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The future of energy - tackling the business challenge

Speech given by Peter Voser, Chief Executive Officer, Royal Dutch Shell plc, to the Alumni of Harvard, IMD, INSEAD, Rochester Business Schools Zurich, April 28th, 2011.
Peter Voser

In this speech, Peter Voser, Chief Executive of Royal Dutch Shell, explains how rising long-term demand and the shift to a sustainable energy system will reshape the global energy landscape in the decades ahead. He also describes what international energy companies like Shell can do to respond to these trends, by developing new energy supplies, broadening the global energy mix and reducing the CO2 intensity of fossil fuels. The transformation of the global energy landscape also throws up significant business challenges for companies like Shell. And Peter finishes with an explanation of how Shell is tackling them.

The future of energy – tackling the business challenge

I’ll begin by thanking you for your invitation to talk today.
 
The opening months of 2011 have been turbulent with the appalling tragedy in Japan, the developments in the Middle East and North Africa, and the ongoing fallout from the financial crisis.   
 
So today is an opportunity to take stock, and a chance for me to tap your collective wisdom and expertise.   
 
With that in mind, I’ll first describe the twin pressures that are reshaping the energy landscape: surging long-term demand and global efforts to build a sustainable energy system.
 
Second, I’ll set out how the energy industry should respond. And, third, I’ll focus on some of my current business priorities. So, first, the big picture.

The global energy challenge

It’s too early to speculate about the long-term implications of what is happening in the Middle East and North Africa. Just as it’s premature to speculate about how the tragedy in Japan might affect the evolution of the global energy mix.   
 
But recent events have served as a powerful reminder that the health of the global economy remains intimately tied to developments in the global energy system.
 
In the past fortnight the IEA has issued a fresh warning about how a prolonged bout of $100-plus oil prices could undermine the economic recovery. And oil price volatility is likely to remain a feature of the next decade and beyond.
 
That’s because energy demand will surge upwards in the coming decades. Even before oil prices touched $125 per barrel recently, prices had increased sharply as demand recovered after the recession.
 
Last year, oil demand increased by 3%. Only twice before has the world experienced such a strong growth rate in 1976 and 2004.
 
That is consistent with the long-term trend of rising demand. By 2050, demand could double or even triple from its level in 2000 if the world continues to use energy in the same way that it does today.
 
That will be propelled by a rising global population (9 billion people, up from today’s 6.7 billion or so)  and strong economic growth in the developing countries.
 
By 2035, energy consumption in non-OECD countries could rise by nearly two-thirds compared with just 3% in OECD member countries.
 
In large part, that’s because many people in the emerging economies are starting to enjoy higher living standards on the back of rising wealth levels. With that comes rising energy use, as they buy their first cars, computers and fridges.
 
And that’s to say nothing of the billions of people who continue to live in energy poverty across the world, for example, 1.4 billion still lack access to electricity.
The energy industry must accommodate their needs, too.
 
Keeping pace with this demand will be extremely tough. In the first half of the century, the world will see a significant expansion in energy supplies, possibly by the order of some 50%.
 
And there will be advances in energy efficiency, which we can realistically expect to moderate demand by around one-fifth over the same period.
 
By 2050, everything from cars to homes will be more energy efficient. And smarter city planning will have resulted in more compact urban layouts and improved public transport systems.
 
This will be critical to easing global energy demand: urban dwellers could account for three-quarters of the global population, up from around 50% today.  
 
Yet this could still leave an enormous gap between supply and demand; one equivalent to the size of the global energy industry as it stood in 2000.
 
At Shell, our scenario planners describe this as a massive “zone of uncertainty” looming over the global economy. To bridge it, we will need to see an enormous expansion in energy supplies, coupled with extraordinary measures to moderate demand.

Shift to a sustainable energy system

The coming years will see a second historic shift, as global efforts to develop a sustainable energy system gather momentum. 
 
According to the consensus of climate scientists, the concentration of CO2 in the atmosphere should be limited to 450 parts per million to avoid levels of global warming with significant negative consequences.
 
On one estimate they have now reached 390 parts per million, and continue to rise at an annual rate of 2ppm. Many governments have introduced legislation to curb their  CO2 emissions. For example, as part of its new Five-Year Plan, the Chinese government wants to deliver a 17% reduction in CO2 emissions per unit of GDP.
 
At Shell, we think that renewable energy sources could supply up to 30% of global energy by 2050, compared with 13% today.
 
And that would be a massive achievement given the enormous financial and technical hurdles facing new energy sources.
 
But even then fossil fuels will still supply around 60% of global energy, with nuclear accounting for the remainder.
 
