Case study: how Shell anticipated the 1973 oil crisis

In 1973, the world econ­o­my was shak­en by a major oil cri­sis. In the wake of the Yom Kip­pur War¹, the Gulf States and OPEC² decid­ed to reduce their oil pro­duc­tion, while increas­ing the price of crude oil by 17% and tax­es for oil com­pa­nies by 70%³. In just a few weeks, the price of a bar­rel of oil sky­rock­et­ed, ris­ing four­fold from 4 to 16 dol­lars⁴. For West­ern economies, this first oil cri­sis put an end to three decades of strong growth. In a mat­ter of weeks, pur­chas­ing pow­er fell, growth col­lapsed and unem­ploy­ment rose.  As pan­ic spread among the major multi­na­tion­als in indus­tri­alised coun­tries, Shell, an oil major, seemed to have antic­i­pat­ed the crisis.

In 1959, Shell set up a plan­ning depart­ment called Group Plan­ning. The first plan­ning exer­cis­es, designed to deter­mine the company’s strate­gic posi­tion­ing, were ini­tial­ly based on fore­cast­ing meth­ods that eval­u­at­ed the future using sim­ple extrap­o­la­tions of past trends. In 1965, Roy­al Dutch Shell intro­duced a com­put­erised fore­cast­ing tool called the Uni­fied Plan­ning Machin­ery (UPM)⁵. This was designed to pre­dict the company’s finan­cial flows on the basis of the company’s results and esti­mates of growth in oil con­sump­tion. How­ev­er, this mod­el-based quan­ti­ta­tive fore­cast­ing method, based on a “busi­ness-as-usu­al” approach, was quick­ly aban­doned in the ear­ly 1970s. At Shell, the fear was that it would sup­press dis­cus­sion rather than encour­age debate on dif­fer­ing per­spec­tives. In addi­tion, the reli­a­bil­i­ty of the fore­cast results was becom­ing less and less sat­is­fac­to­ry. By this time, the oil indus­try was already begin­ning to ques­tion fore­casts that implied con­stant expan­sion and infi­nite growth. The pre­sen­ta­tion of the first results of the Mead­ows report⁶ in 1971 on the lim­its to growth, togeth­er with a BP study fore­cast­ing a sup­ply con­straint linked to vol­un­tary action by OPEC⁷ mem­ber coun­tries, high­light­ed new risks and new areas of uncertainty.

Dur­ing the same peri­od, in 1965, Jim­my David­son, head of eco­nom­ics and plan­ning in Shell’s explo­ration and pro­duc­tion divi­sion, start­ed a new activ­i­ty in Lon­don called Long Range Stud­ies⁸. For this project, he called on Ted New­land, whose aim was to rethink plan­ning in the con­text of an uncer­tain future: “When I arrived in Lon­don in 1965, I was put in a small office on the 18th floor and asked to think about the future with­out any real indi­ca­tion of what was expect­ed of me. It was the typ­i­cal Shell lais­sez-faire approach. Then I found out what was real­ly going to hap­pen, and that’s when the sto­ry real­ly began.” (Ted New­land)⁹.  This appoint­ment marked the begin­ning of a new, and ongo­ing¹⁰, approach to plan­ning at Shell.

In 1967, Jim­my Davi­son and Ted New­land, with the help of Henk Alke­ma and the French­man Pierre Wack, began to devel­op the first long-term stud­ies high­light­ing alter­na­tive futures. To do this, they drew on the exper­tise of the Hud­son Insti­tute, found­ed in 1961 by Her­man Khan, a for­mer RAND Cor­po­ra­tion ana­lyst and founder of the sce­nario method. Based on a study of a wide range of vari­ables (raw mate­ri­als, geopo­lit­i­cal issues, inter­na­tion­al pol­i­tics, cul­tur­al val­ues), the aim was to devise alter­na­tive sce­nar­ios for the future up to the year 2000, in par­tic­u­lar to test the via­bil­i­ty of the idea of “eter­nal growth”¹¹. The work car­ried out with the Hud­son Insti­tute high­light­ed two main scenarios:

• a “stan­dard and har­mo­nious world,” based on free trade and mar­ket relations
• a “world of inter­nal con­tra­dic­tions”, based on grow­ing ten­sions and pro­tec­tion­ism¹².

