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Viewed through the short-term lens of capital markets, Big Oil has won the argument. Demand is soaring, ESG pressures have constrained upstream investment and a supply shortfall might push Brent into triple digits. IOCs that pursue a leisurely transition into diversified energy companies will reap near-term rewards, but expose themselves to ever greater transition risks. When markets finally price in externalities, the full opportunity costs will be laid bare – and investors of all persuasions could pay the price.

Addressing the Qatar Economic Forum last week, Ben van Beurden gave a masterclass in plain speaking around the energy transition and market realities. During a panel session with fellow CEOs from TotalEnergies, ExxonMobil and Qatar Petroleum, the Shell CEO laid out in simple terms the shortcomings of lopsided climate activism and myopic policy-making.

The high profile panellists were presented with results from a live audience poll asking which measures should be pursued to drive the energy transition: divest fossil assets, invest in a mix of renewables or sequester carbon. Van Beurden pounced on the glaring omission of the only market factor that really matters: reducing oil demand:

“Here we have almost 100% of the measures being polled are supply side measures. The reality of course is that the supply side is not going to drive the energy transition. The energy transition is going to be driven on the demand side... Ultimately, our customers will have to make the transition.

“This whole idea that if you just curtail supply, the world has no choice but to go for an energy transition, I think defeats any logic. If you look at the current supply sources of oil and gas, we are looking at decline rates in supply that seriously outpace any demand shrinkage that the world will need to follow in order to get to 1.5 degrees [of global heating]. So the whole idea that, if we just get rid of supply and that would sort of teach the world a lesson on how to do the energy transition, I think is a fallacy, to be perfectly honest.”

Van Beurden’s job is not to rewrite Shell’s chequered history on climate or convince activists of his good intentions. He must steer Shell profitably through what could turn out to be the most tumultuous and volatile decade for energy incumbents in living memory.

Having endured five torrid years that culminated in US oil briefly going negative last year, oil producers of all sizes are primed for what is shaping up to be an extremely profitable period that will enable them to mend their broken balance sheets, resume dividend growth and reset relations with truculent shareholders.

With Brent trading at $75 per barrel and widespread chatter about the possibility of it breaching $100, the tightening oil market provides the perfect justification for oil majors to temper their embryonic conversions into integrated energy companies and maximise revenue generation from operational assets.

As van Beurden put it, a quick transition to meet arbitrary targets means divesting productive assets and shrinking Shell’s overall size. Discussing the landmark Dutch court ruling that ordered Shell to reduce its Scope 3 emissions by 45% this decade, he called for policies that enable an enduring system-wide transition:

“The challenge with reducing the emissions of our products... should not be a challenge of how quickly can we get rid of our customers. It should be a question of how quickly can we work with our customers to change their energy needs.

“Some of that maybe technology dependent, some maybe driven by our business models (or) our innovation, but for a large part that is also going to be driven by the policies of governments that these customers work under. We can only reduce in any one country the emissions of the (fuel) that we sell if we have a significant shift to electric vehicles. That is not something that we can drive. 

“We can of course target that segment of our customer population but if that is only 0.1% or 2% or whatever in the market where you operate, you only can shrink to meet that particular objective.

“So yes we are up for that challenge… But at the same time I’m also calling out to governments to also step up to the plate, because this is not a challenge for one company, not even for one sector. This is a systems challenge that we all have to embrace.”

He went on to describe carbon pricing as “absolutely essential but also absolutely insufficient”, because it will not be a “panacea” for behavioural change. Pricing carbon won’t make people change their car, house or travel preferences:

“The amount of the economy that we are going to move by putting a carbon price in place may be significant but it is less than 50%. The other part needs to be done by smart mandates, smart policy, smart regulation.

“So in addition to having carbon pricing to influence rational economic actors, we also have to have policy and regulation that mandates things that are not going to be moved by just carbon pricing.”

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The Energy Flux view

Van Beurden’s arguments make perfect sense when viewed through the lens of near-term market-driven priorities. By tapping the brakes and focussing on the immediate opportunity to maximise free cash flow, he is meeting his fiduciary duty to shareholders.

But over what time horizon does that duty extend? The further out you look, the more risky this approach appears to be. Institutional investors tend to be diversified. They own a slice of the wider economy and are thus exposed to system-level changes.

Rick Alexander, founder of The Shareholder Commons, makes the point that diversified investors profiting from a failure to price in externalities such as carbon emissions are paying the price in other ways.

“Their portfolios will suffer because they internalize much of the costs that [a polluting] company was able to externalize,” Alexander wrote in a recent newsletter. Shell might prosper while the world burns, but how much comfort will this give shareholders?

Climate change must be seen as an epic market failure. An economic system that rewards investments that imperil the ecological systems upon which life on Earth depends is a broken one. The market might be signalling for more oil supply today, but at what point will it start pricing in the risk that endless demand for unabated consumption is satisfied?

This line of questioning renders mute the argument about how fast the energy transition is really going. Are we approaching a tipping point in the price of EVs against internal combustion engines? Will wind, solar and storage combinations soon beat unabated gas-fired power on a system-level lifetime costs basis?

These are open questions. Pivoting to renewables might not prove to be as profitable for integrated oil companies compared to business as usual, particularly in the roaring 2020s. Oil demand will probably plateau for many years after its global peak.

Reinvesting only a small proportion of bumper oil profits in lower-margin renewables or carbon sequestration projects gives Shell a green story to tell, while mollifying investors with bigger distributions.

The question for van Beurden and others on the panel is: will this strategy leave your company in the best possible position for when markets finally correct and climate risks are priced into business decisions? Or are you banking on that never happening?

Seb Kennedy | Energy Flux | 28 June 2021

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