focus on their goals without divided attention, and that can make each business more investable to various shareholder groups, including those who want the cash returned for income needs and those looking for the exponential growth in a new industry.

But the picture isn’t clear in this case, especially if the idea is to include liquified natural gas with renewables in one new company because it is seen as a “transitional fuel,” when there are many climate-motivated shareholders who will not be on board with that strategy. And for investors in the legacy company, right now the timing is right with oil prices at a level they had not seen since 2014, and with increasing shareholder return programs and divestitures likely, but if oil prices collapse again, those legacy company investors may find themselves in the worse situation than if they had stayed part of the whole.

Carulli said the biggest risk of all, though, is breaking up an engineering company which has been around for a long time as part of a century-old industry, with hundreds of PhDs. who create innovation in technology that could be used across the value chain. “If you separate completely, then that well of human knowledge can collapse,” he said.

Yet similar deals to the recent Shell Permian deal are likely to happen again in the near-term after the beating energy shareholders had to take in recent years, compounded by the pandemic, and appeasing shareholders is only made more difficult when some other shareholders will only be appeased by real progress on energy transition.

Kirsten Spalding, head of the Ceres Investor Network, said it is a hard question to answer as to whether Shell has the right structure and the right people in place in management. But the problem with Shell’s $9 billion Permian sale to ConocoPhillips, from her point of view, wasn’t about how the proceeds were spent but that it accomplished nothing for climate change when the same production merely changes hands. A planned downsizing of fossil fuel assets is what will reduce risk of climate change, and that’s a hard case to make to an oil company — that it is their job to not only maximize value for shareholders, but to do so in a way that does not allow them to sell any existing fossil fuel assets to other companies that may pursue exploration and production.

“I think there is diversity among investors, but at least investors I am working with have one voice about systemic risk and the need to get on a transition plan,” Spalding said. “The most important thing is investing in renewables and making the transition and becoming a diversified energy company and not a fossil fuels company. What happens on that clean energy side, if we see them ramp up and get good at it and start pouring money into it and doing a better job of really running a renewable energy business, then we would be enthusiastic.” 

Many of those investors see only two choices: an oil and gas company either diversifies and does it fast so they become an energy company, or they go out of business in an orderly way. “So far, nobody has taken us up on that option,” Spalding said. 

If a company says they will transition by being a supplier of clean energy, they need to show it in the capital they invest in new technologies.

“You have a massive shift and it requires all the force you have,” Dalman said. “But if you say ‘I don’t think we can become a renewables company and just need to sell and close up shop,’ then it’s fine. There’s nothing wrong with an oil and gas company selling assets and returning cash to shareholders over time, basically taking a harvest strategy approach to transition,” Dalman said.

“Shell has too many competing stakeholders pushing it in too many different directions, resulting in an incoherent, conflicting set of strategies attempting to appease multiple interests but satisfying none,” Loeb wrote in his Q3 letter to investors. “Some shareholders want Shell to invest aggressively in renewable energy. Other shareholders want it to prioritize return of capital and enjoy the exposure to legacy oil and gas.”

The activist investor broke down the existential question for Big Oil in very simple terms: “As the saying goes, you can’t be all things to all people.”