Royal Dutch Shell plc (NYSE:RDS-B) and Total S.A. (NYSE:TOT) are giants in the energy industry, long focusing on their integrated oil and natural gas businesses. But there's been a notable shift in their public comments about their core operations, which have been backed up by dollars spent to expand their businesses beyond carbon-based fuels. Why are they doing this, and does it make sense?

Oil is not dead yet

According to the International Energy Agency (IEA), demand for energy is expected to grow by 25% between 2017 and 2040. That will be driven by increasing demand in emerging markets, largely in Asia (think China and India and their massive urbanizing populations), with developed markets seeing slower growth because of conservation efforts. Electricity will be an increasingly important source of energy as the world attempts to shift away from carbon-based fuels.

A person's torso with high voltage power lines in the background

Image source: Getty Images

Carbon-based fuels are under attack because of global warming concerns. This is headline grabbing news that has investors worried about the future of oil companies like Shell and Total.

However, according to the IEA, the global demand for energy is likely to be so great that oil and natural gas demand will continue to grow for many decades to come. Oil's growth is projected to be backed by demand for chemicals, aviation, and heavy trucks. Natural gas, meanwhile, is increasingly being used to generate electricity because it is cleaner than coal. That should support demand for the fuel even as renewable power options like solar and wind continue their fast-paced growth. In fact, despite the hype, the IEA projects that by 2040 coal and natural gas will still be the two largest sources of electricity generation.

This is not a doomsday scenario for big oil companies, which helps explain why ExxonMobil Corporation has pretty much decided to double down on its oil and gas business. Because oil and natural gas are depleting assets, someone will need to drill more holes to supply the still-robust global demand for these energy sources. That demand should also support the oil and natural gas businesses at Shell and Total. That said, these two energy giants are starting to shift their mix, with an eye to an increasingly electric future.

Spreading their bets

Total, for example, paid roughly $1.8 billion in 2018 to buy a European electric and gas utility. That comes on top of previous investments in solar power giant SunPower Corporation, in which it owns a controlling stake. The French energy giant is clearly building out an electric business to compliment its energy, chemical, and refining operations. The electric operation is tiny, at about 5% of adjusted operating income in 2018. And oil, natural gas, refining, and chemicals will get far more investment over the next few years than Total's electric business. But management expects to continue investing in expanding its electric operations over time, so this is a long-term bet.

Shell has also been investing in the electric space. While part of that includes shifting its mix more toward natural gas, which was helped along by the acquisition of BG Group, it is also investing more directly via its New Energies division. For example, it bought one of the largest electric vehicle charging station owners in Europe in 2018, and took a 49% stake in an Asian renewable power company. And in early 2019 it purchased a company focused on energy storage for homes. According to the company's management, the longer-term goal is to create an electric business that will one day be large enough to sit alongside its oil and gas operations. That said, Shell doesn't break out the results of its New Energies division at this point.

Two people carrying a solar cell at a solar power facility

Image source: Getty Images

The clear goal for both companies is to create a balanced portfolio that includes electricity. That's not a bad business plan given that electricity is projected to be an increasingly important source of energy. In fact, Exxon's choice to double down on oil could lead to it falling behind the broader and changing energy industry over time. A big acquisition could make up for that, of course, but the slow and steady approach that Total and Shell are taking makes complete sense. Smaller moves, in fact, could help limit the risk of an investment misstep.

And then there's the worst case scenario for carbon energy sources. The IEA's 2040 projections change materially if the world gets serious about reducing carbon emissions. In this scenario, renewable power grows meaningfully, with a notable drop in oil demand and slower growth for natural gas. That would be a bad outcome for integrated oil giants, even though oil and gas will still be very important contributors on the world stage. By acting now, Shell and Total are hedging their bets and protecting themselves from this outcome.

Not a crazy idea

At this point, it looks like oil and natural gas, and the products made out of them, will remain vital for many years to come. However, there is a clear trend in the energy space toward electricity. Although it is likely to be a long time before electricity displaces oil and natural gas, Total and Shell are making a solid choice to start adjusting their businesses now. That will allow them to build and learn, and protects them from the potential worst-case scenario in which the world reduces its carbon footprint more swiftly than currently expected. If that sounds good to you, then both are worth a closer look today.