The Shell Game

Shell’s decision Wednesday night to drop out of the proposed London Array has created a lot of finger-pointing and a lot of unanswered questions. The oil giant pulled its 33 percent stake in what would have been - and may well still be - the world’s largest offshore wind project, saying only that the decision was part of an “ongoing review of projects and investment choices.” Shell’s stake in the $4 billion, 1GW wind project will be diverted into development of the Canadian tar sands, which have become a better looking investment given Shell’s recent forecast that “if oil prices remain at $100 per barrel, we expect 2008 reported production to be broadly flat compared with 2007.” Tar sands development makes sense if the price of oil remains high, which will likely happen as easily-recoverable reserves dry up and development and delivery of high CAPEX deposits becomes the norm.

These high-risk projects have other costs too, however.

But who’s really at fault for the crash-and-burn at the London Array? The investor group, made up of Shell, E.On, and Dong Energy, recently entered the project tendering phase for assignment of major construction contracts. Shell, who is alone among the group in having a lucrative way out, probably looked at the cost projections from steel and cement suppliers and turbine makers, threw up a little in its mouth, and promptly left the room. But why would a company that made $8 billion in profits during the first quarter (thats about $4 million an hour) balk at these kind of expenses - especially when it’s also embarking on one of the most expensive industrial projects in the history of, well, industry.

The blame may well lie at the feet of the British Government. Britain, which has long talked a big game about renewables, has done surprisingly little to make those dreams a reality. The government has already cut its EU 2020 renewables target from 20 percent to 15 percent, though, with 12 years left to get there, Britain currently has about two percent of its electricity generated from renewables. And that figure has stagnated for the last few years. Germany, by contrast, generates 15 percent of its energy from renewables, and has a 100 percent target set for 2030.

Some fault the UK’s refusal to adopt a German-style feed-in tariff, which has allowed Germany to outpace the UK in installed solar capacity by a ratio of around 200 to 1. Feed-in tariffs might not be the answer, however. Britain’s Renewables Obligation program, which supports the 15 percent target, mandates the selling of Renewable Energy Credits at around £33.24/MWh.  The ETS carbon price closed last night at £18.41/ton of CO2. Is the price of a MWh actually worth less than the cost of a ton of carbon dioxide?

Some quick back of the envelope math now. The 1 GW London Array is capable of producing around 8,760,000 MWh annually, though possibly a lot less. Taking the high number, the Array would be eligible to sell roughly £290 million in RECs annually, which would recoup the cost of the farm in 12 or so years. Shell’s current output in Canada is close to 155,000 barrels per day, which at £55 per barrel, accounts for £8,525,000 in revenue daily, or roughly £3.1 billion annually. Let’s say Shell is responsible for 33 percent of the 40 million tones of CO2 produced every year by the collective tar sands projects. If that’s the case, Shell would need to purchase roughly £240 million in CO2 credits annually. So, now they’ve only made £2.8 billion, give or take, from the tar sands.

The nature of the oil business makes it virtually impervious to any sort of renewables policy, aggressive or otherwise. As long as they’re assured of a constant revenue stream from increasingly expensive exploration projects backed by high oil prices, these companies won’t be deterred. The UK will need to focus its efforts on getting power companies more interested in developing renewables projects in that country, either through raising the REC price or offering subsidies on the level of those they offer to the oil companies. At least until the oil companies put themselves out of business digging up the Arctic.