Shell Isn’t Worried About Peak Demand But Asset Managers Are

The release of two separate reports in as many weeks on how integrated oil and gas producers will manage an anticipated transition toward low-carbon energy is likely to leave investors in Royal Dutch Shell (RDS.A)(RDS.B) with some questions. The company released its new Energy Transition Report earlier this month, and the final product presents its strategy for maintaining its operations even as the world’s major economies (with the exception of the U.S.) work to meet their greenhouse gas emission reduction targets under the Paris Climate Agreement. The report’s relatively phlegmatic conclusion stands in stark contrast to the results of an annual survey by the UK Sustainable Investment and Finance Association that identified strong concern from asset managers on the same count.

Shell occupies a unique strategic space within the oil and gas sector. It is one of the world’s larger producers of fossil fuels, a status that has caused it to come under fire in the form of lawsuits for climate change damages. These lawsuits have grown in number since 2017 due to a coordinated effort by municipalities in California, New York, and most recently North Carolina to obtain forced financing from Shell (and its largest competitors) for climate change adaptation infrastructure investments. Earlier this month the lawsuits even took on an international aspect after a Dutch environmental NGO threatened to sue Shell in that country if it failed to rapidly adopt a major low-carbon transition strategy. (While ambitious, its most recent Energy Transition Report almost certainly falls short of this.)

At the same time, however, Shell is arguably doing as much as (or more than) any of its peers to invest in renewable energy, especially renewable electricity. The Economist has even described the company as “flirting” with becoming an electric utility. While some of its peers such as Exxon Mobil (XOM) are also making major investments in renewables, Shell has set very ambitious targets for itself, including a 50% reduction to its greenhouse gas emissions by 2050 as part of a global effort to achieve net-zero emission status by 2070.

Shell’s Energy Transition Report paints a picture of a company that will do far more to adopt renewables than it expects either political or economic realities to require in the future. It attributes a low probability to being affected by policy-induced stranded assets, whereby extractable oil and gas remain underground due to future climate policies. This is in part due to the fact that it does not expect such policies to be adopted prior to 2030, at which time it will have produced 80% of its proved oil and gas reserves. Assuming that Shell reduces its oil and gas exploration efforts, then, it is logical to conclude that it will not be affected by stranded assets in the future since the assets in question will have already been sold.

Even then, however, Shell leaves itself room to maintain production after 2030 (potentially justifying continued exploration during the interim). The Transition Report also projects that oil demand will only experience a very gradual decline after peaking in 2025, ultimately achieving only a 15% decline from current levels (or 1% annually) by 2050. Natural gas demand is expected to fare still better due to its use in conjunction with renewable electricity, not peaking until 2035 and then declining by only 0.5% annually. On this basis the report states that “investment in new oil and gas production will be essential to meet ongoing demand.” In other words, even if climate policies do begin to take effect after 2030, Shell anticipates that they will have only a minimal impact on demand for oil (let alone natural gas) through mid-century.

Shell’s projection is more conservative than those of its peers; the mid-point of its oil demand range is, at ~97 million barrels per day by 2040, 10-15% below other estimates in the industry. Even this figure is much higher than what Bloomberg New Energy Finance calculates can be consumed if the world is to stay below the 2 degrees C threshold, however. BNEF estimates from IEA data that global oil demand must peak by 2020 if this target is to be met (compared to Shell’s projected date of 2025) before declining to just over 70 million barrels per day by 2040 (Shell’s estimate for that date is more than 10 million barrels per day higher). Barring a major breakthrough in carbon capture and sequestration technology, this figure will be lower still if the Paris Climate Agreement’s 1.5 degrees C target is to be achieved.

Asset managers have noticed this discrepancy and, based on the results of the UK Sustainable Investment and Finance Association’s survey, overwhelmingly believe that climate policy will cause demand to decline at a rapid pace. 30 fund managers with more than $18 trillion under management agreed by a 9:1 margin with the statement that oil producer valuations will be “significantly” affected by climate risks between now and 2023. Most notably, this result represents a doubling of support for the statement in only one year, illustrating just how much of an impact climate litigation, national internal combustion engine phase-out strategies, and other similar policies are having on asset managers’ perceptions. Nearly two out of three respondents stated that they expect valuations to be affected by peak oil demand over the same time frame, with peak natural gas demand having a similar impact within a decade.

The survey is not to say that Shell’s demand outlook will be wrong, of course. Empirically it can be expected that an oil and gas company with many decades of experience has a better grasp on demand trends than asset managers (much as I would expect those same asset managers to have a better grasp on modern portfolio theory than Shell’s energy markets experts). That said, the survey included major management names such as BlackRock, Deutsche Asset Management, and HSBC Global Asset Management, meaning that the concept of policy-induced stranded assets is no longer strictly the domain of academics and environmental activists. The fact that the surveyed managers have so much money under management means that the projected decline to oil and gas companies’ valuations could become a self-fulfilling prophecy if the managers ever act on their fears.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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