Industry evolution — where are we heading next?

The world faces the three hard truths of surging demand, lagging supplies of “easy oil” and rising CO2 emissions. A transformation of the world’s energy system is therefore necessary and inevitable. Given the complexity of the energy system and the longevity of plant and equipment, that transformation will take decades. In the meantime, more hydrocarbons need to be produced to help meet the world’s growing demand. Energy industry trend watchers are advised to look for trends in three different areas: climate policy frameworks, technology surprises and partnerships between NOCs and IOCs in finding, developing and producing hydrocarbon resources. In this speech, Malcolm provides his views on each of these areas, and discusses a number of examples of technologies that have changed the industry picture or could do so in the coming years.

Industry Evolution — where are we heading next?

Thank you. It’s always a pleasure to engage with McKinsey’s energy community. Ivo Bozon suggested I speak about the following topic: “Industry Evolution: Where are we heading next?” Let me address this question by discussing the “energy challenge”, and with that our scenarios to 2050, plus the trends to watch in three particular areas, namely: CO2 policy, technology surprises, and access to resources.

Three Hard Truths

Let me start off with the energy challenge. While most of the world’s attention is currently directed at the credit crisis, the energy and climate challenge is still there. It’s simply hiding behind the fears of recession. That challenge is shaped by three hard truths. The first hard truth is that, with more people and growing prosperity on the planet, energy demand is surging. The second hard truth is that energy supplies from all sources will struggle to keep pace. The third hard truth is that the environmental stresses from producing and using energy are increasing. The IPCC believes that ‘Business as usual’ energy growth could mean that CO2 emissions from energy would more than double to reach 65 gigatonnes in 2050. I can never quite grasp this type of figure, so let me tell you how I picture this. It is nearly 7 tonnes of CO2 each year for every person on the planet, enough to fill nearly two million two-litre coke bottles per person per year. No wonder it’s a problem. As a consequence, by the end of this century, global temperatures could be up to 6 degrees above the pre-industrial level. With sea level rises of about half a metre. That’s a risk the world cannot afford to ignore. So energy transformation is inevitable. To deal with all three hard truths in an integrated way, we must – in the first half of this century – double our total energy production, and at the same time halve total CO2 emissions That means a four-fold improvement in CO2 output per unit of energy. Transforming the global energy system will be difficult, because of the scale and complexity of this system and the longevity of plant and equipment. Technology will be key but there are no silver bullets.

Scenarios to 2050

To get a sense of the various paths the world could follow, we developed two alternative scenarios – which we call Scramble and Blueprints. In Scramble, governments focus internally on securing energy supplies. The risk of climate change is largely ignored until problems become severe. In Blueprints, cross-border coalitions of countries, cities and companies address all three hard truths simultaneously. There is growing international alignment on the need for a global carbon market and CO2 pricing.

Comparing the scenarios: energy mix

How do the energy outcomes of these scenarios compare? Overall energy use in Blueprints is 15% lower than in Scramble. Perhaps surprisingly, in Blueprints more oil and gas gets consumed than in Scramble. That’s because in Scramble, energy security fears prompt a ‘flight into coal’ and global coal consumption  grows by nearly half in the first two decades of the century. This is already happening. Chinese coal demand has grown by some 85 percent in 5 years. About 20 percent less coal is used in Blueprints. But more important is the rapid introduction of CCS technology to curb power station CO2 emissions. This results in about 25% lower CO2 emissions in Blueprints than in Scramble. Shell prefers a Blueprints approach because it provides a more stable business environment, with faster takeup of new technology and lower greenhouse gas emissions. But I should add that Blueprints isn’t perfect. Even in an ambitious scenario like Blueprints, we might not see atmospheric greenhouse gas concentrations stabilising before the end of the century. Society will have to decide how much faster we can make the necessary changes - at what price – and taking into account all three hard truths. This brings us to the first area of trends to watch: climate policy.

Climate policy framework

It is clear that CO2 and other greenhouse gas emissions must be tackled. But the questions are how, how quickly, and how most cost effectively. We hope the world will follow a Blueprints approach and build cross-border cap-and-trade systems as a matter of urgency. Cap-and-trade systems are the foundation of any effective climate policy framework. That said, different economic sectors, such as power, heavy industry, transport and residential, also require their own, specific, measures to tackle greenhouse gas emissions most effectively.

The impact of new technology

The second group of trends to watch concern technology. Technology has delivered many positive surprises in the past and will surely do so in the future. I think we realise that the window of opportunity for significant hydrocarbons production on this planet is limited by a mix of geological, political, financial and climate factors. But so long as hydrocarbons are needed to fuel economic growth, we should recover them as effectively and efficiently as possible. New technology will help us achieve a higher production peak for hydrocarbons, push the timing of that peak back by years or decades, and to slow down the production decline that will take place later. Let me show three examples where simple technology breakthroughs have transformed the value of oil and gas resources in recent years.

Smart Fields - Champion West

First, let’s start with Smart Fields. According to CERA, Smart Fields could bring up to an additional 8 million barrels a day of extra production from existing fields – so it’s a prize worth pursuing. A good illustration of the impact of smart field technology is the Champion West field in Brunei, which contains hundreds of small accumulations, with thin reservoirs. Discovered in 1975, the field lay untapped for almost 30 years, because we couldn’t figure out a way to develop it economically. The eventual solution in 2005 was to drill smart wells that snake vertically and horizontally through several accumulations at once, with the ability to measure and control flow from up to 7 separate sections. In 2006 Champion West contributed up to 50,000 barrels a day to Brunei Shell. And we are really at the dawn of the impact of smart field technology.