So a sustainable energy system will not just be one in which renewable energy sources meet a growing share of demand. Cleaner fossil fuels will also play a more prominent role.
 
At the same time, a sustainable energy system must cushion its impact on the world’s water and food resources.
 
The production and consumption of energy, water and food are inextricably linked. To get a sense of what this means, consider the World Bank’s recent estimate that global food prices have risen by more than one third over the past year, tipping more than 40 million people into poverty.
 
That is partly attributable to higher fossil fuel prices, which push up the cost of the fertilizers needed to grow food and the petrol and diesel to transport it.  
 
But this is only one piece of the resource consumption puzzle. Another is that producing energy requires water, for drilling, flooding wells, and refining crude.
 
Conversely, large amounts of energy are required to process, transport, desalinate or recycle water for consumption.
 
So governments and industry will have to take a more holistic view of these issues, as demand for energy, water and food rise in concert.
 
At Shell, the truly global scale of our operations gives us an acute sense of these trends and challenges. We operate in more than 90 countries, and we sell our fuels and lubricants through a network of some 43,000 retail outlets.

Industry contribution

So how can we and the energy industry help to satisfy rising demand for energy – while also safeguarding the environment for future generations?
 
As a first priority, the industry must continue to develop and deliver new energy supplies.
 
The need is urgent. At Shell, we think that the world will need to produce 40 million barrels of oil a day by 2020 from new fields that haven’t been developed yet, due to the combined effect of increasing demand and falling production rates.
 
For perspective, that’s about four times what Saudi Arabia produces or ten times the production in the UK and Norwegian sections of the North Sea.
 
So that’s why, at Shell, we’re maintaining one of the most ambitious investment programmes in the industry. All told, we expect to invest more than $100 billion between 2011 and 2014.
 
And we’ve kept the investment taps flowing throughout the recession.
 
We’ve set a new target of raising our production to 3.7 million barrels of oil per day by 2014. That would represent a 12% increase on 2010 levels, and one of the fastest growth rates in the industry.

Broadening the global energy mix

A second priority for the energy industry must be to broaden the global energy mix, expanding the contribution of renewable energy sources.
 
At Shell, our main effort is in biofuels, which fit our traditional expertise in process engineering and, of course, our global retail network.
 
Of all the low-carbon transport fuels, biofuels can make the biggest contribution to reducing CO2 emissions from cars and trucks over the next 20 years.
 
We expect their share of the world’s transport fuel market to grow from between 2% and 3% today to around 9% by 2030.
 
We are already one of the world’s biggest biofuels distributors. And we are now moving into the production of ethanol, thanks to our proposed joint venture with Cosan, Brazil’s biggest biofuels producer.
 
Brazilian sugarcane ethanol emits around 70% less CO2 than standard petrol, across the entire lifecyle.
 
And with the capacity to produce more than 2 billion litres a year our joint venture will be one of the world’s largest biofuels producers.
 
Of course, I recognise that biofuels also bring substantial social and environmental challenges. So one way we’re addressing these is by working with NGOs to push for international standards for the sustainable sourcing of biofuels.

Reducing the carbon intensity of fossil fuels

Despite the promise of renewable energy, a third task for the industry must be to reduce the carbon intensity of fossil fuels.
 
And it’s imperative that we pursue the quickest and cheapest options. That throws the spotlight on energy efficiency.
 
Here, we must remember that developing economies are attempting to improve the living standards of billions of people. So by improving energy efficiency in advanced economies, we can create space for that to happen.
 
At Shell, our scientists are developing groundbreaking energy-saving fuels for our customers. These include Shell Fuelsave, the most advanced fuel economy product in the market. It helps drivers save up to one litre of fuel per tank, based on a 50-litre fill-up.
 
And our chemicals business contributes to everyday products that save energy. These include washing detergents that clean at lower temperatures, building insulation materials that are lighter and more energy efficient, and foams that improve the energy efficiency of refrigerators and freezers.
 
In the power sector, the fastest and cheapest way to reduce CO2 emissions is to replace coal-fired power with natural gas.
 
Natural gas plants emit between 50% and 70% less CO2 than coal fired power stations, and much lower levels of pollutants like carbon monoxide, and nitrous and sulphur oxide. That’s not all: gas-fired power plants can be switched on and off easily, making them an ideal complement to the intermittent power from wind turbines and solar panels.
 
And over the longer-term, carbon capture and storage technology could reduce gas plants’ CO2 output to almost zero by capturing their emissions and storing them safely underground. 
 
At Shell, we’re raising our gas production, so that by next year it will account for more than half of our overall production.
 
And we’re also working on a number of CCS research and demonstration projects in the power sector. For example, with partners and government support we are helping to develop an advanced test centre at Mongstad, Norway.
 
