Anglo-Dutch Shell announced an A$617 million ($418 million) offer for Australia's ERM Power in August marking another move by the oil and gas major into the power sector. In March this year, Shell completed its rebranding of the UK's First Utility as Shell Energy, having bought the electricity retailer in 2018. While still small in comparison with its forecast upstream spend of $54.6 billion from 2019-2025, Shell is starting to commit serious money to its power sector ambitions.
However, in one sense, rather than a radical means of addressing the challenges posed by the energy transition, this is old-fashioned vertical integration.
Shell's production profile, as with most of the other oil majors, has steadily become more gaseous, a phenomenon accelerated by its huge $52 billion acquisition of BG in 2016. Low gas prices as a result of the ramp up in US LNG output, among other factors, are depressing returns on wholesale gas trading, but have improved gas-fired generation margins. Owning the entire value chain means dollars should be made somewhere along the line.
In the oil sector, the trend has most recently been in the opposite direction with oil companies splitting off their E&P functions from refining activities, a strategy which could begin to look somewhat less smart in a weaker oil price environment. Vertical integration may not be the most efficient business model, but it is a resilient structure in hard times.
Destination fuel
Shell's move…
Anglo-Dutch Shell announced an A$617 million ($418 million) offer for Australia's ERM Power in August marking another move by the oil and gas major into the power sector. In March this year, Shell completed its rebranding of the UK's First Utility as Shell Energy, having bought the electricity retailer in 2018. While still small in comparison with its forecast upstream spend of $54.6 billion from 2019-2025, Shell is starting to commit serious money to its power sector ambitions.
However, in one sense, rather than a radical means of addressing the challenges posed by the energy transition, this is old-fashioned vertical integration.
Shell's production profile, as with most of the other oil majors, has steadily become more gaseous, a phenomenon accelerated by its huge $52 billion acquisition of BG in 2016. Low gas prices as a result of the ramp up in US LNG output, among other factors, are depressing returns on wholesale gas trading, but have improved gas-fired generation margins. Owning the entire value chain means dollars should be made somewhere along the line.
In the oil sector, the trend has most recently been in the opposite direction with oil companies splitting off their E&P functions from refining activities, a strategy which could begin to look somewhat less smart in a weaker oil price environment. Vertical integration may not be the most efficient business model, but it is a resilient structure in hard times.
Destination fuel
Shell's move does, however, have motivations beyond vertical integration. It reflects its expectation that electricity's share of end-use energy consumption will grow from around 20% to 50% by the 2070s, which begs the question, what will power this huge expansion in electricity consumption?
The level of investment pouring into new LNG schemes in the US, Canada, Mozambique, Russia and Qatar suggest that gas's long-term future is bright as French consultancy Cedigaz argued in its recent gas outlook published August 5. The current slump in gas and LNG prices is unfortunate, but recent final investment decisions on new LNG plants are targeting gas/LNG demand from the mid-2020s on. Cheap gas now should make affordable the market expansion in developing Asia and gas-for-coal switching in Europe that these investments require.
But the net-zero carbon by 2050 ambitions recently adopted by two G7 economies - France and the UK - alongside a commitment from EU Commission president-elect Ursula von der Leyen to legislate on the entire bloc reaching carbon neutrality by 2050, appear to suggest otherwise.
Net-zero implications
Net-zero carbon targets imply a major broadening of decarbonisation efforts from the power sector to industry, heating, agriculture and transport. That does not mean that the power sector has done its bit, rather it implies continued radical change and the near elimination of all unabated fossil fuel generation, not a vision that fits neatly with Shell's gas-to-power investments.
The net-zero carbon by 2050 movement may be dominated by European countries for the moment, but it is not exclusively European. According to an estimate in June by the Energy and Climate Intelligence Unit, 16% of the global economy in terms of GDP is now covered by such targets.
According to the UN, global greenhouse gas emissions must be reduced to net zero around 2050, if the rise in global temperatures is to be limited as close as possible to 1.5°C above pre-industrial levels. If these warnings are heeded, more countries will adopt net zero carbon targets.
Take for example Spain's energy transition. Coal is on its way out. Just 4.3 GW of coal-fired generation will be left by 2022 and none by 2035 based on current policy plans. Nuclear will also disappear, with Spain's 7.1 GW of capacity shut down gradually between 2027 and 2035. Yet Madrid sees no boost for gas-fired generation to fill the shortfall. Instead, 74% of electricity is to be generated by renewables by 2030 with the intention of reaching 100% by 2050.
Germany is another example, although it has yet to adopt a net-zero carbon target. It is in the process of developing its own coal phase-out program. Unlike Spain, Germany will lose its nuclear generation first, while the coal phase-out bill is expected to follow the recommendations presented by the country's coal commission in January, which suggested the last coal-fired generation plant would close in 2038.
Renewables, including large hydro, made up 34.9% of electricity generation in Germany in 2018 and 38.5% in Spain. Given that large hydro has few or no options for growth in these countries, wind and solar power will have to more than treble generation just to match 2018 demand levels by 2050.
Neither country's renewable energy sectors currently look sufficiently dynamic to meet that challenge. Both have gone through a period of subsidisation and then subsidy retrenchment as costs grew. Wholesale electricity prices may have fallen, but retail prices have not.
Onshore wind - currently stalled in Germany owing to increasingly onerous licensing processes - and solar may have become competitive with fossil fuels, but that doesn't mean market forces alone will be sufficient to drive the kind of forced expansion net zero carbon targets imply.
Electrification dependence
Net-zero carbon targets imply a much greater share of final energy consumption is emissions-free. While renewable energy sources may presently serve 34.9% of German electricity demand, they provide only 14% of final energy consumption.
Electrification will have to play a huge role in decarbonising industry, heat and transport because greenhouse gas emissions control is most easily achieved at the point of electricity generation, either by renewable energy sources or abated fossil fuels, rather than at multiple points of final energy use, for example in vehicle engines or buildings' boilers.
This is true even if a hydrogen pathway is adopted as green hydrogen relies on clean electricity generation just as much as an electric vehicle's carbon footprint depends on the energy mix that charges it.
Net-zero carbon strategies' dependence on electrification will give new life to electricity demand as forecast in Shell's long-term energy outlook.
Shell's thinking - not without reason - may thus be that the zero-carbon targets simply don't add up. Consequently, a bet on natural gas as a low carbon or fully-abated feedstock either for hydrogen production or power generation is a good one.
Rising renewables generation has tended to push gas out of the generation mix, as the fuel with the highest marginal costs. This is changing as a result of the fall in gas and LNG prices, as well as, in Europe at least, rising carbon costs, owing to reform of the EU Emissions Trading System. In a world where zero fuel-cost generation provides the majority of power without competition from must-run baseload nuclear and coal, gas-fired generation should regain not just market share in generation, but its price setting role in power markets.