4-D Seismic

A second breakthrough technology has been “time-lapse” seismic, or 4D seismic. A study by CERA estimated that 4D Seismic has the potential to deliver an additional 50-60 billion barrels — twice the known reserves of the USA. That alone could provide over 10 million barrels per day of production over a 15- year period. This is not just a CERA dream. Use of 4-D Seismic in Shell has generated an extra half a billion dollars net income over the past 10 years in Europe alone.

Tight gas technology boosts US production

Even today, as we speak, the application of new technology is significantly shifting the global energy equilibrium by opening up huge unconventional oil and gas resources. US gas provides a case in point, my third technology example. A few years ago, the US National Petroleum Council warned that it would be hard to maintain US gas production and that large scale LNG imports would become necessary to meet domestic demand. So companies Scrambled to establish LNG import capacity, 50 or more terminal schemes were mooted and 14 have been or are being built. The flat trend of Lower 48 production from 1998 to 2006 seemed to confirm the pessimistic outlook. But, look at the turnaround. Today, production is growing rapidly by some 9 percent in just the last 2 years. People are wondering just how little LNG the US will require. This growth in domestic gas supply is the result of improved technology for producing gas from tight sands and shales. For example, since buying our Pinedale tight gas field in Wyoming in 2002 we have used multiple new technologies including microseismic and underbalanced drilling to treble production while reducing costs and well delivery times by over 25%. Such advances industry-wide could open some 500 trillion cubic feet of untapped unconventional gas resources in North America, possibly considerably more. That will supply current US consumption for at least two decades.

Turning CO2 into rock

Even as we think of the recent past, most of us miss how technology breakthroughs of the sort I’ve mentioned together add up to deliver a true technological revolution. So consider how difficult we find it to imagine what impact technology could deliver in the future. I spoke earlier about CO2 Capture and Storage as a vital technology for reducing CO2 emissions in the fossil fuels chain. But many researchers are looking at other CO2 solutions. This is all relatively new research — so surely gives scope for radical breakthroughs, as it is such a pressing issue for the world. For instance, in Shell, our scientists have found ways to turn CO2 into rock quite literally. We know how to mineralise CO2 by causing a reaction between CO2 and a commonly-found mineral, ironmagnesium silicate, which results in a carbonate. Under the right conditions, a process that takes millennia in nature, can be reduced to just a few hours or even minutes. While there are still hurdles to overcome, we hope that mineralisation will form part of a spectrum of CO2 solutions.

Harvesting oil from biomass

In Shell’s Downstream area, I think it’s fair to say that we’re an industry leader in developing sustainable biofuels, made from non-food biomass or food crop residue.

The value of Open Doors

Technology is fine, but there are many challenges that technology alone does not address. This brings me to my third area with trends to watch — that of effective resource management. I believe that unlocking the world’s oil and gas resources in the most effective and efficient way requires the full capabilities of all industry players. The past 40 years have seen huge changes and cycles in the role of International Oil Companies (IOCs) and National Oil Companies (NOCs). But too often is this portrayed by media as a “them and us” situation of opposing parties, a world we surely left behind decades ago. I have the utmost admiration for many NOCs for the skills and capabilities of their people, for their R&D programmes, for their subsurface know-how, their project execution, their operations management, and for their stewardship of national energy resources in the best interest of their countries. But I also believe that the huge global challenges of efficient and effective finding, development and production of hydrocarbons will require a contribution of all players. And that IOCs can play a key role in this. It is not that I think NOCs can’t live without IOCs. Of course they can, and many do. But IOCs can bring added value: in technology, global learning, global contract leverage, capable people with global experience, and especially experience in developing deep local supply chain capacity and in helping to develop national staff. This last is a must — as the challenges of our industry are so great that we need the world’s best talent from every country. Indeed, in Shell's top 200 leaders, 27 nationalities are represented. But we as IOCs definitely have to earn our opportunities to be a chosen partner. As well as technology, capable people and all the rest — it especially takes humility, loyalty and commitment to the long term. I realise that. But does foreign investment really help? Well, the evidence suggests that countries with an Open Doors attitude to NOC-IOC partnership do benefit.

Summary: Three Trends to Watch

Finally, ladies and gentlemen, As I said, Ivo asked me to predict “where are we headed next”. But it’s a brave person who will predict anything in the world at present. Certainly not the oil price next week or next month. Indeed, 2015 seems easier to plan for than 2009. Yet it is in such turbulent times as these that making the right choices really counts. For companies. And for countries. So, as you ponder your own choices in this recessionary crisis, don’t be blinded by today’s headlines — but instead reflect on the three hard truths of surging demand, lagging supply growth and increased environmental stress, as these will surely shape our long term future. And as we enter a new era of revolutionary energy change – with a limited window of opportunity for hydrocarbons production - there are three trends in particular to keep watching: climate policies, technology development, and IOC-NOC partnerships. First, we urgently need CO2 cap-and-trade systems, and we need to tackle emissions from coal-fired power as a matter of priority, using CCS. And we need to prolong the life of liquid transportation fuels through reducing their CO2 intensity. Second, technology will help provide CO2 solutions and our ability to recover hydrocarbons efficiently. But innovation requires very bright humans — and money. Which is why in Shell we have increased our R&D spending nearly threefold since 2002 to 50 percent higher than our nearest IOC competitor. Third, in a globalising world, with surging energy demand, more difficult resources to unlock, high financial hurdles and a limited window of opportunity for hydrocarbons production growth, Open Doors is still a winning strategy, perhaps even more so than ever before. Thank you.