Shell World Online

Straight talk on energy’s hard choices

January 18, 2008

Q:  Shell has become a veritable moneymaking machine with higher-than-expected quarterly results, but oil and gas production fell 4% over the first nine months of 2007. What gives?

A:  First, I would say that we’re a responsible moneymaking and investment machine. After all, we invest as much as we earn in future energy production and processing. Our investment level in 2007 was approximately $2 billion a month.

Production is a complex story, impacted by specific factors and structural change. The security situation in Nigeria, for example, is specific and means the volume you can produce is below potential. The influence of the weather, such as last year’s very mild winter in Europe and North America, is also specific.

Structural factors include the fact that Shell will increasingly have oil and gas reserves that are more difficult to produce. That is why we are investing more and more for each new barrel. In such a situation it’s wrong to look only at our current production and investment figures, because you’re not comparing like with like. Investments in new production from the deep Gulf of Mexico or from unconventional oil in North America are more expensive than for conventional oil in Nigeria, for example, but the earnings potential per barrel in North America is also higher. We have been making this clear to the markets.

Specifically with regard to the Gulf of Mexico, last autumn we secured the most concessions of all the companies submitting bids for acreage there. Not because we outbid the other parties, but because we submitted bids for most of the available blocks and did so successfully. Why were we so eager? Because we wanted to secure much acreage. We are familiar with this area and have the expertise within the company that can be used to great effect there. We are eager to continue to grow in the Gulf of Mexico as this neatly matches up with our present strengths. The stable fiscal and political climate also has a role to play. That is why we have also considerably expanded our acreage in Australia and Canada.

Q:  Still, production decreases from oil and gas fields continue and the demand for energy is increasing all the while. So the peak-oil theory would appear to be correct.

A:  The peak-oil theory, as first published by King Hubbert, an American former Shell employee, is correct for easy-to-access oil, at least. But he would most certainly not have had the Gulf of Mexico on his radar screen, let alone oil sands. A peak-oil theory could also be set up for oil sands, but we’re still only at the very start of their development. And even more unconventional sources have yet to be discovered.

This will require the development of a great deal of knowledge and expertise and large-scale investments in unconventional oil projects. We have said that around 15% of Shell’s oil production will come from unconventional sources in 2015. The oil industry is already particularly capital intensive, but this will only increase – it will become an enormous investment industry. What proof do I have? The world will be using more energy in 2015 than today and more is being invested for every new barrel. This trend will certainly not be broken in 2015. A growing global population and growing prosperity are additional “inconvenient truths”.

Q:  So does that mean things have only just begun with $100 oil?

A:   Well, we always use a much lower oil price when making our investment decisions to see whether the projects would still be profitable in that case. You can produce this “difficult oil” profitably at oil prices that are considerably lower than $100.

This almost mythical $100 is based on the perception of an imminent capacity shortage. The reality is that there are no hold-ups anywhere in the entire supply chain: tankers do not have to wait for loading, refineries do not have to wait for tankers, trucks are not held up at the refinery and consumers do not have to wait at the filling station. The physical logistics are working well.

I think that demand will respond at the current price, albeit with some delay. It will, however, not result in a drop in demand but in a slower rate of growth. There are also a great many psychological factors in the current price.

Q:  Shell would appear to be less enthusiastic now than in the past about setting up large production joint ventures with other private oil companies.

A:   In the history of the oil industry it has been commonplace to set up sometimes very complex joint ventures. This often stemmed from a desire to spread the risks. But now we have reached an era in which it is becoming increasingly important to distinguish yourself from the rest by offering advanced technology. It is also becoming more important to take our own lead in projects. Our Pearl gas to liquids project in Qatar is one example. Pearl GTL is Shell without other oil companies, despite the massive investment. Twenty years ago, we would have diluted our shareholding by working with other partners, but now we consider it more important to set up Pearl entirely in line with our own standards of management, technology and finance.

In some cases you carry out the project together with a state-owned company. But that’s a completely different situation from one in which you form a big consortium of various international oil companies.

Q:  Financial analysts say Shell is investing so much, particularly in very expensive projects, that this is leading to a higher average capital intensity in future production. Are they correct?

A:   Yes, but that’s precisely what we’re banking on. We believe we have the technology available or under development to carry out those future projects. Often national oil companies are quite capable of producing easy oil themselves. Look at Russia, for example. We’re concentrating on things others are incapable of doing when it comes to technology, project management, devising commercial constructions and operational excellence, including safety and environmental policies. This is what governments are inviting us to do and this is how we derive our income. That’s the new rationale behind our existence.

