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Retreat from the ice

After spending billions of dollars on its two drilling seasons off Alaska, Royal Dutch Shell has announced that it is withdrawing from its Arctic drilling programme.  The company is now writing off its investment, blaming its failure to find meaningful oil and gas reserves and the uncertain regulatory climate in the US for the aborted mission.

Greenpeace and other NGOs which have campaigned against the exploration of the Arctic have claimed an important victory for one of the world’s last wildernesses and also in the battle against climate change.

Complex reality
The reality though is somewhat more complex. There is a growing realisation in the oil and gas industry internationally that it may be facing low oil prices for a longer period than it anticipated even a few months ago. If the oil price were still at around $100 per barrel would Shell have made the same announcement? Or would the company have been more prepared to sink further capital expenditure in the hope of making a major discovery? We have come across wildly varying estimates of the operational costs of each barrel of Arctic oil extracted, but if there is little imminent prospect of recouping the capital expenditure already spent and likely to be spent in a low oil price environment, Shell’s decision is a simple matter of business economics. Remember, the company has made strong commitments concerning its dividend policy and is hoping to complete the acquisition of UK peer BG Group, which again was predicated on high oil prices – the numbers for further investment spending were beginning not to add up.

But what do we make of Shell’s comment regarding the uncertain regulatory climate in the US? Shell’s project in Alaska had clearly been supported by the White House, but the US president has become increasingly vocal on climate change as he seeks to secure his legacy. It is also obvious that Shell had been frustrated by the legal challenge presented at seemingly every turn by opponents to its activity in the region.

Is Shell seeking more political support to encourage it to go back to the Arctic once oil prices recover? Or is it firing a shot back at regulators in the US and internationally? Interestingly, there has been no comment about the licences themselves.

Regulation
Softer regulation to encourage oil and gas development is in our view unlikely, in particular as it has only been a few short years since BP’s catastrophic oil spill in the Gulf of Mexico. We accept that the oil and gas industry can legitimately call for more regulatory certainty but we are concerned that the company may be seeking more favourable treatment in future. This would most certainly result in greater legal challenge, at least in the US context.

Project pause
The current low oil prices are leading to sharp reductions in oil companies’ capital expenditure, with projects being slowed, postponed or even cancelled. A longer period of low oil prices is one future scenario that we believe oil majors will now accept is more likely than a year ago. The decision by Shell could mark the beginning of the end of high capital expenditure super projects by Western oil majors. However, prolonged low prices for oil and gas may also make investments in energy efficiency and renewables less attractive. Nevertheless, and given the regulatory concerns Shell has cited, this pause in oil and gas investment provides a great opportunity permanently to hasten the move beyond fossil fuels to other energy sources, thus rebalancing the energy industry’s potential response to a recovery in future demand and possibly reducing the total amount of further investment into oil and gas.

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