Shell’s Arctic Departure Is A Sign Of The End Of The Oil Age

Originally published on EnergyPost.
By Karel Beckman

Shell’s departure from the Arctic is a very significant event in the global energy picture, writes Energy Post editor-in-chief Karel Beckman. It is another sign that the End of the Oil Age is in sight.

After Volkswagen, a second major European company had to face acute embarrassment this week. Shell did not commit fraud, but they sure made a billion-dollar blooper in the Arctic. Yes, taking risks is part of what business is about, and sometimes wells turn up dry, but there is a lot more to the story than that.

Clearly the disappointing results of a single exploratory well (“Burger J”) in a single basin can’t have been sufficient reason for Shell to suddenly give up on its Arctic venture altogether. “For the foreseeable future”, as the company put it, i.e. indefinitely. In fact, the company did give two additional reasons: “the high costs associated with the project, and the challenging and unpredictable federal regulatory environment in offshore Alaska”.

But neither of these can have come as a surprise. Critics have been warning for a long time that the costs of Alaskan drilling are prohibitive, and the “regulatory environment” in this part of the world will inevitably be unpredictable.

Land of destiny

So why didn’t Shell see coming what everybody else saw? The company could have turned what was an economic miscalculation into a reputational victory if it had exited the Arctic earlier, when people asked for it. Now the proud Dutch-British company, in 2013 the number one in the world on the Fortune 500 list, is not only derided as a poor investor but its image as a responsible, sustainable company has been severely, perhaps irreparably tarnished. Not for nothing was Shell pushed out of the prestigious Prince of Wales’s Corporate Leaders Group on climate change recently, all the more painful as they had been one of the founding members.

There were, needless to say, reasons why Shell gambled so heavily on the Arctic. As I explained in an article earlier this year, for Shell the Arctic represents (or represented) the single largest long-term prospect of finding new oil and gas reserves. This is made very clear by this graph in the company’s Investor Handbook 2014, on page 16:

The Arctic, as this chart makes clear, was for Shell its land of destiny. This has now turned out to be a mirage. So where will the company turn next?

Superabundance

This question is not easy to answer – and it’s a question that not only Shell faces, but other major oil companies as well – both the international and national ones, as I will try to explain.

From the perspective of major oil producers, long-term oil market prospects look pretty bleak. This is not because there is not enough oil around – but because there is too much.

In a new book, “The Price of Oil”, which we featured on our website last week, researchers Roberto F. Aguilera of Curtin University in Australia and Marian Radetzki of Luleå University of Technology in Sweden, explain why the world is headed for an era of oil “superabundance”. A double revolution – the expansion of shale oil across the globe as well as the fracking and horizontal drilling of conventional oil fieds – could add some 39 million barrels per day (mbpd) to global production, i.e. almost 50% of current production, they calculate.

Note, incidentally, that from this perspective the famous Arctic oil and gas treasure chest turns out to be rather modest. The Arctic region is said to contain 15 billion barrels of “recoverable” oil (which is not to say this amount could be economically produced). These new technologies would cough this up in a single year.

Supermajors

The problem for the Shells of this world is that the coming superabundance is not good news at all. On the contrary. First of all, it means lower prices. Even more importantly, producing shale oil and fracking conventional wells are types of activity that “anyone” can do.

Supermajors like Shell, BP and ExxonMobil have a unique sellling point: they are the only ones that have the skills and resources to take on gigantic projects in difficult environments, such as in the Arctic or in the deep sea. But fracking anybody can play at.

No longer will the oil kings of petrostates roll in money, rule empires of corruption, finance fanatics, buy the latest weaponry. They may just hang on to their football clubs

That’s why Shell first missed the shale gas boat in the US and then when they finally got onboard, had to leave again, with nose bloodied. It is only two years ago that then-CEO Peter Voser admitted to the Financial Times that he very much regretted Shell’s $24-billion venture into US shale. The company had to write off over $2 billion at the time on its US shale activities.

Shell was simply unable to survive in this kind of highly competitive market in which small, versatile players set the tone. But that’s the kind of market that is now looming on the horizon on a global scale.

Peak demand

Yet this is only half of the story. The supply side half. There is also the demand side to consider.

In the oil sector it is still a firmly held belief that demand for oil will grow strongly over the next few decades, as emerging countries will see their populations and standards of living increase. ExxonMobil, for example, in its Outlook for Energy: A View to 2040 report, expects oil demand to grow by 30% from 89 mbpd in 2010 to 115 mbpd in 2040.

