CAUTIOUS SHELL´S THREE BIG BETS / THE FINANCIAL TIMES COMMENT & ANALYSIS

Cautious Shell’s three big bets

BG’s suite of projects will need to be delivered on time and on budget. That is a big ‘if’ with Brazil
By: Nick Butler  
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Great companies become and stay great by taking big bets. The art of betting is, of course, about understanding the odds and being prepared and able to lose if it comes to it. Every big company has been through the process; the only difference in the oil and gas industry is that the numbers are bigger. The rule of betting in the corporate world is not to put at risk more than 10 per cent of the total business. For the biggest, that leaves plenty of scope.

What is puzzling, though, is when a company with a record of deep caution stretching back to the second world war makes a series of wagers that run contrary to conventional wisdom. The company is Shell, which in the past few months has placed three big bets.

Bet number one is the deal with BG Group , the UK’s third-largest oil and gas producer, which is now going through the process of securing regulatory approval. The takeover values BG at $70bn, more than 50 per cent above its previous market valuation. Even with the promised cost savings, such a premium can make sense for Shell shareholders only if two conditions are met.

First, BG’s suite of projects need to be delivered on time and on budget. That is a big if when it comes to Brazil. BG operates only a few of the assets crucial to these projects; for the rest, it is in the uneasy position of relying on Petrobras, the state-controlled oil company that is at the centre of a corruption scandal.

The second requirement — and the essence of Shell’s bet — is that natural gas prices rise. At present, prices in Asia and Europe are falling, and the US looks sets to become self-sufficient to the point where surpluses are likely be exported into an over-supplied global market. Some renewables are coming down in price, and any further technical breakthroughs will cut into demand.

Growth in energy demand worldwide is already modest. The global market, which is increasingly shaped by liquefied natural gas supplies, is now overwhelmingly dependent on what happens next in China, where economic growth is slowing. None of this suggests global gas demand will outstrip supply any time soon. But, although some investors would like to think the deal will never be completed, I believe they are wrong. The bet has been placed.

Bet number two is on the Arctic. In contrast to most of the industry, Shell is pushing ahead with its plans to drill in the Chukchi Sea off the north-west coast of Alaska, indifferent to the environmental lobby and the implications of the rebasing of the oil price over the past year.

Drilling — if it goes ahead in the face of regulatory and legal challenges — will add $1.4bn to exploration costs this year and more in 2016, taking the total above $8bn. That does not include the $2.1bn Shell paid for the licences. The wells must be the most expensive drilled anywhere on earth. No oil has yet been found. The physical conditions mean that producing any oil that is discovered will be highly expensive so the company’s confidence in the volumes it expects to find and the future price of oil must be extraordinarily high.

The company’s confidence in the volumes it expects to find and the future price of oil must be extraordinarily high

Bet number three is the proposed strategic alliance with Gazprom. Many companies have (or believe they have) alliances or partnerships with Gazprom. Indeed, Shell announced such a deal in 2010, although little came of it. This time the link is much more serious, with a set of specific projects already named: first the development of two new extensions of the Nordstream line taking Russian gas into the markets of western Europe; and second the expansion of Shell’s LNG export project in the Russian far east. Both were announced with fanfare at the St Petersburg forum last month — an event attended by President Vladimir Putin. In this case the bet is not just on the gas price and the scale of the market but also on a resolution of political tension over Ukraine, and a return to something like normal trading relations between Russia and the west.

The assumptions behind these bets run contrary to current market sentiment. If this approach was followed by any other company, I would think it had been bewitched by some clever presentation into believing energy prices were set to rise in the next few years — to $150 or $200 a barrel for oil, say. Or that they were trapped by judgments made when the outlook was different, and cannot now retreat without embarrassment.

In most companies, such mistakes are perfectly possible. I remember when a chairman was deposed because he had irrevocably tied himself to a price forecast that proved to be wrong.

But Shell is such a serious company that such irrational behaviour seems incredible. That means they must know or believe something that the rest of us have missed.


The writer is visiting professor and chair of the King’s Policy Institute at King’s College London, and was previously BP group vice-president for strategy and policy development