Shell pops the hood on its energy transition strategy: Fuel for Thought

The internal combustion engine faces an expiry date as the transportation sector moves decidedly towards electrification. Plastics and heavy transportation will not sustain high oil demand on their own.

The question is whether the inevitable energy transition from liquid transportation fuels to electricity will take a few years or several decades. Either way it poses an existential threat for oil companies.

For oil majors, the latest climate-related setback has been financial in nature, with institutional investors, including sovereign wealth funds, concerned about long-term positions in fossil fuels.

In October 2018, BP's Bob Dudley publicly defended oil majors, in light of fossil fuel divestments and concerns that oil assets could be written off at scale if the energy transition were to accelerate. He argued that oil companies are best placed to lead the energy transition.

When Norway's Statoil changed its name to Equinor, oil traders joked that it sounded more like a pharmaceutical company, but they also acknowledged the hard realities behind the oil major's shift toward becoming an energy company.

The supermajors have an unenviable task ahead -- timing their diversification strategy right, ensuring current supply is not disrupted, continuing to pay high dividends and implementing a transition plan that ensures survival.

How exactly this will be achieved has been tough to gauge. In late December 2018, Shell's Executive Vice President of New Energies, Mark Gainsborough, popped the hood on the company’s energy transition plan and answered some burning questions.

Declaration of intent

Shell started its New Energies segment in 2016 to invest in two new businesses -- new transportation fuels and the power sector, targeting returns in the high teens and around 8%-12%, respectively.

Gainsborough said the oil major will pump $1 billion-$2 billion in New Energies every year out of its annual capital expenditures of $25 billion. "But the expectation is if we find good commercial opportunities over time we can look at ways of ramping that up," he said, adding options to include M&A and organic growth.

The New Energies business will be monetized in the same manner as shale, natural gas and deepwater drilling have been. Natural gas and deepwater drilling have already become cash generators, shale is next, and New Energies will follow, Shell said.

"The bottom line is over the next 20 to 30 years we need the cash from the conventional businesses to fund growth and new opportunities like New Energies," Gainsborough said.

He said Shell also plans to link executive remuneration to reductions in the carbon footprint and "really hard-wire this into the thinking of the company."

Chasing power, and scale

One of the key concerns about the energy transition of oil majors has been scale: Conventional oilfields cost several billions of dollars, but a solar or wind farm costs a fraction of that.

"I think if we wanted to be on the same scale of business as we are today, it's almost inevitable that you would have a bigger power business," Gainsborough said. "We really want to scale that business up quite materially."

Shell's plans to dominate the power sector from generation to household charging systems – imitating its "downstream heritage" in fuel distribution like petrol stations. Aggregating hundreds of smaller renewable projects could also make up for big megaprojects.

Shell is also replicating its US power trading business, where it is the second-largest power trader in terawatt hours, in Asia Pacific – similar to oil, Gainsborough said.

The challenge is that oil majors are attempting to enter a completely different business with incumbents, and one that's heavily regulated in Asia. How this plays out remains to be seen.

Pragmatism on fossil fuels

The new business model for oil majors will be driven by the carbon intensity of the products they sell, and not just the carbon footprint of their operations. The new energy businesses are being positioned so they can be rapidly scaled up if fossil fuels decline rapidly.

Shell was confident oil will not disappear overnight and natural gas will be vital in the energy transition.

Gainsborough said there are overlaps, too, such as using offshore and deepwater expertise in offshore wind and floating renewables.

In Queensland, the oil major is combining a large-scale 200 MW solar farm with an existing combined cycle gas turbine. The project is yet to reach a final investment decision, and could save gas for the domestic gas market.

Shell is expanding its venture capital business into Shanghai to take advantage of the early stage investments in new technologies and startups, given the innovation boom in China in particular. Its new fuels business is also looking at biofuels, hydrogen and battery charging.

Hydrogen is seeing growing corporate and government interest. In October 2018, Japan's trade ministry backed a ministerial-level meeting on using hydrogen as a fuel source in Tokyo, the first of its kind.

"We've been busy building hydrogen stations, mainly in California and in Germany, which we see as the two lead markets for hydrogen," Gainsborough said. "But we've [also] done a few stations in the UK and some in the Netherlands and a few other markets."