So on all these fronts, the energy industry can help to drive the development of a secure and sustainable global energy supply.

Business challenges: the world’s most competitive and innovative energy company

I’m at risk of making it all sound too easy, especially in front of this audience.
 
You will have sensed that each of these aspirations involves substantial business challenges and risks.
 
At a time of macro-economic instability, I’m talking about investing tens of billions of dollars, often in new and unfamiliar markets. And in challenging environments like the deep waters of the Gulf of Mexico and the Arctic and sub-Arctic. 

And I’m talking about raising our production of oil and gas – our core products, while preparing for, and even leading, major disruptive changes in the global energy markets.  
 
Moreover, the competitive pressures are building across the energy industry. In large part, that’s because of the rise of the national oil companies. They control access to some of the world’s most promising growth markets and to a sizeable chunk of its natural resources.
 
For example, the OPEC countries alone account for more than two-thirds of the world’s proven oil reserves.
 
Shell has a proud history of building partnerships with the national oil companies. Now the national oil companies are fast building their own technical and financial muscle. And they have been making an increasing number of overseas acquisitions in the past two years.
 
So to win critical business opportunities, we in turn must sharpen our capabilities. And pushing the boundaries of technological innovation must be the priority.       
 
To tackle all these challenges, I’ve set a clear goal: I want Shell to become the world’s most competitive and innovative energy company.
 
And I see three critical steps to making that happen.

Financial strategy

The first is maintaining a sound financial strategy. That means preserving a strong balance sheet, as well as heavy investment throughout the business cycle.
 
That’s why we resisted calls for more share buy-backs in 2008 as the downturn gathered pace. It’s also why we have a target gearing range of 0-30%.
 
This is critical to meeting the energy challenge. Energy projects easily take ten years from the drawing board to start-up. And they are very capital intensive: for example, we’ve invested some $18-19 billion in our Pearl gas-to-liquids project, which is nearing completion in Qatar.
 
When completed it will convert natural gas into liquid fuels and chemicals feedstocks, for export around the world.
 
Now, some of you might wonder about the challenge of raising billions of dollars of capital amid the disruption of the past three years.
 
But Shell is in a relatively fortunate position when it comes to capital raising. As a large and successful energy company, we’ve continued to enjoy open access to the world’s capital markets.
 
Instead, our main challenge lies in balancing the risks and returns to our equity and debt holders as we invest for long-term growth.
 
To get this right, we also need to generate the cash to repay debt and provide shareholders with an attractive return. Last year, for example, we declared dividends totalling some $10 billion.
 
Our cash flow from operations was $24 billion in 2009 excluding movements in working capital. And as our production grows we want to achieve an 80% increase to $43 billion in 2012, assuming an oil price of $80 per barrel.  
 
But the nature of the return we pay our shareholders is changing, as the time horizons of our investments lengthen.
 
Because energy resources are getting harder to access, more of our projects are based on new technologies and innovative project models. And their risk parameters are still relatively unclear. 
 
Our investors have in turn broadened their time horizons, acknowledging that Shell’s new projects will produce higher rewards over the longer-term.
 
Last year, for the first time, we offered them the choice to receive dividends in cash or in shares through a scrip dividend programme.
 
For investors, this is a straightforward way to forego cash and reinvest in future share appreciation. And for Shell, it means we can put the cash to work in the projects that will deliver growth over the longer term.

Strengthening Shell’s competitive position

Which brings me to a second step to making Shell the world’s most competitive and innovative energy company: strengthening our competitive position, so that our investment plans do deliver maximum value for our shareholders.
 
We’re 12 months into a three-year strategic plan to make that happen.
 
In the near term, we’re making the company leaner and more efficient. The early signs are encouraging:  we managed a total of $4 billion in savings in 2009 and 2010.
 
And to promote capital efficiency, we are selling many of our more marginal – or “non-core” assets. This ensures that we focus our financial and management resources on our most promising markets and projects. For example, we recently announced asset sales in Africa and Europe worth well over $2 billion. In 2009 and 2010, we made a total of $10 billion of sales.
 
Our competitiveness will also be determined by our ability to deliver our major projects safely, as well as on time and on budget.
 
In all, Shell has 20 projects scheduled to start production between now and 2014.
 
So last year, for the first time, 10% of Shell employees’ annual bonus was determined by the company’s performance in delivering projects. That’s in addition to the 20% governed by the company’s track record on safety.
 
And in 2009, we established a new Projects and Technology business, which has assumed global oversight for the technical delivery of our major projects. Through this, we are driving a culture of continuous improvement and technical excellence.
 
