THREE DECADES OFSCENARIO PLANNING

IN SHELL

GROUP – II

SANJEEV RALLISARMAPAISANGARANJITH

SHELL

• ROYAL DUTCH SHELL

• GLOBAL OIL AND GAS COMPANY

• HQ IN NETHERLANDS, REGISTERED OFFICE IN LONDON

• FIFTH LARGEST COMPANY IN THE WORLD

• SECOND LARGEST ENERGY COMPANY

SHELL• OIL EXPLORATION AND PRODUCTION

• REFINING

• DISTRIBUTION AND MARKETING

• PETROCHEMICALS

• POWER GENERATION

• TRADING

• RENEWABLE ENERGY

SCOPE • INTRODUCTION

• FORECASTS vs SCENARIOS

• BRIEF HISTORY OF SHELL SCENARIOS

• SCENARIOS AS INTEGRAL PART OF STRATEGIC PLANNING

• SELECTING PROJECTS USING REAL OPTIONS

• COMBINING SCENARIO ANALYSIS AND REAL OPTIONS

• CONCLUSION

INVESTMENT RISKS DUE TO EXTERNAL UNCERTAINTIES

FOR EXAMPLE

US FOREIGN POLICY WAS FUNDAMENTALLYALTERED POST WTC ATTACK IN 2001

FORECASTS vs SCENARIOS• FORECASTS

– BASED ON TODAY’S REALITIES

– DOES NOT ACCOUNT FOR UNCERTAINTIES

– ARE DANGEROUS AS THEY ARE WRONG WHEN NEEDED THE MOST

FORECASTS vs SCENARIOS• SCENARIOS

– ARE NOT PROJECTIONS, PREDICTIONS OR PREFERENCES

– COHERENT AND CREDIBLE ALTERNATIVE STORIES ABOUT THE FUTURE

– TAKE INTO ACCOUNT VARIOUS UNCERTAINTIES

– DESIGNED TO HELP COMPANIES TO DEVELOP STRATEGIES AND TEST THEIR PLANS

FORECASTS vs SCENARIOS• SCENARIOS- SERVE MULTIPLE FUNCTIONS

– PRESENT A BACKGROUND FOR DESIGN AND SELECTION OF STRATEGIES

– HELP MAKE MANAGERS AWARE OF ENVIRONMENTAL UNCERTAINTIES BY CONFRONTING THEM WITH DIFFERENT FUTURE STATES

– PROVIDE A TOOL TO IDENTIFY WHAT MIGHT POSSIBLE HAPPEN AND HOW CAN ONE ACT OR REACT TO FUTURE DEVELOPMENTS

– OFFER POSSIBILITY OF COMBINING QUANTITATIVE DATA WITH QUALITATIVE INPUT

– HELP MANAGERS MENTAL MODELS BY CONFRONTING THEM WITH THEIR OWN BIASED VIEWPOINTS

FORECASTS vs SCENARIOSTHE PRESENT

THE FUTURE

ALTERNATIVE FUTURE IMAGES

SCENARIOS

FORECASTSTHE PATH

CURRENT REALITIES(MENTAL MAPS) MULTIPLE PATHS

SCENARIOS COMBINED WITH REAL OPTIONS ANALYSIS

• EMPHASIZES THAT MANY INVESTMENTS CREATE FOLLOW ON OPPORTUNITIES

• SCENARIOS CAN CONTRIBUTE TO REAL OPTIONS IN THREE LEVELS– HELP IDENTIFY OPTIONS IN THE FUTURE– HELP TIME THE DECISION TO EXERCISE REAL

