Climate-related risks and opportunities

Our approach for assessing and managing the risks and opportunities associated with climate change includes considering different time horizons. The time horizons and their relevance to risks, opportunities and business planning are as follows:

• Short term (up to three years): we develop detailed financial projections and use them to manage performance and expectations on a three-year cycle.
• Medium term (generally three to 10 years): most of our expected production and earnings in this period come from our existing assets.
• Long term (generally beyond 10 years): for this period, it is expected that the current Shell portfolio will change and evolve with the energy transition. Decision-making and risk identification on the thematic structure of the future portfolio are guided by the pace of society’s progress and the aim of being in step with society as it moves towards the goals of the Paris Agreement.

The overall climate change risk consists of four components, based on the nature of our exposure and the options for our mitigation responses. The four components are regulatory risks, commercial risks, physical risks and societal risks:

• Regulatory risks (time horizon: short term) include increased compliance costs for assets and/or products such as carbon costs; restrictions on the use of fossil fuels; and lack of net-zero-aligned global and national policy and frameworks.
• Commercial risks (time horizon: medium to long term) include lower sales volumes and/or margins because of generally reduced or eliminated demand; the possibility of underutilised or stranded oil and gas assets; changing preferences of investors and financial institutions; and additional costs for decarbonisation of operations.
• Physical risks (time horizon ranging from short to long term) include structural damage to assets and downtime caused by acute events; reduced efficiency because of changing ambient conditions; increased operations and maintenance costs; and value-chain disruptions.
• Societal risks (time horizon: continuous) include the potential for a deteriorating relationship with the public, other companies, and governments in countries where Shell operates; class action lawsuits or similar litigation; potential stakeholder criticism related to transparency and clarity around plans and actions to achieve climate targets; and decline in reputation, brand value and competitive advantage.

See “Risk factors”.

Climate change and the energy transition have also created some business opportunities for Shell. See also “Our portfolio and climate change”.

Impact of climate-related risks and opportunities on strategy, planning and business decisions

For Powering Progress, we must evolve our portfolio of assets and the mix of energy that we sell, so we can meet the cleaner energy needs of our customers in the coming decades. We aim to achieve this by repositioning our traditional businesses for resilience and taking advantage of the growth opportunities created by emerging customer needs.

We assess our portfolio decisions, including investments and divestments, against the potential impacts of the energy transition to the use of lower-carbon energy. These include higher regulatory costs linked to carbon emissions and lower demand for oil and gas. We continue to transform our organisation, ensuring that our portfolio is well positioned for the future of energy. In February 2021, we announced our updated strategy (see Strategy and outlook).

We believe that our business strategy is resilient and adapted to the current implementation of the Paris Agreement, which is now progressing through the mechanism of countries developing their individual nationally determined contributions (NDCs). The Paris Agreement does not stipulate that emissions must fall in all sectors or countries simultaneously, or that all actors within the system will reduce their emissions at the same time or to the same degree. It acknowledges that emissions might even increase in some parts of the world. What is important is that overall emissions fall.

The transition to lower-carbon energy requires major changes to industrial, commercial and residential infrastructure. This takes time and substantial investment. Our annual planning cycle and periodic portfolio reviews aim to ensure that our levels of capital investment and operating expenses are appropriate in the context of an uncertain and changing external environment.

The annual business plan is our way of putting the strategy into effect. A business plan is created, which is then approved by the Board. The plan contains forecasts of Shell’s cash flows, and seeks to ensure that we can service financing requirements, pay dividends and fund investment activities.

Shell’s business plan includes assumptions about internal and external parameters. Some of the key assumptions relate to:

• commodity prices;
• production levels and product demand;
• exchange rates;
• future carbon costs;
• the schedules of growth programmes; and
• risks and opportunities that may have material impacts on free cash flow.

Shell’s strategy recognises that the world is transitioning to a lower-carbon energy system, but acknowledges that the pace and specific path forward remain uncertain and may differ across regions and countries. This means that Shell will need to make agile business decisions in step with society.

Scenario planning is a well-established process for exploring possible future outcomes. Many factors and variables are considered in this exercise. These include the future size and cost of resource bases and macroeconomic, geopolitical, social, technological and regulatory developments. Our portfolio and strategy have been assessed against a wide range of outlooks. These include the potential impacts of various possible energy transition pathways, and changes in societal expectations around climate change. Our latest set of Shell scenarios was one of the many variables used in guiding the updated strategy which we announced in February 2021. One of the key aspects that underpin Shell’s financial statements are the oil and gas price and refining margin assumptions. These price assumptions are developed with input from our scenarios and other factors.

GHG elements in the business plans consist of a GHG-emissions forecast, GHG-abatement plan and GHG costs. To assess the resilience of new projects, we consider the potential costs associated with operational GHG emissions. We have developed country-specific short-, medium- and long-term estimates of future carbon costs which are reviewed and updated annually. By 2050, our real-terms carbon cost estimates for all countries are expected to increase to at least $100 per tonne of GHG emissions.

The process for developing our cost of carbon estimates uses short-term policy outlooks and long-term scenario forecasts, both of which reflect the current nationally determined contributions (NDCs) submitted by countries as part of the Paris Agreement and evolving national policy developments. NDCs under the Paris Agreement are subject to revisions every five years. The United Nations estimate that the current NDCs are consistent with limiting the rise in global average temperature to around three degrees Celsius above pre-industrial levels. In the coming decades, we expect countries to tighten their NDCs to meet the goals of the Paris Agreement. We expect to update our estimates as countries update their NDCs and climate policies. Accordingly, we believe our estimates appropriately reflect society’s current implementation of the Paris Agreement. We continue to test the robustness of our projects with a material GHG footprint by using long-term carbon cost estimates that are consistent with limiting the rise in global average temperature to well below two degrees Celsius.

Shell’s annual carbon cost exposure is expected to increase over the next decade because of evolving carbon regulations. This expected increase is based on forecasts of Shell’s equity share of emissions from operated and non-operated assets, and real-terms carbon cost estimates which range from $5 to $110 per tonne of GHG emissions in 2030. This exposure also takes into account the estimated impact of free allowances as relevant to assets based on their location. The regulatory carbon cost estimate is refreshed on an annual basis as part of the development of our business plan.