With a view to the longer term, we’re also building a portfolio of projects that can support our competitive position for many years to come.
 
That brings the world’s growth markets into sharp focus.
 
To deliver value in these markets we will need to pursue the right opportunities with the right partners at the right time.
 
Our gas business in China serves as a great blueprint. The Chinese government has thrown its weight behind natural gas, signalling that it wants to boost its share of the country’s energy mix to the 8-10% mark. That could treble the country’s gas demand by 2020.
 
So China’s national oil companies are keen to forge relationships with energy companies which have an expertise in gas production and distribution. 
 
Take Shell’s partnership with Petrochina. Together, we are working on several projects to tap the country’s resources of tight gas, shale gas, and coal bed methane.
 
These include the Changbei tight gas field in Shaanxi Province, which supplies gas to Beijing and other cities in eastern China.  
 
Tight gas, shale gas and coal bed methane are all abundant gas sources that are trapped in relatively impermeable rock.
 
As recently as ten years ago, the industry considered these resources too difficult and costly to access. But having mastered advanced techniques in drilling and fracturing, we can now increase the rate at which we recover the gas.That boosts the volume of gas produced by each well, making them economically viable.
 
These advances may be recent, but they’ve already had dramatic implications. North America may now have more than 100 years’ worth of natural gas supplies at the current rate of consumption, just a few years after it was feared production would decline.
 
Remarkably, China’s technically recoverable shale gas resources could be 50% bigger than those of the US. That’s according to a report published this month by the United States Energy Information Administration.
 
So these are just some of the ways in which we are strengthening Shell’s competitive position, now and for the future.

Innovation and technology

And that brings me to the final point I’d like to cover.
 
In sharpening our competitive edge, innovation and technology will be critical. And they will be especially important to our ability to build thriving relationships with the national oil companies.
 
Pearl, our giant new gas-to-liquids plant in Qatar, is a vivid example.
A joint development with Qatar Petroleum, Pearl will be the world’s first world scale GTL plant, that is, on the scale of a large oil refinery.
 
It will produce enough GTL gasoil to fill over 160,000 cars a day and enough synthetic base oil each year to make lubricants for more than 225 million cars.
 
Pearl will also convert natural gas into liquid feedstocks for the chemicals industry, such as Naphtha for plastics.
 
For Shell, Pearl is the culmination of some 30 years of dedicated innovation and investment. And we hold some 3,500 patents related to all stages of the gas-to-liquids process.
 
Pearl is one of the largest industrial developments in the world. At one point, more than 50,000 workers from 60 nations were at work on a construction site the size of 350 football pitches.
 
For Qatar, the holder of the world’s third largest proven gas reserves, it’s a great way to generate additional revenues from its resources. And for Shell, it will add as much as 8% to our overall production when it’s up and running in 2012. And it will be a major factor in boosting our cash flow from operations by as much as 80% between 2009 and 2012.

So when I say that innovation and technology underpin our competitiveness, I really mean it. And this will only become more important, as the competition intensifies across the industry.
 
That’s why we invest around $1 billion a year on research and development, the most of all international oil companies.
 
We’re now increasing the pace at which we commercialise our ideas. We’ve stripped some of the layers of complexity out of our innovation processes.
 
And we’ve brought our research and development activities together under one roof in our new Projects and Technology business. We’re also entering into a host of new external partnerships, not just with the national oil companies, but with universities, governments and smaller businesses in other sectors.
 
Take our work on biofuels. We are working with Virent, a US company, to convert plant sugars directly into gasoline and diesel for use in standard engines.
 
The advantage is that these fuels could then be blended with traditional fuel in high concentrations and used in existing engines and distributed through existing networks. At the moment, only specially modified engines can run on high concentrations of biofuels.

Conclusion

And it’s this kind of co-operative and inter-disciplinary approach that will be so important to meeting the global energy challenge.
 
That’s why it’s so encouraging to see governments and businesses increasingly working together to satisfy rising demand for energy and to safeguard the environment for future generations.

We’re also seeing the first glimpses of a more collaborative approach to tackling the world’s growing water, food, and energy needs. 
 
All of which makes it an exciting time to be at Shell. Thanks to the dazzling range of skills and expertise at our disposal, we have the chance to take a leading role in tackling these challenges.

And today I hope I’ve given you an insight into the business plans and strategies that I think will turn all this potential into concrete progress. I also hope that I’ve prompted plenty of questions and comments in your minds. 

It is not every day that I have the privilege and the opportunity to engage with the combined brainpower of the alumni of the IMD, Harvard, INSEAD, and Rochester business schools. So I look forward to a lively discussion.

Thank you.