Impact of climate-related risks and opportunities on Shell’s businesses, strategy and financial planning
The transformation of the energy system to net-zero emissions will require simultaneous action in three areas – an unprecedented improvement in the efficiency with which energy is used, a sharp reduction in the carbon intensity of the energy mix and the mitigation of residual emissions using technology and natural sinks. While it is difficult to predict the exact combination of actions that will deliver the net-zero goal, scenarios help us to understand the direction and pace of the transition needed.
We have been developing scenarios within Shell for almost 50 years, helping Shell leaders to explore ways forward and make better decisions. Shell scenarios are designed to stretch management’s thinking in considering events that may be only remotely possible. They help them make crucial choices in times of uncertainty and transition as we grapple with tough energy and environmental issues.
Shell scenarios are aligned to different energy transition pathways and help guide risk and opportunity identification and decision-making. Our energy transformation scenarios – Waves, Islands and Sky 1.5 – are all possible pathways towards the future that have both attractive and challenging features. Out of the three scenarios, Sky 1.5 has a pace and timing for energy decarbonisation that is fast enough to limit global warming to 1.5 degrees Celsius above pre-industrial levels by the end of this century. The full report can be found at https://www.shell.com/transformationscenarios.
Different socio-economic and technological parameters are used to construct these scenarios, such as:
- sectoral and regional energy demand;
- future trajectory of oil consumption, demand for natural gas;
- renewable electricity demand and the pace of the electrification of the global energy system;
- supply of solar and wind energy;
- pace of uptake of electric vehicles;
- demand for biofuels;
- growth of the hydrogen economy;
- level of carbon capture and storage;
- deployment of lower-carbon energy technologies; and
- global trade of oil and gas.
Management consideration of different climate change outcomes informs a range of areas including, but not limited to, the setting of the long-term strategy, business planning, and investment and divestment decisions. The outcomes considered by management vary in relation to the extent and pace of the energy transition.
Impact on strategic planning
The application of scenario analysis informs our assessment of the impact of climate-related risks and opportunities on our strategy and business planning, both at the Group and business units’ levels. At the Group level, the potential impacts of the energy transition on our business model are discussed and assessed at the Board and the Executive Committee level as part of the annual strategic and business planning cycle. This assessment allows us to challenge accepted ways of thinking, identify material risks and opportunities, and formulate key tensions and trade-offs.
Key financial and non-financial components of business planning
The output of our annual business planning process is presented and approved by the Board. The plan contains operational and financial metrics, and its objective is to drive delivery of our Powering Progress strategy.
Decarbonisation targets are key inputs of our business planning process. Each business owner offers viable Scope 1, 2 and 3 reduction opportunities as part of this process, in line with the Carbon Management Framework (CMF) (see “Governance of climate-related risks and opportunities”).
The business plan is underpinned by assumptions about internal and external parameters. These assumptions are developed with input from our scenarios and internal estimates and outlooks. Some of the key assumptions relate to:
- commodity prices;
- refining margins;
- production levels and product demand;
- exchange rates;
- future carbon costs;
- the schedules of capital investment programmes; and
- risks and opportunities that may have material impacts on free cash flow.
The level of uncertainty around these assumptions increases over longer time horizons.
Impact on business and financial planning
There is no one single scenario that underpins Shell’s business and financial planning. Generally, our scenarios are designed to stretch management’s thinking including considering events that may be only remotely possible. Scenarios are not intended to be predictions of likely future events or outcomes and, therefore, are not the basis for Shell’s operating plans and financial statements. Our scenarios help in developing our future oil and gas pricing outlooks. The oil and gas pricing outlooks take account of various factors relating to the energy transition such as potential changes in supply and demand (see details of scenario parameters above). The low, medium and high pricing outlooks are prepared by a team of experts, reviewed by the Shell Executive Committee and approved by the CEO and CFO. The medium pricing outlook represents management’s reasonable best estimate and is the basis for Shell’s financial statements, operating plans and impairment testing.
Shell’s targets to reduce absolute Scope 1 and 2 emissions by 50% by 2030, compared with 2016 levels on a net basis, and 20% reduction of net carbon intensity of Scope 3 emissions by 2030 have been included in Shell’s operating plan. Meeting the goals of the Paris Agreement requires the global economy to transform in a number of complex and connected ways. Shell will continue to revise its operating plan, price outlooks and assumptions as it moves towards net-zero emissions by 2050, in step with society.
Meeting the goals of the Paris Agreement requires the global economy to transform in a number of complex and connected ways. We continue to update our analysis and the corresponding price outlooks and business plans, in line with our strategy and in step with society.
As described in “Climate-related risks and opportunities identified by Shell over the short, medium and long term”, the low pricing outlooks could result in increased commercial, regulatory and societal risks, as well as transition opportunities. How these risks are prioritised is described in “Shell’s processes for identifying and assessing climate-related risks”. Given our ambition to become a net-zero emissions energy business by 2050, in step with society, the use of low-pricing outlooks is a part of our resilience testing and resulting actions. Physical risk is expected to be more material in higher temperature scenarios.