The only danger would be that oil and gas prices would drop considerably for a prolonged period, and that we would have deployed technology that was too expensive. But we have no worries in that regard at the present time.

Q:  Analysts also criticise Shell for being relatively slow in converting new resources into proven reserves.

A:   I think that things are moving rapidly at the present time. We have been the top upstream investor for several years. But I also observe that there are several factors that extend the time needed to get large new projects off the ground. And the further we move in the direction of unconventional oil the more time-consuming and expensive this will become. Drilling more wells in familiar oil or gas structures is a relatively rapid means of adding proven reserves, but if you first have to acquire acreage deep beneath the Gulf of Mexico or on the edge of Alaska, six to seven years can easily lapse before the first oil is produced from those areas.

Q:  Shell’s increased activities relating to unconventional oil results in higher CO2 emissions. What does this mean for Shell’s emissions policy?

A:   Governments ultimately determine which oil concessions are to be opened up, also where this includes heavy oil or oil sands. The production and processing of these “unconventionals” emit more CO2 than in the case of easy oil or a conventional gas field. But it is pointless comparing the CO2 emissions of an oil sands project in Canada, for example, with that of the Groningen gas field in the Netherlands and subsequently designating the latter as the world standard. There is also little point in comparing this with coal, which generates more CO2 emissions. What counts is that Shell is committed to giving much consideration to how to set up production and processing for unconventional oil and gas so that we maximise performance where our CO2 emissions are concerned. This may include CO2 storage in the longer term. Our objective is for our performance in managing CO2 emissions to always be in the top quartile in the industry for such operations. This prevents us from comparing apples and oranges.

Q:  Is that a message understood by politicians and NGOs?

A:   Perhaps not right now. But what people must realise is that increasing demand for energy can only be met today by using more fossil fuels. That does not correspond naturally with decreasing CO2 emissions. It is impossible to rapidly replace oil, gas and coal with another resource because the development of solar, wind and biomass is still at an early stage. It is similarly impossible to have a large number of new nuclear power plants operational in the short term. Nor is it possible to rapidly reduce the demand for energy without this resulting in a drop in prosperity. Developing countries would have serious objections, as would the citizens of developed countries, if they were suddenly no longer allowed to use their cars.

Reducing CO2 emissions is only feasible in the medium term if it is captured and stored on a large scale. However, large-scale storage has not been implemented anywhere and a considerable number of technological, legal and economic issues will have to be resolved before it is.

Q:  Experts warn that CO2 storage cannot be introduced so quickly on such a grand scale as the public and politicians think. Do you agree?

A:   I see two phases. In the first, new power stations will be made “capture ready”, i.e. their design will take account of subsequent facilities for capturing and compressing CO2 from exhaust gases. Using Shell’s coal gasification system would clearly be beneficial, as it produces virtually pure CO2. Using today’s technology, the capture, compression and storage of CO2 at traditional coal-fired power stations is expensive and energy-intensive, which means more CO2 emissions.

The second phase dawns when technological breakthroughs are achieved and all the legal issues, such as liability, have been resolved.

The date set by the European Union for its climate and energy objectives is 2020. This does not leave a great deal of time to realise such ambitious goals. However, the EU budgets do not take account of carbon capture and storage (CCS) and there is still no willingness to accommodate CCS within the European Emission Trading Scheme, as a result of which parties would receive negotiable emission certificates if they store CO2. Moreover, it is very difficult to leave the individual member states to implement and execute this policy, as they are all wary of losing their respective competitive positions. This is why I believe Brussels should assume greater responsibility for co-ordinating and executing the climate and energy policy in the EU. 

Q:  Shell is investing heavily in technology to distinguish itself from other companies, but aren’t others developing at exactly the same pace?

A:   I have a good feeling about the headway we have made in recent years, which is not easy to copy. Consider also the large numbers of people we have been recruiting and the standard working methods we are implementing everywhere. Our task is to rise to the top and then remain a step ahead of the rest.

I’m proud that we understood relatively early the importance of having a strong technology and project-management agenda and immediately set to work to realise it. I can recall enough examples from the past in which we were aware of the developments in time, for example by means of our scenario techniques, but did not follow them up adequately.

