At first glance, the Royal Dutch Shell (LSE: RDSB) share price looks like a desirable investment. The stock is trading at a price-to-earnings (P/E) ratio of 13.3. It also offers a dividend yield of 6.3%.
However, the oil and gas major is facing one major challenge in the years ahead that could hurt its growth. It could also render billions of pounds of investment defunct. This is the threat of climate change.
Investors all around the world are starting to wake up to the threat of climate change and the impact it could have on industries. For most companies, re-focusing their businesses to be more green is relatively easy. Unfortunately, for Shell, it isn’t.
The company, along with the rest of its Big Oil peers, is one of the world’s largest producers of CO2. Its whole business model is based around finding, extracting and helping customers use fossil fuels. This puts Shell at risk of owing so-called stranded assets. These would include oil & gas platforms the company has spent billions developing but are no longer able to operate due to climate regulations.
In this worst-case scenario, Shell would have to spend billions de-commissioning assets. This could lead to a dividend cut and ballooning losses. The share price could crumble as a result. The last time Shell reported an operating loss (2015), the stock price plunged to 1,300p. It’s not unreasonable to suggest this could happen again.
Investing in the future
Having said all of the above, Shell is trying to stay ahead of the curve by investing in the future. The firm has committed to investing $6bn in green energy projects between 2016 and the end of 2020. On top of this, Shell plans to spend $2bn-$3bn through its “new energies division” every year between 2021 to 2025.
These spending plans are a start, but they pale in comparison to the company’s oil & gas spending plans. The group is still spending around 10 times more every year on hydrocarbon projects.
Climate concerns aside for a moment, this seems to be the right decision for the immediate future. Most forecasts show oil & gas demand will continue to grow until at least the mid-2020s. However, after that, it’s unclear what the future holds for the industry.
As such, it seems Shell is heading in the right direction. Nevertheless, with the world’s transition away from fossil fuels gathering pace, management should take notice. A more significant capital commitment from the company for renewable projects would be welcome and would reduce the risk of climate change hurting Shell’s business model.
If you’re worried about the impact climate change may have on the company’s bottom line, it might be better to stay away. There are plenty of other renewables-focused businesses out there with brighter long-term prospects.
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Rupert Hargreaves owns shares in Royal Dutch Shell B. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.