Royal Dutch Shell (RDS.B) is one of the largest integrated energy companies on Earth. That has put it in the crosshairs of environmentalists looking to take on global warming. The company has started to do something about this issue, but it may not be enough to satisfy detractors. That could make life much more difficult for Shell and its shareholders.
The big change
Shell made the very difficult decision in 2020 to cut its dividend by a huge 65%. There were two reasons why the giant energy company took this step. First, drilling for oil requires a lot of capital investment, and at the time weak oil prices were making it difficult to fund spending needs. Second, the company announced plans to alter the makeup of its business, shifting toward growth in cleaner energy businesses and reducing its emphasis on oil.
That second announcement was notable, as it meant that Shell had heard what investors, governments, and environmentalists were saying about reducing carbon and it was taking action. Some of its peers, notably Chevron and ExxonMobil were, and for the most part still are, dragging their feet on this front. Shell's goal is to get to net zero carbon by 2050, with interim goals of a 20% reduction by 2030 and a 45% reduction by 2035.
There are a lot of moving parts to this plan, but it entails reducing oil production, increasing natural gas exposure, and ramping up investment in renewable energy. Shell is not new to the clean energy space either, so it has some expertise to build off of. The goals seem reasonable, but there's one key thing investors have to remember -- the oil business, though shrinking, is helping to fund the transition to a cleaner future.
A wrench in the gears
Everything seemed lined up for Shell. It had even gotten back to increasing its dividend, now having raised it twice since the cut. That was meant as a sign to investors that the company was financially strong and could be trusted to address clean energy concerns and maintain a growing dividend over time. Based on shareholder proxy voting, investors appeared pleased with the direction the company was heading. Then Shell lost a court case in Europe around its environmental impact.
The big takeaway from the case is that Shell was told to increase the pace of its clean energy transition. The court mandated target for carbon emission reduction was 45% by 2030. That pushes forward the 2035 goal by five years, but means more than doubling the carbon reduction originally planned for 2030. This is a massive change.
The company responded by outlining the steps it has taken so far and plans to take in the future. And by saying it will appeal the decision. That is the logical step for Shell, but investors need to consider what happens if it loses this fight. Most notably, it will likely have to divest more oil assets to meet the court's mandate. That means less revenue to support the shift toward clean energy. In turn, this will probably lead to increased use of the balance sheet to fund the transition. That is not an ideal solution.
What to do about it?
At this point, nothing is likely to happen in the near term. However, investors looking for a long-term energy investment might want to step back here and rethink how they go about putting their money to work. This isn't to suggest that Shell is a bad company, only that the court loss raises the risks for this energy company in an unpredictable way.
The best alternative right now is likely Total (TTE 1.18%), which is going down a similar clean energy path, has maintained its dividend, and has shareholder support for its transition. Alternatively there is BP, but the company's 2020 dividend cut and high leverage compared to peers are issues that some may, justifiably, find concerning. That said, be prepared, if Shell does end up losing this fight, it is likely that other energy names will find themselves facing similar problems down the line.