Q:  Shell’s strategy is “More Upstream, Profitable Downstream”, i.e. growth in the exploration and production of oil and gas and only growth in transport, refining, marketing and chemicals where this is sufficiently profitable. But the highest profit growth of the past two years was actually seen in downstream. Will the strategy change?

A:   No. It’s great that we’ve been so successful in this sector, but downstream is and will always be cyclical, much more so than exploration and production. Upstream also offers us more scope to distinguish ourselves in the field of technology. So it will remain “More Upstream, Profitable Downstream”. You also observe that both segments are converging in our new projects: gas to liquids is downstream plus upstream, which is also the case for oil sands and sour gas.

Q:  What progress has there been in Nigeria over the past year?

A:   Our people on the ground are seeing some improvement, but we must admit, it’s often a case of two small steps forward and one step back. This has unfortunately not resulted in a return to our old production volumes. Nigeria is very rich in oil and gas, onshore and offshore. If you look at the long term, i.e. over decades, these reserves will indeed be produced. We can and want to participate in this, but only if our people can work safely there.

Q:  So Shell will continue to invest in Nigeria?

A:   Yes, but as I said, provided our personnel can work there safely. Incidentally, continued investment is a necessity. Nigerian oilfields experience a substantial natural fall in production, so production would rapidly decline if investment were discontinued. We are also investing large amounts in Nigeria LNG (which produces liquefied natural gas) and the associated gas-gathering system. The latter is essential: if you fail to invest in this, you will either have to continue flaring off associated gas, or you will have to shut down oil production. Neither is acceptable.

Q:  A year ago, the future of the Russian Sakhalin II project was the talk of the day. How do you look back on that 12 months later?

A:   This is a project that now has a new ownership configuration with majority stakeholder Gazprom and with Shell holding 27.5%, but also with responsibility for providing the technology. The project has made great progress over the past 12 months, also with regard to the relations with the Russian government. We are also collaborating well with our Russian partners. I’m convinced that Sakhalin II will be a showcase project on a global scale.

Q:  So no hard feelings about how the ownership reconfiguration came about?

A:   If this is something that bothers you, you should not participate in international business. What we have learned from this is that you can only work with large Russian partners in Russia. We are now a partner of Gazprom in Sakhalin and have entered into a strategic alliance with Rosneft. There is a direct, demonstrable logic in Russia for doing business with Russian partners. This also involves direct political involvement. But that is no different from the Netherlands, for example, where the state had always been a partner in our gas production enterprise. We have always felt comfortable in that situation.

Q:  So what does the future hold for Sakhalin II? Wasn’t it agreed that the project would develop into a major gas hub on Russia’s eastern seaboard?

A:   I like to look at things realistically. Let’s first finish the project and make sure everything is up and running properly and then start developing the next phase. From the very beginning, our vision has been to expand the number of LNG trains and Gazprom has adopted this. So we will need to look at where the gas feeds for the extra plant are to come from. But I repeat, this is relevant in a future phase, for which no fixed dates have been set.

Q:  When will Shell choose the large-scale renewable energy business it intends to develop?

A:   People in Europe in particular tend to think the transition to renewables will take place much sooner than our own analyses would suggest. This will be a dynamic process that will develop slowly. We have already dismissed several options. Our search will continue in three directions: second-generation biofuels, large-scale wind farms and second-generation solar cells. And also hydrogen in the long term, although this is not actually a renewable as you have to use a great deal of energy to produce it.

If one day a renewable proves to be a true competitor of oil and gas we would be prepared to invest a considerable amount in it. We do not want to be a small player because we would eventually lose out. But large investments are only worthwhile if the price/performance ratio vis-à-vis the market is sound. Renewables are still too expensive and there is really no point investing in large-scale production of something that is too expensive for consumers.

We are and will remain an ordinary company and so we have to meet all the normal business criteria. We’re not taking part in a popularity contest. Moreover, Shell cannot solve the world’s energy problems. However big our company is, we only provide a fraction of global energy requirements.

We do have a role to play here, and it is one we are dedicated to filling. We invest in research, development and the demonstration of new technology from which these alternative sources must at some point materialise. We are trying hard to find alternative energy sources and we have occasionally been too fast off the mark compared to our competitors. So far our investments in renewables have earned us little or no return. But we will continue to pursue this.

* Jeroen van der Veer spoke to Piet de Wit

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