Climate-related risks and opportunities identified by Shell over the short, medium and long term
We are continually enhancing our strategic risk management approach to addressing climate-related risks. Our strategy is shaped in response to risks and opportunities identified across the customer sectors and regions we work in.
The process for identifying and assessing climate-related risks and opportunities is set out under “Climate Risk Management”. Shell has identified climate change and the associated energy transition as a material risk based on societal concerns and developments related to climate change and managing GHG emissions. The risks could potentially result in changes to the demand for our products, our operational costs, supply chains, markets, the regulatory environment, our licence to operate, and litigation. The risks are composed of a combination of complex and interrelated elements that affect Shell’s overall business value chain, and our asset, product and business portfolio. The risk landscape is evolving rapidly. To achieve our emissions reduction targets, active holistic management of all climate-related risk components is important. The composite risk is broken down into the following sub-components:
- commercial risk;
- regulatory risk;
- societal risk (including litigation risk); and
- physical risk.
We also seek to identify opportunities for Shell in the energy transition, from our existing position as a leading global energy provider. These risks and opportunities are described below and are also summarised in the “Risk factors” section of the Strategic Report.
Time horizons: short, medium and long
Due to the inherent uncertainty, and the pervasive nature of the risks across our strategy and business model, we monitor climate-related risks and opportunities across multiple time horizons.
- Short term (up to three years): we develop detailed financial projections and use them to manage performance and expectations on a three-year cycle. These projections incorporate decarbonisation measures required to meet our short-term targets.
- Medium term (generally three to 10 years): embedded within our operating plan, with our continued focus on the customer, the investments and portfolio shifts required in the medium term that will fundamentally reshape Shell’s portfolio. At the same time, our existing asset base is expected to provide the cash flow to finance this transition of our revenue in this period.
- Long term (generally beyond 10 years): it is expected that our portfolio and product mix will look very different, addressing the shift from an asset-based approach to a customer-based business model.
Transition risks
Climate-related commercial risk
- The transition to a low-carbon economy may lead to lower sales volumes and/or margins due to a general reduction or elimination of demand for oil and gas products, possibly resulting in underutilised or stranded oil and gas assets and a failure to secure new opportunities.
- Changing preferences of investors and financial institutions could reduce access to and increase the cost of capital.
Relevant time horizon:
medium and long
Potential material impacts on the organisation
Lower demand and margins for oil and gas products
Changing customer sentiment towards renewable and sustainable energy products may reduce demand for our oil and gas products. An excess of supply over demand could reduce fossil fuel prices. This could be a factor contributing to additional provisions for our assets and result in lower earnings, cancelled projects and potential impairment of certain assets.
Changing preferences of investors and financial institutions
Financial institutions are increasingly aligning their portfolios to a low-carbon and net-zero world, driven by both regulatory and broader stakeholder pressures. A failure to decarbonise the business portfolios in line with investor and lender expectations could have a material adverse effect on our ability to use financing for certain types of projects. This could also adversely affect our potential partners’ ability to finance their portion of costs, either through equity or debt.
Sensitivity analysis of a 1% shift in Shell’s weighted average cost of capital on asset carrying-values is presented in “Carbon pricing and discount rate sensitivities”.
Remaining in step with the pace and extent of the energy transition
The energy transition provides us with significant opportunities, as described in the “Transition opportunities” below. If we fail to stay in step with the pace and extent of change or customers' and other stakeholders’ demand for low-carbon products, this could adversely affect our reputation and future earnings. If we move much faster than society, we risk investing in technologies, markets or low-carbon products that are unsuccessful. Therefore we cannot transition too quickly or we will be trying to sell products that customers do not want. This could also have a material adverse effect on financial results.
Technology and innovation are essential to our efforts to help meet the world’s energy demands competitively. If we are unable to develop the right technology and products in a timely and cost-effective manner, or if we develop technologies, products and solutions that harm the environment or people’s health, there could be an adverse effect on our future earnings.
Climate-related regulatory risk
The transition to a low-carbon economy will likely increase the cost of compliance for our assets and/or products, and may include restrictions on the use of hydrocarbons. The lack of net-zero-aligned global and national policies and frameworks increases the uncertainty around this risk.
Relevant time horizon:
short, medium, and long
Potential material impacts on the organisation
Increased compliance costs
Some governments have introduced carbon-pricing mechanisms, which we believe can be an effective way to reduce GHG emissions across the economy at the lowest overall cost to society.
