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The Relevance Of Shell’s Sky Energy Scenario

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The internet is going gaga over Royal Dutch Shell’s new “Sky” scenario, which discusses the impact on the energy industry of efforts to limit climate change.  Many treat the existence of such a scenario developed by a major oil company as evidence that a) an important oil industry player expects this to happen, b) projections of a severe climate policy future are validated.

Writing as an aged methane emission, this is not really new.  In the 1990s, Shell was cited by many environmental advocates for appearing to have sided with them.  As Curtis and Romm said in 1996, “Imagine another world in which fossil-fuel use had begun a slow, steady decline; more than a third of the market for new electricity generation was supplied from renewable sources; the renewables industry had annual sales of $150 billion; and the fastest-growing new source of power was solar energy. An environmentalist’s fantasy, right? No, that’s one of two planning scenarios for three to four decades from now, developed by Royal Dutch/Shell Group, the world’s most profitable oil company, which is widely viewed as a bench mark for strategic planning.” 

The point is that, even if one considers forecasts to be predictions of the future, scenarios are most definitely not. Rather, they are a way to test the effect of possible outcomes, often used by companies like Shell to help decide their way forward.  Of course, some merely use them to cover their hindparts, as in, “well, we did have a scenario that foresaw this.”

The concept of scenario forecasting as developed by Pierre Wack and refined by Peter Schwartz was never intended as predictive but rather diagnostic.  Considering major changes in the industry environment and the differential impacts on various sectors of the industry can be quite useful, as some past examples show.  Recognizing that the rising market share of Middle East producers might lead to more exporter pricing power could suggest that low-end petroleum products such as heavy fuel oil might be price out of the market (1970s).  Similarly, the rising potential for carbon taxes would hit some current petroleum projects worse than others:  notably oil sands would be effected more than natural gas projects.

In effect, Shell is doing what many activists have said large oil companies should do:  try to understand the impact of aggressive climate change policies on their business (although they aren’t specifically estimating the effect on the value of their assets).  As such, it should be considered useful for evaluating climate change policies rather than opinions on climate change, just as a ‘business-as-usual’ scenario, such as the IEA’s “Current Policies” scenario is not intended as predictive of the future policy environment.

Perhaps the biggest mistake is to take likely trends out of a forecast and put them into a scenario.  Many energy companies have long had a ‘green’ scenario to test stronger environmental regulations, but in a world of growing economic activity, it should be assumed that regulations on per-unit emissions would be tightened over the long term.  If vehicle miles travelled are growing 2% per year, for example, total emissions would increase 2% per year if the emissions per mile are not being reduced, which is usually going to be unacceptable.  Most forecasters like the EIA and IEA do not want to predict that governments will tighten emissions standards, but such is more likely to be ‘business-as-usual’ than stasis in per-unit emissions.

Ultimately, the scenario user is charged with estimating the probabilities that a scenario will occur, and his or her own risk tolerance, before reacting (or not) to the possible outcome.  At present, investing in coal fired power in Asia might be attractive under some scenarios (such as the IEA’s “Current Policies”) but would hardly be low-risk.  Moves to restrict greenhouse gas emissions have been much less than international agreements call for, but they are being implemented, and a future where unbridled coal combustion isn’t penalized seems unlikely.

The big difference between Shell’s green scenarios two decades ago and now is not their content, but the increased probability that the future policy regime will be tilted against Greenhouse Gas Emissions.  The value of the scenarios is thus in the micro-level analysis of its impact much more than its existence, but the bulk of the attention given to it reflects the prominence of the ongoing tribal battle over climate change science, rather than, say, debating the efficacy of carbon taxes over renewable energy subsidies.

Sources:  Curtis, Charles and Joseph Romm “Mideast Oil Forever?” The Atlantic, April 1996.

Peter Schwartz, The Art of the Long View, Doubleday, 1991.

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