As BP (LSE:BP) stock fell in 2023, Shell (LSE:SHEL) saw its share price rise. It finished the year 57% higher than it started.
Strong oil prices helped, but this doesn’t tell the whole story. So why did Shell do so well as BP faltered?
Energy transition
The main reason, in my view, is Shell’s approach to the energy transition worked better than BP’s. The rise of renewables is arguably the biggest challenge for oil companies right now.
Broadly speaking, there are two main strategies. One involves trying to shift to a renewables portfolio by investing in wind and solar and the other involves sticking to hydrocarbons.
Neither is without risk though. Investing in wind and solar projects is an expensive business, but the long-term outlook for hydrocarbons is much less clear.
This means there’s something of a dilemma for oil companies. And BP and Shell elected to go in different directions in 2023.
BP decided to go after renewables, investing heavily in offshore wind generation in the US. Shell, on the other hand, decided to stay away from these projects and concentrate on hydrocarbons.
Staying out of trouble
For 2023, at least, it was Shell who had the right approach. BP’s investments in US wind caused significant problems for the company and its shareholders.
High inflation and increased interest rates caused the cost of building offshore wind farms to rise to the point that it became no longer viable. As a result, BP had to scrap the project.
This resulted in an impairment charge of around $540m. By staying out of these kinds of projects, Shell managed to avoid the same problems.
Instead, Shell elected to return its capital to shareholders. As well as maintaining its dividend, the company spent around half of its free cash flow on share buybacks.
As a result, the outstanding share count fell by around 5%. Understandably, that proved to be popular with investors at a time when BP was running into problems.
Sustainability?
Shell clearly had the better approach for 2023, when inflation was high and interest rates were rising. But whether this will prove to be the right strategy for the long term is another question.
Inflation is starting to fall in both the UK and the US and there’s speculation that interest rates might be about to come down. That could change the economics for renewable energy projects.
There’s also a real danger of increased regulatory pressure on fossil fuels companies. And with this not being under the company’s control, I think it’s a risk investors ought to take seriously.
If pressed, I’d say I prefer Shell’s strategy. I think focusing on the areas where the business has better experience is a good move and it looks as though the market has the same view.
It’s perhaps worth noting that US oil majors ExxonMobil and Chevron have been taking the same approach. That doesn’t mean it’s the right plan, but it’s the one that makes the most sense to investors like me.
