With a $238 billion market cap, Royal Dutch Shell (NYSE:RDS.B) is easily one of the world's largest integrated oil and natural gas companies. It has been working to increase its green credentials by investing in electricity assets and clean energy, but the vast majority of its portfolio is still in the oil & gas sector. And according to CEO Ben van Beurden, it's going to stay that way for a very long time. Here's what you need to know.
The oil backstory
Shell's history dates to the late 1800s, when it started transporting liquid fuels by sea. One of the first companies to do so, Shell quickly found that it was a far more profitable business than the import/export trade it was doing elsewhere in the company -- including the import of, yes, shells from the Far East. And thus, Shell, the energy company, was born.
The company grew and expandens the entire energy sector, from the upstream (drilling for oil and natural gas) to the midstream (pipelines) to the downstream (refining and chemicals). These three businesses account for virtually all of the company's revenues. But carbon fuels are being displaced by cleaner alternatives, including solar and wind power. With more than a 100-year history behind it, Shell is used to shifting with the times. And today is no different, with the company slowly starting to dip its toe into the electricity space.
It isn't alone in this effort, with France's Total also making moves in the same direction. That said, Shell has been pretty clear that it wants to build its electricity-related business to the point where it stands toe to toe with its other energy investments. But the path to that goal isn't going to be quick, with the oil giant planning to invest only around $2 billion to $3 billion or so a year into the space. That may sound like a huge sum, but it's only about 10% of what the company normally spends on capital projects each year.
Why not move faster?
So Shell sees the clean-energy writing on the wall, but why isn't it moving faster to adjust its portfolio? After all, if the world were to switch to clean energy right now, Shell would be left with worthless investments in oil and natural gas. The energy company's CEO recently sat down with Reuters and explained that his company has no choice but to keep investing in carbon-based fuels, saying, "Despite what a lot of activists say, it is entirely legitimate to invest in oil and gas because the world demands it."
That may sound at odds with what you see in the popular press, but it really isn't. The International Energy Agency (IEA) looks at the energy markets today and where they're likely to go in the future. This global energy watch group highlights that oil and natural gas make up roughly 50% of the global energy market today. That's a huge number, and one that can't change overnight because of the infrastructure built around it, notably including the vehicles -- cars, trucks, ships, and airplanes -- that carry people and products around the world today. Renewable-energy sources, by comparison, make up only 15% or so of global energy supply.
Even in the future, oil and natural gas will remain very important. It's true that renewables will be the star of the show, growing quickly for decades into the future. But even if the world gets serious about reducing carbon emissions, the IEA projects that oil and natural gas will still be close to 50% of the energy mix in 2040. Coal, which is largely used to produce electricity, is going to see the greatest loss of share. That's the backdrop that led van Beurden to tell Reuters: "One of the bigger risks is not so much that we will become dinosaurs because we are still investing in oil and gas when there is no need for it anymore. A bigger risk is prematurely turning your back on oil and gas."
Essentially, what he's saying is that oil and natural gas are still needed. It would be nice to simply drop them from the energy picture, but it can't be done overnight. It will take time to transition the world away from these vital energy sources.
That fact bumps up against another one: Oil and natural gas are depleting assets. Once you pull either out of the ground, it's gone for good. You have to find new sources if you want more of it. So as older oil and natural gas fields run dry, you risk a supply shortfall if you don't keep drilling. And that's why Shell continues to spend billions of dollars a year on its oil and gas businesses.
The numbers are huge, too, with Shell's total capital investment budget going as high as $32 billion a year through 2025. With only $2 billion to $3 billion or so going toward its small but growing electricity operations, that means Shell is putting around 90% of its cash to work in the oil and gas space. It's not alone. ExxonMobil (NYSE:XOM), for example, has decided to double down on oil and gas and is planning to spend as much as $35 billion a year to develop these energy businesses. Notably, Exxon is not building an electricity business -- though it is looking at other clean alternatives, such as using algae to produce biofuels -- so nearly all of that money is going to oil and natural gas.
We don't live in a perfect world
It would be wonderful if the entire globe got together and stopped using oil and natural gas. The truth is, over time, that might actually happen. But it won't happen quickly, because there's just too much infrastructure built around these vital energy sources. And just as important, it will take time to build out the clean power facilities that will be needed to replace oil and gas. For investors with a value bent, out-of-favor oil and gas companies like Shell and Exxon might actually be worth a deep dive.