OPTION– PROVIDE AN IMPORTANT INPUT IN THE

PROCESS OF EVALUATING IT

BRIEF HISTORY OF SHELL SCENARIOS

• PIONEERS IN SCENARIOS PLANNING

• FIRST SCENARIOS DEVELOPED IN 1972– SIX SCENARIOS WHICH INCLUDED

ECONOMIC GROWTH, OIL SUPPLY AND OIL PRICE OPTIONS

– SUITED TO ADDRESS MEDIUM TERM CONCERNS

BRIEF HISTORY OF SHELL SCENARIOS

• IN 1974– “THE RAPIDS” EMERGED AS FRAMEWORK TO BUILD

SPECIFIC SCENARIOS

• “WORLD OF INTERNAL CONTRADICTIONS” (WIC) WERE FIRST COMPREHENSIVE LONG TERM SCENARIOS ON ECONOMIC AND ENERGY MARKET PREDICTIONS

• “CONSTRAINED GROWTH” WAS DEVELOPED IN 1975 AS PART OF WIC – RECOVERY WOULD BE SLOWER THAN PREVIOUS

UPSWINGS

BRIEF HISTORY OF SHELL SCENARIOS• IN 1980s, THE SHELL SCENARIOS ELABORATED SOCIO-

POLITICAL ANALYSIS

– “NEXT WAVE” SUGGESTED THAT BY 1986/87 THE PRICE FOR OIL COULD DROP TO USD 18/BBL

– “DEVOLUTION” SUGGESTED GRADUAL OPENING UP OF CENTRAL AND EASTERN EUROPE DUE TO NEED FOR TECHNOLOGY AND CONSUMER GOODS

• BY 1987 SHELL SCENARIOS HAD GROWN IN SIZE, COMPRISING THREE SEPARATE VOLUMES ON OIL, ENERGY AND SOCIO-ECONOMIC TRENDS

– FIRST TIME SCENARIOS IDENTIFIED POSSIBLE TENSIONS ARISING FROM GLOBALIZATION AS A FUNDAMENTAL TREND

BRIEF HISTORY OF SHELL SCENARIOS

• IN 1990s– “THERE IS NO ALTERNATIVE” (TINA) EVOLVED DUE TO

DISMANTLING OF ECONOMIC BORDERS AND LIBERALIZATION

• “THE NEW GAME” (A TINA ABOVE) EMPHASIZED GLOBAL GOVERNANCE

• “PEOPLE POWER” (A TINA BELOW) EXPLORED EFFECTS OF GROWING NUMBERS OF PEOPLE BECOMING WEALTHIER AND EDUCATED

• IN 2000s– “PEOPLE AND CONNECTIONS” STRESSED THAT PEOPLE

WANT GOVERNMENT REGULATIONS TO ASSURE UNINTERRUPTED SUPPLY OF GOODS

SCENARIOUS - INTEGRAL PART OF STRATEGIC PLANNING

TYPES OF SCENARIOS IN STRATEGIC PLANNING

GLOBAL SCENARIOUS

•DESIGNED TO HELP COMAPANY FORMULATE OVERALL TACTICAL STRATEGY

•PERMIT MANAGEMENT TO EXPLORE NEW IDEAS BY MOVING AWAY FROM GROUP THINK

FOCUSSED SCENARIOS-

• DEAL WITH COUNTRY SPECIFIC ISSUES OR INDIVIDUAL PROJECTS

•ALLIGNED TO IMPROVE JUDGMENT OF INDIVIDUAL MANAGERS ON INVETSMENT DECISIONS

PROJECT SCENARIOS-

•HELP ASCERTAIN ROBUSTNESS OF INVESTMENT DUE TO GLOBAL AND FOCUSED SCENARIOS

SCENARIOUS - INTEGRAL PART OF STRATEGIC PLANNING

STEPS TO EFFECTIVE STRATEGIC PLANNING

GLOBAL SCENARIOUS KEPT AT CENTRE OF THE PROCESS

COMBINED WITH OTHER APPLICATIONS TO IDENTIFY RISKS AND OPPURTUNITIES

STUDY DEMAND TRENDS AND ANALYSE COMPETITORS BEHAVIOUR

DEFINE THE GROUPS CUSTOMER VALUE PROPOSITION

ARRIVING AT STRATEGIC DECISIONS

SELECTING PROJECTS USING DCF APPROACH

ALLOCATE RESOURCES BASED ON HIGHEST NET PRESENT VALUE (NPV)

