The oil companies need Scenario Planning more than ever

When I worked in Scenario Planning in Shell more years ago than I care to remember one of the key variables was the price of Crude Oil. Indeed in many ways the alternative scenarios could be characterised as “High” or “Low” oil price scenarios. The point of course was that predicting future prices was a mug’s game. It still is. Single line forecasts are always wrong.

Scenarios make uncertainty explicit. If you describe two scenarios in which in one case the oil price in ten years time is $50 a barrel and in the other its $100 you are not forecasting. You are challenging your management team to test its strategies against both cases. If (say) an investment looks robust in both cases you will likely proceed. If it looks dodgy under both scenarios you won’t.

Investors seek a degree of predictability in their investments. The likes of BP and Shell historically have offered that. A Pension Fund putting a substantial slug of its assets into equities wants the dividends to be secure and in the past they always were. When Shell cut its dividend recently it was a shock to the system. In a short space of time it went from the rather negative policy of buying its own shares (“buybacks”) with excess earnings to not having enough earnings even to pay shareholders’ dividends. That seemed very much like panic.

The Oil industry has grown on the premise that the world increasingly needed its products. Demand only went in one direction. There is a direct link to supply – the higher the demand the higher the price and the more the marginal fields became profitable. But now economies under pressure could be stagnant at a time when previous investment in renewables is making a significant contribution to power generation. More wind, less gas. All of this can be modelled in scenarios. Price, demand and supply and the relationship between them and the extent to which they drive the potential substitution of one energy source by another lie at the heart of Scenario Planning.

If I was an investor I would not ask BP or Shell what their oil price forecast was. I would ask them what their strategy was under alternative and sharply contrasting price scenarios. I would ask them, for example, if they had plans to invest in renewable energy and whether those plans were firm under different future oil price scenarios. The planners in Shell were often told that our balls were made of crystal. It was true. But we found a way not to fail in our forecasts by saying – but what if ?”. It sounds like this technique is needed more than ever today.

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