The race to a sustainable future is forcing Europe's energy groups to figure out exactly how to transform their businesses. Take a scalpel to operations and carve out carbon-intensive assets piece by piece? Or take the leap and sell them all in one fell swoop?

A number of sector advisers have told Mergermarket in recent months that the industry's leading names—think BP, Shell, Total and Eni—are looking to reduce exposure in their upstream oil businesses, as investor sentiment towards carbon-heavy assets rapidly sours and the EU sets its sights on a net-zero future.

Not only do they have to decide on whether to bundle assets or sell them off piecemeal, there's also the question of how to divest. There's a lot to think about.

1. Go public: The argument in favour of IPOs

There's a lot to be said for the IPO option, especially considering where we sit in both the economic and market cycles.

Last year, the economy was crippled and energy groups bore the brunt of weakened demand. Fast forward to mid-2021 and the global economy is restarting. Not only that, investors are rotating out of hyped tech stocks in favour of more humdrum, cyclical stocks. That's good news for energy groups, as is the rising demand for hydrocarbons as energy consumption recovers. It's also good news for existing shareholders who may want cash from the sale to reinvest where they see fit.

But—and it's a big but—investors increasingly do not want to put their money into carbon and you don't get much more carbon-intensive than oil. For example, there’s been some speculation that Wintershall DEA, the gas group owned by BASF and Russia's LetterOne, is thinking of ditching its IPO for a spin-off, owing to lacklustre demand. This speaks volumes, considering that gas is widely viewed as a favourable energy source for bridging the gradual transition to renewables.

However, European energy groups with squeaky clean assets have more options available for funding their transitions. Oil and gas players Repsol and Eni, for example, have launched strategic reviews and are considering listing their respective renewables units, both of which are almost guaranteed to see appetite from climate-minded investors.

By splitting these assets off and raising cash on the stock market, the IPO proceeds can be reinvested into expanding renewables projects. This approach has the added benefit that, as independent entities, these renewables businesses should achieve the valuations they rightly deserve with better access to financing and at a lower cost of capital.

2. Slice and dice: The argument in favour of spin-offs

Then there's the demerger option. Mining giant Anglo American has taken this route, deciding to spin off its thermal coal business this year amid growing pressure from shareholders. This could be a template for others to follow.

Rather than attempting to drum up interest for an out-of-fashion asset, Thungela Resources listed on the Johannesburg and London stock exchanges. This approach requires less effort and involves less uncertainty as there is no offering process.

However, this may not result in a great outcome for existing shareholders. Investors will hold stock in the new company and demergers can result in significant short-term selling pressure, aka “flowback”, as demonstrated by Thungela's price plummeting on its first day of trading on the LSE. This can be especially pronounced if the demerged entity is significantly smaller than the parent and subsequently drops out of stock indices.

Energy groups are in an unenviable position but, either way, they will have to do something.