Energy Musings - July 8, 2024

Last week was chaotic for Europe's renewable energy industry. Shell quantified its biofuel refinery impairment. It suggests long-term market problems. The British election upends its energy future.

Renewables And The UK Energy Scene

When we wrote about the renewable energy slowdown in Europe recently, we anticipated having to revisit the story once Shell plc announced the financial impact of pausing construction of its biofuel plant at its Rotterdam refinery.  The potential cost was excluded from the company’s release announcing the construction pause.  However, the editors were alerted that Shell was studying the impairment cost.  We now know the potential magnitude of the financial hit Shell will absorb. 

While the Shell disclosure was receiving media attention, a more significant event unfolded with ramifications for the renewable energy market.  It is the revamping of the U.K. energy landscape following the Labor Party’s landslide election victory on July 4. 

Shell’s Problems

Last Friday, Shell reported that the impairment charge for its biofuel plant pause will be between $600 million and $1 billion.  The final figure will be announced when Shell reports second-quarter earnings on August 1.  The charge is meaningful, but it is only part of the total impairment charge Shell is considering.  They listed another write-down of $600-$800 million for a chemical plant in Singapore that Shell has agreed to sell to Glencore and Indonesia’s PT Chandra Asri Pacific.  This “kitchen sink” write-down will total $1.5-$2.0 billion and impact 2Q 2024 reported earnings. 

At the end of 1Q 2024, Shell’s asset value was $402 billion, so the write-down at most will be one-half of one percent, a tiny amount.  However, the impairment charge will help improve Shell’s future financial performance, which most investors, analysts, and the media will applaud when those results are reported. 

Pausing the biofuel refinery’s construction was an example of and is consistent with the less-green-focused agenda of Shell’s new management.  The company’s announcement upset climate change activists.  However, it was climate activist attacks on Shell, including their lawsuit that resulted in the company being ordered by a Dutch court to cut its carbon emissions by 45% by 2030 compared to its 2019 amount, which drove the company to abandon its Netherlands headquarters.  Actions do have repercussions. 

Last year, Wael Sawan, Shell’s new CEO, told the Financial Times, “We need to get leaner, we need to get more focused, we need to get more disciplined.  That inevitably will include choices around where we are going to operate but also importantly how we operate.”  Sawan was outlining the essence of his management’s strategy for Shell.  The comment followed Shell’s announcement it was cutting 200 jobs from its low-carbon solutions business and putting another 150 jobs under review.  The cut represented 15% of the unit’s labor force.  The strategy shift caused several senior executives to leave because they opposed the change.  What many people do not appreciate is that Sawan previously oversaw Shell’s renewables business before being elevated to the CEO position.  He is intimately familiar with the economics, opportunities, and challenges of the various renewable energy markets and Shell’s relative strengths and weaknesses. 

The departing executives likely opposed Sawan’s decision to increase investment in Shell’s gas business at the expense of the renewables business.  Shell aims to grow its liquefied natural gas sales volume by 20-30% by 2030, which requires increased investment from the prior management’s commitment.  While Sawan remains committed to making Shell a “multi-energy” company, he said it would no longer “pretend to lead” in energy transition businesses where the company lacked a strong market presence and the specific skills necessary to succeed. 

“In transport and industry, we already have a significant market share,” Sawan said.  “We think it is only natural for us to lead as we support the decarbonization of those sectors.”  Besides hydrogen production, Shell will focus its low-carbon investments in the electric vehicle charging, biofuels, and carbon capture and storage businesses.  Having emphasized biofuels as one of its low-carbon focus areas, the pausing of the biofuel refinery construction is a notable move. 

Shell stated it was “confident the market will tighten towards the end of the decade.”  However, the decade’s end is 5 ½ years away, a relatively long time.  The biodiesel and sustainable aviation fuel (SAF) markets depend on government support and mandates.  Therefore, Shell’s suggestion of a long time before market tightness means it sees structural market problems that will not be resolved quickly.  In the U.S., biofuel prices are down and raw material costs are up, squeezing operating margins and forcing some biofuel refineries to shut down.  Shell’s statement suggests it sees the biofuel and SAF market problems as structural and that will prove more challenging than the optimists believe. 

Europe’s Coming Aviation Turmoil

One of the market fallouts from the European push for increased biofuel and SAF use will be higher energy costs, especially for airlines.  Lufthansa, which operates Eurowings, Swiss and Austrian Airlines, and its German flagship service, announced it will impose a surcharge on tickets for all its flights departing European airports starting next year to offset the high cost of meeting the SAF mandate.  The surcharge will range between €1 ($1.08) and €72 ($77.99).  The low end of the surcharge range will have little impact on flying, but the upper end could become a problem. 

Recently, Luis Gallego, the boss of IAG, the owner of five airlines including British Airways, Iberia, and Aer Lingus, told the Financial Times that switching to SAF will “have a big impact” on the industry.  The European Commission will require airlines to use SAF for 2% of their fuel next year, increasing to 6% in 2030, 20% in 2035, 34% in 2040, and 70% by 2050.  SAF is currently 4-5 times more expensive than kerosine jet fuel. 

“Flying is going to be more expensive.  That is an issue, we are trying to improve efficiency to mitigate that, but it will have an impact on demand,” said Gallego.  Last year, the U.K. government approved a similar SAF mandate as the EC.  IAG’s airlines used 12% of the world’s SAF supply last year.  However, SAF represented only 1% of total aviation fuel consumption. 

To prevent airlines from circumventing the SAF rule, the EC also prohibits airlines from “tankering.”  That is the practice of intentionally carrying extra fuel to avoid having to refuel with SAF. 

Britain’s Upended Energy Market

Shell’s biofuel and SAF outlook may reflect management’s assessment of the current rightward shift in European politics and the growing backlash from citizens over green energy mandates.  The one election outside of the rightward trend was last week’s British election.  The victorious Labor Party has a strong green energy plan for Britain.  For hydrocarbon enterprises, the Labor Party also has some harsh plans.