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BP, Shell Renewable Invest Cuts Make Business Sense

THE WALL STREET JOURNAL

MARCH 25, 2009, 4:21 A.M. ET

By James Herron

Of DOW JONES NEWSWIRES

LONDON (Dow Jones)–BP PLC (BP) and Royal Dutch Shell PLC (RDSB.LN) have angered environmental groups by quietly cutting back their investment in renewable energy, but experts said the move reflects a business reality that is hard to contest.

Most industry experts agree that oil and gas will continue to be the world’s main source of energy for decades to come and investing in projects to produce these fuels is what BP and Shell – the two major oil companies that have worked hardest to burnish their green credentials – do best and most profitably.

As the low oil price reduces cash flow, oil companies find themselves under increasing pressure to invest in their core business and pay high dividends. Investors will demand that every investment dollar generate the maximum return, meaning renewables like wind and solar are likely to get short shrift.

“We are businessmen, and we put the money we have available for investment into the opportunities that give us the best returns for the shareholders,” said Shell’s head of gas and power, Linda Cook. “If those were in renewables today, we’d be putting money there… It’s just not the case.”

Poor Returns

The almost $100-per-barrel slump in the price of oil from its peak last year has slashed profits at all the major oil companies. Both BP and Shell will be borrowing money to fund their investment programs and dividend payouts if the oil price doesn’t rebound above $60 per barrel. On Monday U.S. light sweet crude closed at $53.80 per barrel.

Recently, BP slashed 2009 investment in its alternative energy and other non-core business units by almost 30% and Shell says it will make no significant new investments in wind or solar power in the future. Both are maintaining steady investment in oil and gas exploration.

“In the short term, I can understand where they’re coming from,” said Philip Wolfe, chief executive of the U.K. Renewable Energy Association. “The comparative economics have moved against renewables.”

“Wind and solar are interesting, but they continue to struggle to compete with other investment opportunities we have in our portfolio, even with substantial subsidies in many markets,” Cook said.

“When (capital expenditure) is under pressure, it’s one of the first things to get dropped,” said NCB Stockbrokers analyst Peter Hutton. “The fact that they have cut back so sharply suggests that investment so far has not remunerated as they expected it to.”

BP has invested $2.9 billion in its alternative energy division since its 2005 launch, 4.2% of total capital investment. Shell has spent about $1.5 billion, or 1.5% of total investment over that period.

Despite this, their daily output of renewable energy is less than one-tenth of 1 percent of their oil and gas production.

BP and Shell are among the top 10 U.S. wind power generators, but in energy terms their output is equivalent to just a couple of thousand barrels of oil per day, the size of a single, very small oil field.

BP’s is one of the world’s largest manufacturers of photovoltaic solar cells,but the output of its factories is equally insignificant in comparison with its oil and gas wells.

In other words, neither company has moved “Beyond Petroleum,” as BP’s current advertising slogan puts it.

As long as the economics of wind and solar remain weak, it makes much more sense for these companies to take a long-term view and focus on research into technologies that might work for them in the future, rather than try to maximize renewable energy production from today’s sources, Hutton said.

Future Potential

“There is a long-term future (in renewable energy) and it’s something they need to maintain a clear and consistent investment in,” said Hutton. But BP and Shell need to focus on an area in which they have a natural competitive advantage and which will make economic sense in the long term, he said.

Given its experience refining and distributing liquid fuels in every corner of the world, Shell believes it has this kind of advantage with biofuels.

“We’re looking hard at research into the next generation of biofuels that wouldn’t compete directly with food sources,” said Shell’s refining and marketing chief, Mark Williams.

First-generation biofuels, such ethanol made from corn or biodiesel made from rapeseed, are already in production, but currently are only economic because of large government subsidies. They have also stoked controversy because they are seen as diverting food from the mouths of the poor into the sport-utility vehicles of the rich.

The second-generation biofuels Shell and BP are researching will be made from inedible or waste crops using novel chemical or biological processes.

“Ethanol made from miscanthus, switchgrass, bagasse and other non-edible, cellulosic feedstock is set to be a staple fuel tomorrow because of its benefits for the environment and energy security,” said Vivienne Cox, BP’s alternative energy chief, in a speech earlier this year.

Shell is in a partnership with North American biotech companies Codexis Inc. and Iogen Corp. to develop enzymes and chemical processes to boost the efficiency and lower the cost of producing ethanol from wheat straw. BP has a similar collaboration with Massachusetts-based Verenium Corp. and plans to begin producing cellulosic ethanol on a commercial scale by 2012.

“We see second-generation biofuels as an important part of the renewable energy sector going forward,” said Wolfe. “Clearly (oil companies’) core business is liquid fuels and therefore biofuels is a natural sector for them to be in.”

Falling Costs

The technology behind this is still in development and isn’t proven on a commercial scale, but both companies said they believe their research can unlock the potential.

“The costs of manufacturing cellulosic ethanol have come down from around $6 a gallon to under $3 in the last 10 years, thanks to advances in enzymes and conversion technologies. We anticipate the costs coming down to around $1.50,” said Cox.

There’s no guarantee this technology will deliver, but if it does, giant companies such as BP and Shell said they will be well placed to develop them on the scale required.

“One day we invested less than 1% of our capex in gas-to-liquids,” said Cook. Today, Shell’s biggest investment is an $18 billion gas-to-liquids plant under construction in Qatar that will produce 260,000 barrels a day of fuel, although it has taken around 30 years of development to reach that scale.

In the short term, there’s little doubt that oil companies can get by without playing a major role in renewable energy, and the sector can also do fine without them, said Wolfe. However, it’s inconceivable that in the long term they could remain successful without being involved in the development of fossil-fuel alternatives, he added.

-By James Herron, Dow Jones Newswires; +44 (0)20 7842 9317; [email protected]
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