Shell To Wind Down Fossil Fuel Output In Strategic Shift

Shell To Wind Down Fossil Fuel Output In Strategic Shift By Sarah M

Shell to Wind Down Fossil-Fuel Output in Strategic Shift By Sarah McFarlan, appeared in the Wall Street Journal, February 12, 2021, print edition. LONDON— Royal Dutch Shell PLC said it would start reducing oil production, calling an end to a decades-old strategy centered on pumping more hydrocarbons as it and other energy giants seek to capitalize on a shift to low-carbon power. The move marks a historic shift for the company, which after starting out importing seashells began selling kerosene in the 19th century and had sought to grow its oil business ever since. Until recent years, it pursued expensive, environmentally challenging projects in Canadian oil sands and Alaska, driven by fears the world could run out of oil.

Now, it sees demand faltering long before oil runs out. Shell said Thursday its oil production had already peaked and it expects output to decline 1-2% a year, including from asset sales, reducing its exposure to commodity prices over the longer term. The company plans to cut its production of traditional fuels such as diesel and gasoline by 55% in the next decade. At the same time, the company said it would double the amount of electricity it sells and roll out thousands of new electric-vehicle charging points. The strategy follows similar plans from rivals BP PLC and Total SE to reduce their dependence on fossil fuels while expanding in renewable power such as wind and solar, partly in response to growth in regulatory and investor pressure.

By contrast, U.S. companies Exxon Mobil Corp. and Chevron Corp. don’t plan to invest substantially in electricity and both say the world will need vast amounts of fossil fuels for decades to come. Exxon does, though, plan to invest in technology to reduce carbon emissions. However, the pivot to low-carbon energy is seen by analysts as challenging because it requires investments in areas where major oil companies don’t necessarily have a competitive advantage and that have lower returns. Renewables projects typically generate returns of around 10%, compared with the traditional 15% targeted on oil-and-gas projects. As such, major oil companies’ green ambitions have so far failed to ignite enthusiasm among investors, at a time when the energy industry is grappling with the fallout from the pandemic, which prompted BP and Shell to cut their dividends.

The share prices of Europe’s three largest oil companies have fallen dramatically since Covid-19 sapped demand and sent oil prices lower, with Shell down 35% over the past year, BP 45% lower and Total down 24%. Shell shares traded 2% lower Thursday. Shell sought to allay any concerns about its new strategy Thursday, saying fossil-fuel production would remain a material source of revenue into the 2030s, while reiterating its policy to increase its dividend by 4% each year. “By accessing the enormous opportunities that the future of energy holds we will create the conditions for future share price appreciation,” said Chief Executive Ben van Beurden. “We expect to radically transform Shell over the next 30 years.” Unlike BP and Total, Shell didn’t give targets for adding renewable energy production capacity.

The company said it didn’t necessarily need to own generation capacity to sell more power, and that it thought it could make more money focusing on areas like trading and selling the electricity. Shell confirmed that from now it would allocate around 25% of its spending, or $5 billion to $6 billion, to renewable energy and marketing—which includes its gas stations and lubricants business—up from 11% previously. The company aims to sell 560 terawatt hours of electricity a year by 2030, double its current sales, but stopped short of setting targets for power generation. Shell sells much more power than it produces. This is similar to its oil-and-gas business, where Shell sells around three times as much of the fuels as it produces.

In recent years, Shell has expanded outside of oil and gas with acquisitions of businesses including U.K. power supplier First Utility, electric-vehicle charging company Ubitricity and battery firm Sonnen. At the same time, it plans to invest $8 billion a year on oil-and-gas production, seeking particularly high-value projects, and an additional $4 billion a year on its so-called integrated-gas business, which includes liquefied-natural gas. The company will add seven million metric tons of LNG production capacity by the mid-2020s, including from projects already sanctioned in Canada and Nigeria. European energy companies’ plans to invest more in low-carbon power come at a time when they are still trying to reduce debt.

Shell wants to cut its debt to $65 billion from $75.4 billion at the end of last year and targets annual asset sales of $4 billion to help meet its goal. E, Graded Application Problem Set One Due no later than 10:00 p.m. Wednesday, March 24. (Submit by uploading your work in the Canvas Quizzes, quiz: Graded Application Problem Set-1) Additional questions on next page. Coordinating instructions: This is 1 of 2 graded application problem sets. It is worth up to 6 course percentage points.

Both graded application problems sets will be worth up to 6 course percentage points. If you earn greater than 9 course percentage points on the combined graded application problem sets, then any course percentage points earned above 9 will count in your course grade as extra credit. Once you complete your work, create a “.pdf” file and upload to the canvas quiz called Graded Application Problem Set One. The quiz opens March 3 and closes at 10:00 p.m. on March 24. The last submission counts.

Read the article: Shell to Wind Down Fossil-Fuel Output in Strategic Shift, By Sarah McFarlan, appeared in the Wall Street Journal, February 12, 2021. The article is available on Canvas. Answer the following questions and submit as a PDF in Canvas quizzes.

Questions

1. What is the law of diminishing marginal returns? Does this law refer to a firm’s production in the short run or the long run?
2. From the article: “[Royal Dutch Shell] plans to cut its production of traditional fuels such as diesel and gasoline by 55% in the next decade… the company said it would double the amount of electricity it sells and roll out thousands of new electric-vehicle charging points.” Would Shell’s decision to decrease production of fuels and increase its production of electricity be a long-run production decision because it will have occurred over “the next decade”? Briefly explain your answer.
3. From the article: “Renewables projects typically generate returns of around 10%, compared with the traditional 15% targeted on oil-and-gas projects.” Assume that a firm chooses to invest in a renewable project that earns a 10 percent rate of return rather than an oil-and-gas project that would have earned a 15 percent rate of return. Would the firm earn an economic profit on the renewable project? Define economic profit and describe the difference between that and accounting profits as discussed in class. Briefly explain your answer.
4. From the article: Royal Dutch Shell “… plans to cut its production of traditional fuels such as diesel and gasoline by 55% in the next decade. At the same time, the company said it would double the amount of electricity it sells…” (a) Draw and label a demand and supply curve in the market for diesel fuel. (b) Draw another graph that depicts a demand curve and supply curve in the market for electricity. (c) If other things remain equal, show the impact of Shell’s decision to change its production of diesel fuel and electricity. (d) Summarize the impact of these changes on the equilibrium price and quantity of diesel fuel and electricity.