Shell’s cost of compliance with the EU Emissions Trading Scheme (ETS) and related schemes was around $493 million in 2022, as recognised in Shell’s Consolidated Statement of Income for 2022. A further $3,512 million of costs were incurred in respect of biofuels ($2,918 million) and renewable power ($594 million) programmes (see Note 5 to the “Consolidated Financial Statements”).
Shell’s annual carbon cost exposure is expected to increase over the next decade because of evolving carbon regulations. The forecasted annual cost exposure in 2023 is estimated to be around $0.8 billion and around $1.5 billion in 2032. This estimate is based on a forecast of Shell’s equity share of emissions from operated and non-operated assets (including joint ventures and associates), and real-term carbon cost estimates using the mid-price scenario (see Note 4 to the “Consolidated Financial Statements” for more information). This exposure also takes into account the estimated impact of free allowances as relevant to assets based on their location.
Restrictions on use of hydrocarbons
Around 90% of the global economy is now signed up to net-zero commitments as of June 2022, according to the Energy and Climate Intelligence Unit. This brings an increasing risk that governments set future regulatory frameworks that restrict further exploration and production of hydrocarbons, and bring in controls to limit the use of such products. Failure to replace proved reserves could result in an accelerated decrease of future production, which could have a material adverse effect on our earnings, cash flows and financial condition.
Lack of net-zero-aligned global and national policies and frameworks
The lack of net-zero-aligned global and national policies and frameworks increases the uncertainty around how carbon pricing and other regulatory mechanisms will be implemented in the future. This makes it harder to determine the appropriate assumptions to be taken into account in our financial planning and investment decision processes.
Climate-related societal risk (including litigation risk)
As societal expectations develop around climate change, there is a potential impact on Shell’s licence to operate, reputation, brand and competitive position. This is likely to include litigation.
Relevant time horizon:
short, medium and long
Potential material impacts on the organisation
Decline in reputation and brand
Societal expectations of businesses are increasing, with a focus on business ethics, quality of products, contribution to society, safety and minimising damage to the environment. There is an increasing focus on the role of the oil and gas sector in the context of climate change and the energy transition. This could negatively affect our brand, reputation and licence to operate, which could limit our ability to deliver our strategy, reduce consumer demand for our branded and non-branded products, harm our ability to secure new resources and contracts, and restrict our ability to access capital markets or attract staff.
Deteriorating relationships with key stakeholders
Failure to decarbonise Shell’s value chain in line with societal, governmental and investor expectations is a material risk to Shell’s reputation as a responsible and market-leading energy company. The impact of this risk includes shareholder divestment, greater regulatory scrutiny and potential asset closure resulting from public interest groups’ protests.
Litigation
There is an increasing risk to oil and gas companies from public, private and governmental lawsuits. Such action may have wide-ranging consequences, including forcing entities to hand over strategic autonomy in part to regulators, divest from hydrocarbon technologies, denial of regulatory approvals and/or paying fines/penalties or large compensation packages to the plaintiff.
In some countries, governments, regulators, organisations and individuals have filed lawsuits of a wide variety, including seeking to hold oil and gas companies liable for costs associated with climate change, or seeking court-ordered reductions in emissions, challenging the regulatory approvals and operating licenses, or challenging energy transition strategies and plans. While we believe these lawsuits to be without merit, losing could have a material adverse effect on our earnings, cash flows and financial condition.
For example, in May 2021, the District Court in The Hague, the Netherlands, ruled that, by end 2030, Shell must reduce, from its consolidated subsidiaries, its aggregate net Scope 1, 2 and 3 emissions by 45%, compared with 2019 levels. The Scope 1 component is a results-based obligation and the Scope 2 and 3 components are a significant best efforts obligation. In 2019, our Scope 1 emissions from our consolidated subsidiaries were 86 million tonnes of carbon dioxide equivalent (CO2e) (rounded) (financial control basis).
Physical risks
Climate-related physical risk
The potential physical effects of climate change may impact Shell’s assets, operations, supply chains, employees and markets.
Relevant time horizon:
short, medium and long
Potential material impacts on the organisation
Mitigation of physical risks, whether or not related to climate change, is considered and embedded in the design and construction of assets. The potential impact of physical changes comes from both acute and chronic physical risks.
