Industry in transition
Shell Plc. is one of the largest players in the global oil and gas industry. Given profits in this industry are driven by energy prices, share prices generally move in the same direction. This would make Shell a seemingly obvious investment this year as oil and gas prices have risen to near historic highs. However, there are both short-term and long-term complexities to navigate.
Short-term windfall profits
In the short-term, the energy shortages in Europe have driven high prices and super profits for energy producers. This level of profitability could be considered unethical given many households and businesses are facing energy shortages and crippling bills. The EU has suggested these windfall profits should be taxed and redistributed to ease some of this pressure.
For investors, this does not necessarily mean downside to the share price. Long-term success is far more important than short-term profits, particularly if these profits are unsustainable. Indeed, the issues driven by the current energy shortage are not lost on Shell, who are supportive of a windfall tax.
While investors should enjoy some of the fruits of the current energy market, the share market is broadly looking through it to a more normal environment where demand and supply eventually respond to price signals. In particular, the supply response elicited by today’s high prices will dictate decades of profitability.
Long-term climate risk
In the long-term, oil and gas is a sunset industry dominated by the transition into new, low carbon energy generation.
Current investment in green energy solutions is falling far short of the US$4 trillion per annum needed . However, Shell is one of the companies leading the charge. It is growing its investment in green energy to US$2bn a year across renewable energy generation, biofuels, hydrogen and carbon capture and storage. To put this into context, this investment is the equivalent of 20% of the total oil and gas industry spend on low carbon technology in 2021, and more than 10 times the investment we expect from New Zealand’s renewable energy producers. For Shell, this is not only capital committed to climate change but it will also help it retain its leading position in energy markets long into the future.
Our research tells us that the global energy transition is far behind Paris Agreement climate goals and the world will still be reliant on oil well past 2040, and gas for even longer. While capital is lining up to invest in green energy solutions, the lead time to build renewable generation is up to a decade and regulation is still prohibitive. This means Shell will continue to profit from fossil fuels for years to come.
We have been asked how we can justify investments such as Shell when this does not align with climate goals, or the values of some investors.
We argue that investors who care about sustainability must invest in oil and gas companies to drive change. These are the companies that control the world’s fossil fuels and have the capital and expertise to deliver a renewable transition. Shareholders are the owners of these companies; they have a seat at the table to determine the outcome.
Climate change and returns align
As companies compete to develop a constrained pipeline of renewable opportunities, the financial returns from these projects are being bid down. This appears to create a dichotomy between climate goals and financial returns. But we believe an inability to deliver enough green energy will keep energy prices high, underpinning the long-term economics of renewable investment. Furthermore, we expect carbon taxes will eventually be levied, forcing companies to decarbonise to protect returns. Shell’s early advantage in green energy will ensure it is well positioned for both of these dynamics.
Climate goals and shareholder goals are well aligned for Shell, and we will use our shareholder votes to ensure it continues to invest to progress the climate transition as quickly as possible. This will also protect future returns. Imagine if every investor did that.