However, this prospect is looking increasingly unlikely. To begin with, tightening climate policies are likely to lead to markedly lower oil demand. The International Energy Agency (IEA), in its latest World Energy Outlook (2014) report, projects that in a business-as-usual scenario (“Current Policies” in IEA lingo) oil demand will indeed be some 116 mbpd in 2040.

However, in its middle scenario (“New Policies”), in which countries will take the climate measures they say they will be taking, oil demand stalls at 104 mbpd, “peaking” around 2020.

In its most ambitious scenario (called “450”), in which countries take the measures that are needed to limit greenhouse gas concentrations to 450 ppm (the 2-degrees scenario), oil consumption will crash to 72 mbpd!

No one who has listened to the Presidents of the US and China recently could be sure this won’t happen. Nor will climate be the only reason for governments to limit oil consumption. Air pollution and traffic jams are another powerful motive to curb automobility. It is hard to imagine that countries like China and India will follow the US or even the European example in habits of car ownership and travelling. It would pretty much choke their countries.

And there is an alternative around these days: electric cars. Volkswagen (number 9 in that same global Fortune 500 list) has demonstrated that the limits of clean oil-based cars have been reached. Battery storage costs are coming down. This represents a huge opportunity for electric cars.

Critics will say EV’s will only slowly grow, which may be true. But even if EV’s will make up only a small part of the total vehicle fleet for the foreseeable future, this will be enough to put a ceiling on oil demand – and thereby wreck oil companies’ profitability. Ask European utilities, which are almost collapsing as a result of just a small amount of renewable energy cutting into their profit margins.

Weaponry

Thus, Shell’s withdrawal from the Arctic is a very significant event. It is another sign that the End of the Oil Superhighway is in sight – in the way that Sheik Yamani, former Saudi Oil Minister, meant. You know his pronouncement: “The Stone Age came to an end, not because we had a lack of stones, and the oil age will come to an end not because we have a lack of oil.” 

Gas may be a useful and profitable activity to engage in, but for Royal Dutch Shell it will never be what oil was

No doubt oil will continue to be produced and used for a long time to come. But no longer will it rule supreme. No longer will oil multinationals decide the fate of nations. No longer will countries go to war with each other over oil. No longer will the oil kings of petrostates roll in money, rule empires of corruption, finance fanatics, buy the latest weaponry. They may just hang on to their football clubs.

In their book the Price of Oil, Aguilera and Radetzki make a highly significant point: they show that in the period from the early 1970’s until recently, the price of oil has been extraordinarily high compared to all other metals and minerals. They ascribe this to “political rather than economic forces”, such as the widespread nationalisations in the 1970s. According to the authors, not depletion of reserves, but “the resource curse, represented by domestic and international conflicts over the oil rent, is probably the most important explanation for the extraordinary oil price developments”. Those days, they add, are about to end. 

Plan B

So where does this leave Shell and its peers? Where do they go next?

Shell does have a plan B. It’s called natural gas. To be sure, gas has a lot going for it. It is very likely to play a significant role in the world’s energy future. But it is not nearly the same as oil.

It’s much more capital-intensive to produce. Not as easy to transport. It faces much more competition than oil ever did. In transport, gas has to compete with oil, biofuels, hydrogen, electric cars. In electricity, gas – a fossil fuel – has to compete with renewables, which are getting cheaper, and a host of other energy sources. In heating, it faces competition from renewables and from modern building methods which increasingly make gas heating superfluous.

In addition, it is highly unlikely that the big Asian markets, China and India, will ever adopt gas in the way they rely on oil. China currently uses gas for less than 4% in its power sector. The IEA in a report earlier this year bluntly stated that “gas will not become the fuel of choice in China’s power sector”. That’s not even counting the rest of its energy use. The same holds true for India. In Europe, gas demand has been going down in recent years.

Gas may be a useful and profitable activity to engage in, but for Royal Dutch Shell it will never be what oil was. In fact, observers may wonder, where will Shell get its gas? In this context, it seems significant that Shell has chosen, earlier this year, to pursue a broad “strategic alliance” with Vladimir Putin’s Gazprom to secure its gas interests. How’s that for “an unpredictable regulatory environment”?

It may be time for Shell to start thinking of new roads altogether.

Reprinted with permission.