There comes a time when ageing aristocrats have to accept that everything must change so that everything can remain the same.
One of a handful of oil majors that dominated the global energy market over the last century, Royal Dutch Shell (NYSE:RDSa), (LON:RDSa) is betting more and more heavily on a very different business to ensure it can dominate the next one too. While it has had a sizeable power trading and supply business for years, servicing mainly its internal needs and those of industry, it’s now on the verge of selling electricity to the masses too.
Management believes it has to take that leap if the company is to stay relevant in the long term. “The energy system is going to electrify over time and that electricity needs to be renewable,” Shell Energy chief executive Colin Crooks told Sky News last week, as the company rebranded U.K-based First Utility, its initial big venture into household power supply.
As a declaration of intent, the rebranding included the launch of one of the lowest basic tariff plans on the U.K. market, 100% sourced from renewables. It also offered customers a 3% discount on purchases at its gas stations.
Guessing Game
As with other industries under disruption, one of the biggest challenges is guessing which part of the business will provide the most value in future: generation? Transmission? Household supply?
Guessing is made trickier by the ongoing oil production push and pull that's keeping wholesale energy prices volatile. Add to that the ability of governments to transfer value from one group of market users to another via regulatory price caps, grid fees, environmental taxes and subsidies. It’s a lottery: Germany’s RWE (DE:RWEG) has averaged a return on equity of -18% over the last five years, according to data compiled by Investing.com. Meanwhile, the U.K's Scottish and Southern Energy (LON:SSE) has managed an eminently respectable 12.7%.
Shell's shares have had a mixed ride. The stock, which hit a high of $73.86 in May 2018 only to plummet 25% by December, has regained some of its momentum. Its U.S. traded ADR, which are up 13% since the end of 2018, closed Friday at $62.59.
True to its history of operating upstream as well as downstream, Shell is hedging its bets. In addition to First Utility,this year it also bought sonnen, a German maker of residential power storage units that operates in the same space as Tesla’s (NASDAQ:TSLA) Power Wall, and two makers of charging solutions, Greenlots and NewMotion, to serve the growing ranks of electric vehicle drivers.
It’s also bidding, together with a Dutch pension fund, for Eneco, one of the biggest Dutch power suppliers, and is commissioning two big wind parks off the Dutch coast. In all, it aims to invest up to $2 billion a year through its “New Energies” division during 2019 and 2020.
That’s an awkward number, consuming up to 8% of the group capex budget, and a sum equivalent to over 12% of last year’s dividend. Shareholders, who have only just gotten used to getting their quarterly dividends fully paid in cash again, could easily grumble that the money could be spent better—either on developing the company's oil and gas assets, or on higher payouts.
Strategic Advantages
Nonetheless, Shell has three big factors in its favor.
First is the strength of its balance sheet and its profound knowledge of the energy commodity markets. The company is not going to be forced out of business by some unexpected turn in wholesale energy prices, unlike a dozen of First Utility's competitors.
Second, bets on renewable power are getting cheaper as the technology matures: that doesn’t completely protect it from volatility in energy policy, but it does lessen the need for subsidies to make the numbers add up, and reduces the risk of Shell repeating its first disastrous flirtation with green power (around the same time that BP (NYSE:BP), (LON:BP) was trying to tell the world it was “Beyond Petroleum”). The tender for the wind farms it’s building together with Eneco specifies that no subsidy for wind power should be included in the business modelling.
Thirdly, disruption means that there are some decent-sized legacy businesses around that could offer the chance for instant scale at relatively low cost.
One company in particular could become a key test of Shell’s commitment to its new business line. With six times the customer base of First Utility and $8 billion in annual revenue, U.K.-based supplier Npower, would require a step change in the investment budget—and it would also require the patience to turn around a business that has lost money for the last four years.
That is the kind of acquisition that could seriously test the patience of Shell’s shareholders. But if the oil and gas major is serious—as Crooks claims—about being “the biggest power business globally,” then it’s the kind of gamble Shell will have to take sooner or later.