Acute risks, such as flooding and droughts, wildfires and more severe tropical storms, and chronic risks, such as rising temperatures and rising sea levels, could potentially impact some of our facilities, operations and supply chains. The frequency of these hazards and impacts is expected to increase in certain high-risk locations. Extreme weather events, whether or not related to climate change, could have a negative impact on our earnings, cash flows and financial conditions.
We have performed a limited analysis addressing a range of typical climate change features for a select group of assets. As this is an emerging area of risk assessment, we aim to deepen our understanding of these potential future risks.
Additionally, the impact of physical climate change on our operations is unlikely to be limited to the boundaries of our assets. The overall impact including how supply chains, resource availability and markets may be affected also needs to be considered for a holistic assessment of this risk. Our assets manage this risk as part of broad risk and threat management processes as required by our HSSE & SP Control Framework.
Transition opportunities
Climate-related opportunities
The transition to a low-carbon economy also brings significant opportunities for us to benefit from changing customer demands, given our position as a leading global energy provider.
Relevant time horizon:
short, medium and long
Potential material impacts on the organisation
As the global energy mix changes, our current infrastructure, know-how and global footprint put us in an ideal position to service the changing energy demands of the market. Our research and development (R&D) activities are key to achieving our net-zero emissions target.
As we shift from an asset-based to a customer-focused business model our current key focus areas for seizing this opportunity are:
1. Renewables and Energy Solutions
This encompasses our wind, solar, hydrogen, electric vehicle charging, nature-based solutions, and carbon capture and storage businesses. Electricity generated by wind and solar power plays a direct role in reducing emissions in passenger transport and parts of industry. It can also be used to create hydrogen. We expect hydrogen to present a business opportunity for heavy-duty road freight over a shorter time horizon and within shipping, industry and, possibly, aviation, over a longer time horizon. Hydrogen also has the potential to become a material part of Shell’s business-to-business (B2B) operations, as heavy industry begins to transition away from energy sourced from hydrocarbons.
In 2022, Shell announced the final investment decision to build Holland Hydrogen 1, a 200 MW electrolyser that will be constructed on the Tweede Maasvlakte in the Port of Rotterdam and is expected to produce up to 60,000 kilograms of renewable hydrogen per day.
In 2022, Shell's spending on CCS opportunities (operating expenses and cash capital expenditure) amounted to around $220 million, an increase of 51% from the $146 million in 2021. Shell’s equity share of captured and stored CO2 was around 0.4 million tonnes in 2022, in line with the 2021 amount.
2. Biofuels
Shell and the non-operated joint venture Raízen (Shell interest 44%) are together one of the world’s largest blenders and distributors of biofuels. Shell plans to continue to invest in and increase the production of these low-carbon fuels. Our low-carbon fuels projects and operations around the world form part of a wider commitment to provide a range of energy choices for customers. For example, we believe that sustainable aviation fuels (SAF) provide the most effective way of reducing emissions within the aviation sector, with wider adoption of SAF enabling us to provide more low-carbon fuels to our customers. Biofuels may also present opportunities in the shipping, road freight and other sectors.
Together with our customers, we are working on changing energy demand and developing ways to help increase the use of low-carbon fuels and decrease carbon emissions from this sector. Meanwhile, on the supply side, in Rotterdam in the Netherlands, Shell is building an 820,000-tonnes-a-year biofuels facility. This is expected to be among the largest in Europe producing sustainable aviation fuel and renewable diesel made from waste and certified sustainable vegetable oils.
3. Natural gas
Demand for liquefied natural gas (LNG) is expected to grow. As one of the world’s largest suppliers of liquefied natural gas (LNG), with around 40 million tonnes of equity capacity, we can ship natural gas to where it is needed. LNG plays an important role in enabling countries to replace coal-fired power generation with a less carbon-intensive alternative. Shell seeks to provide more affordable, reliable and cleaner energy to our customers. In 2022, we produced gas for the first time from the Shell-operated Colibri project in Trinidad and Tobago. While the majority of Colibri’s gas will be exported as LNG, around 25% will be used to power local homes and businesses.
4. Transforming refineries into energy and chemicals parks
An important aim of our Powering Progress strategy is to transform refineries into energy and chemicals parks so that we can sell more low-carbon and sustainable products.
