Shell’s approach to the pricing challenge

With forecasting the future price oil generally being little better than an exercise in crystal ball gazing, oil companies face a tricky problem when evaluating potential projects whose viability depends on erratic commodity pricing. During an analyst call on July 30, two Shell executives explained their company’s approach to the oil price conundrum.

For some time Shell has used a price of $70 for screening projects, a price of $90 for ranking projects within a project portfolio, and a price of $110 for testing a project’s upside potential, Simon Henry, Shell’s chief financial officer said. Ben van Beurden, Shell’s chief executive officer, said that Shell uses these price levels for long-term planning, for evaluating projects that may have lives of 30 to 40 years. Short term planning, on the other hand, requires current oil prices, to ensure that the company retains a robust financial status, with the ability to pay its dividends, van Beurden said.

Henry said that projects that do not demonstrate a positive net present value at the screening level of $70 oil do not make the cut for further consideration. The projects that pass this first test are then compared using the $90 price, to determine which projects seem best to pursue. The $110 price provides insights into a project’s potential, should oil prices rise above expected levels.

Van Beurden also responded to a question about whether liquefied natural gas can compete on price with other fuels, in the absence of some form of carbon price that would change the market dynamics. Van Beurden commented that, at present, gas demand is becoming squeezed between cheap coal and strong pushes towards the use of renewable energy sources.

“That’s happening in Germany and it’s starting to happen in Japan,” he said.

Putting a price on carbon could level the playing field but would also result in higher energy prices, he said. This approach could work in the rich countries but would be ineffective in countries in South Asia or Africa, for example, where coal usage would continue unabated. The required approach in the developing world is to make gas more competitive, van Beurden said.

- ALAN BAILEY