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Shell’s Energy Transition Speeds Up

: 18 Dec 2017

Summary

  • Royal Dutch Shell doubled down on its previously-announced investments in clean energy earlier this month when its CEO told investors that it has raised this to $2 billion next year.
  • The company also announced its intention to reduced its greenhouse gas emissions by 50% through 2050.
  • While the success of Shell’s proposed energy transition remains uncertain, its plans reflect recent developments in the energy markets and multinational policymaking.

Last July the multinational petroleum and gas giant Royal Dutch Shell (RDS.A)(RDS.B) announced its intention to spend $1 billion a year on clean energy investments through its New Energy division. As I highlighted the following month, this decision was set against a busy backdrop of involvement by the company in the Climate Leadership Council, which (unsuccessfully) urged the Trump administration to keep the U.S. in the Paris Climate Accord, and investments in renewable electricity capacity. Those maneuvers, it turns out, were just the opening moves. As reported by The New York Times last week, Shell’s transition from a fossil fuel producer to a broader energy provider is rapidly accelerating.

Earlier this month Shell’s CEO, Ben van Beurden, informed investors that the New Energy division’s renewable energy investments will double next year to $2 billion annually, a pace that it intends to maintain through 2020. While but a fraction of its total research budget, the fact that it only took the company a few months to double its previous clean energy investments is notable. Equally important was Mr. van Beurden’s reveal of the company’s intention to cut its greenhouse gas emissions in half by 2050 after first reducing its carbon footprint by 20% through 2035. While slow compared to the footprint reduction targets established by many American jurisdictions (Wall Street’s home state of New York is targeting a 40% reduction from 1990 levels by 2030, for example), the impetus for Shell is the same as for New York, as quoted in the NYT article:

‘We will do this in step with society’s drive to align with the Paris goals,’ Mr. Van Beurden added, ‘and we will do it by reducing the net carbon footprint of the full range of Shell emissions, from our operations and from the consumption from our products.’

Shell, as a multinational firm that is both headquartered and incorporated in Europe, is more affected by the Paris Climate Accord’s goal of preventing the planet from warming more than 2 degrees C, and by extension keeping the atmospheric CO2 concentration under 450 ppm, than its American peers. Both the Netherlands (in which it is headquartered) and the United Kingdom (in which it is incorporated) is party to the agreement, as is virtually every other country, with the exception of the United States, that Shell conducts business in. The company’s transition must therefore be viewed within the context of the global agreement which, while non-binding, is intended to be but the first step toward binding agreements that are to be established within the next several years. Much as some of Shell’s American peers and Climate Leadership Council’s co-members advocated for that country to remain within the Paris Accord, the European company’s recent announcements can be viewed as an effort to establish a seat at the table.

This is a valid strategy given that, if the Paris Accord’s targets are to be met, a majority of the world’s fossil fuel reserves, and a large fraction of its petroleum and natural gas reserves, will need to remain uncombusted (assuming that carbon capture and sequestration continues to be financially unfeasible in the meantime). While the overall volume of fossil fuels that will need to remain underground if the Paris Accord becomes binding has been well-established by climate scientists, there is no consensus as to how this “carbon budget” will be apportioned between different fossil fuels such as coal, petroleum, and natural gas, let alone countries or individual companies. Both Shell’s investments in renewable energy technologies and its carbon footprint reduction target are important components of this strategy; in addition to providing the company with the ability to contribute to discussions regarding how the carbon budget is allocated, any reduction to its carbon footprint via investments in renewable energy capacity will provide it with a financial buffer against future restrictions on fossil fuel consumption.

Finally, there are three main reasons for investors to avoid thinking that Shell’s new commitments will hurt shareholder returns moving forward. The first is the continued presence of low petroleum and natural gas prices in both the U.S. and E.U. markets (see figure). The opportunity cost incurred by increased investments in non-fossil energy sources will continue to be low so long as fossil energy prices remain at or near the levels that have persisted since late 2014.

Second, this fall in fossil energy prices has coincided with a sharp decline in the costs of producing renewable energy, especially renewable electricity. While the fall of global natural gas prices that has occurred since 2014 has offset the practical impact of reduced renewable electricity production costs to an extent, it has not reduced expectations of continued cost declines for pathways such as wind and solar PV. Bloomberg New Energy Finance’s most recent outlookcontains projections for onshore and offshore wind costs to decline by another 47% and 71%, respectively, through 2040, for example. Indeed, there is even an argument to be made that cheap natural gas has made future cost declines for renewable electricity more feasible by reducing the latter’s levelized costs, given that natural gas currently is the primary back-up for renewables with their low capacity factors.

Third, pragmatists will point out, with reason, that the growing reliance of the world on natural gas over coal (see figure) for electricity generation will only make it easier for Shell to achieve its carbon footprint reduction target. The company, of course, is a producer primarily of petroleum and natural gas rather than coal, so it will not have the advantage carried by many electric utilities of being able to reduce its greenhouse gas emissions by simply replacing its coal consumption with natural gas and (to a lesser extent) renewables. The widespread and rapid vehicle electrification that some analysts expect to occurin the 2020s would cause the consumption of petroleum products to be displaced by electricity that would in turn be largely produced by natural gas and renewables, however. Shell’s investments in the latter two energy sources therefore position it to achieve a smaller footprint in the event that the transportation sector undergoes such a shift in the future.

2017 has seen Shell’s management take some major steps toward a future transition that would, in the words of The New York Times, see it become “less of an oil company.” While Shell is not the only major fossil fuel producer to be preparing for such a future, with petroleum and natural gas majors doubling their number of stakes in major clean energy investments to 44 in 2016, this year certainly saw it become a front-runner in that regard within its sector. This month’s announcement continues that trend and, if anything, signals that investors can expect the company to continue to be a leading practitioner of the thesis that fossil energy producers will need to become energy producers in a more general and less carbon-intensive sense if they are to thrive in a post-Paris Accord global economy.

Disclosure: I am/we are long XLE.

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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