CALCULATED USING DISCOUNTED CASH FLOW (DCF)

FUTURE DISCOUNTED VALUE OF CASH FLOWS

PRESENT VALUE ADJUSTED FOR BOTH TIME AND RISK

SUITABLE WHEN UNCERTAINTY IS LOW

MORE CONSERVATIVE APPROACH

SELECTING PROJECTS USING REAL OPTIONS

REAL OPTION ANALYSIS

USEFUL TOOL WHEN UNCERTAINTY IS HIGH

EVOLVED FROM FINANCIAL OPTION PRICING MODELS

REAL OPTIONS ENHANCE DCF ANALYSIS

RECAPTURES PROJECT VALUE LOST BY DCF ANALYSIS

BASED ON THE ASSUMPTION THAT THERE IS A TRADED SECURITY WHOSE PAYOFFS AND RISKS ARE SIMILAR TO THE REAL PROJECT

HISTORY AS PREDICTOR OF FUTURE

DISCONTINUITY

µ µ α

α

Historical Behavior of Source Uncertainity

Potential Future Behavior of Source Uncertainity

Factors imparted by Firms Decision

Factors outside firms control

SCENARIO ANALYSIS & REAL OPTION COMBINED

IN HIGHLY UNCERTAIN ENVIRONMENT, REAL OPTION ANALYSIS IS PARTICULARLY SUITABLE BECAUSE-

•PROJECT’S VALUE CHANGES OVER TIME•AVAILABILITY OF NEW INFORMATION•ABILITY TO ACT ON THAT INFORMATION

SCENARIO- GAS EXPLORATION IN WEST AFRICA

• DISCOVERY OF SIGNIFICANT AMOUNT OF NATURAL GAS IN WEST AFRICA

• REQUIRES PIPING / LIQUIFICATION / TRANSPORTING / REGASIFICATION

• INVOLVES SIGNIFICANT COST FOR ALL THESE ACTIVITIES

1990s

GAS MARKET LARGELY DECONTROLLED

MEAN GAS PRICE $2.0/MMBTU WITH AN ANNUAL VOLATILITY OF 57.2%

UNDER THIS CONDITION COMPANY WILL NOT CONSIDER DEVELOPING WEST AFRICAN GAS FIELDS DUE TO HIGH COST ASSOCIATED AND YIELDING NEGATIVE NPV

OPTION DURING 2000s NORTH AMERICA

• NATURAL GAS PRICE MORE THAN DOUBLED BETWEEN 2000 AND 2005 AT $ 4.6 /MMBtu WITH 100% VOLATILITY

• CONCERN FOR POLLUTION, PREFERRED FOR DOMESTIC HEATING

• MASSIVE INVESTMENT IN CCGT PLANTS FOR ELECTRIC GENERATION

• RESTRICTION IN EXPLORATION eg UNCONVENTIONAL METHODS, AREA, etc,

• IMPORT WILL BE REQUIRED TO MEET HIGHER DEMANDS UNDER SUCH CONDITIONS

SCENARIOS COMBINED WITH REAL OPTIONS ANALYSIS

• EMPHASIZES THAT MANY INVESTMENTS CREATE FOLLOW ON OPPORTUNITIES

• SCENARIOS CAN CONTRIBUTE TO REAL OPTIONS IN THREE LEVELS– HELP IDENTIFY OPTIONS IN THE FUTURE– HELP TIME THE DECISION TO EXERCISE REAL

OPTION– PROVIDE AN IMPORTANT INPUT IN THE

PROCESS OF EVALUATING IT

CONCLUSION SCENARIO PLANNING IS AN IMPORTANT TOOL FOR UNDER STANDING •CRITICAL UNCERTAINTIES•INTER-RELATIONSHIPS OF THE UNCERTAINTIES

SCENARIO ANALYSIS IS COMBINED WITH REAL OPTION ANALYSIS •TO CHOOSE PARTICULAR PROJECTS•TO ALLOCATE CAPITAL EFFICIENTLY IN THE BEST INTEREST OF THE SHAREHOLDERS

Thank You