At Shell, this work con­sid­er­ably improved our under­stand­ing of the company’s geopo­lit­i­cal and com­pet­i­tive envi­ron­ment.  More specif­i­cal­ly, this explo­ration high­light­ed sev­er­al impor­tant results and enabled us to sort out the “pre­de­ter­mined ele­ments” (pre­dictable fac­tors) and the “uncer­tain­ties” (uncer­tain fac­tors). For exam­ple, it became increas­ing­ly clear that the Gulf States would become the most influ­en­tial play­ers in terms of oil sup­ply. This meant that the oil mar­ket could shift from a buyer’s mar­ket to a seller’s mar­ket. In this con­text, the avail­abil­i­ty and price of oil no longer depend­ed sole­ly on reserves and drilling tech­niques, but also on the polit­i­cal choic­es of pro­duc­ing countries.

For Pierre Wack¹³, Shell’s sce­nario plan­ning the­o­rist, the objec­tive has nev­er been to pre­dict the future. The aim of a sce­nario is to mod­i­fy a decision-maker’s men­tal mod­el¹⁴. A man­ag­er or deci­sion-mak­er always acts ratio­nal­ly on the basis of his men­tal mod­el, i.e. his view of the world, his habits, his expe­ri­ence and his per­cep­tion of his envi­ron­ment. Wack calls a decision-maker’s men­tal mod­el the “micro­cosm”. When a man­ag­er makes a deci­sion, he eval­u­ates a set of alter­na­tives with­in his own ana­lyt­i­cal frame­work. A man­ag­er decides ratio­nal­ly accord­ing to his own “micro­cosm”.

The aim of a sce­nario is there­fore to ques­tion, chal­lenge or influ­ence the deci­sion-mak­ers’ “micro­cosm”. This is why sce­nar­ios are less con­cerned with pre­dict­ing out­comes than with under­stand­ing the forces that would lead to those out­comes. Sce­nario design is first and fore­most a learn­ing process, designed to pro­vide a bet­ter under­stand­ing of the company’s inter­nal and exter­nal envi­ron­ment. Sce­nar­ios should then help deci­sion-mak­ers to ques­tion their own men­tal mod­els and mod­i­fy them if nec­es­sary. Sce­nar­ios thus enable man­agers to renew their per­cep­tion of the envi­ron­ment, to per­ceive con­tin­gency fac­tors and to devel­op new ana­lyt­i­cal skills.

From this per­spec­tive, Wack high­lights sev­er­al impor­tant points¹⁶. First­ly, sce­nar­ios enable a com­mon vision of the future to be expressed, and a shared under­stand­ing of new real­i­ties to be devel­oped through­out the organ­i­sa­tion. How­ev­er, these sce­nar­ios will only be accept­ed and effec­tive when they have tru­ly trans­formed the deci­sion-mak­ers’ ini­tial men­tal mod­els. To achieve this, it is impor­tant to avoid stud­ies that include sev­er­al sce­nar­ios describ­ing alter­na­tive out­comes along a sin­gle dimen­sion. The temp­ta­tion is always to iden­ti­fy a medi­an sce­nario as the most like­ly ref­er­ence. On the con­trary, the sce­nar­ios should focus on very dif­fer­ent crit­i­cal uncer­tain­ties to give deci­sion-mak­ers a more in-depth under­stand­ing of the risks. Last­ly, it is prefer­able to intro­duce dis­con­ti­nu­ities and dis­rup­tions in “no-sur­prise” sce­nar­ios. In fact, a sce­nario with too many breaks would run the risk of being elim­i­nat­ed immediately.

In the 1970s, the sce­nar­ios designed by the teams of Ted New­land and Pierre Wack proved to be for­mi­da­ble teach­ing tools for test­ing Shell man­agers’ per­cep­tions of the future. They pre­sent­ed a first set of sce­nar­ios: type A sce­nar­ios. These sce­nar­ios fore­saw tech­ni­cal lim­its to oil extrac­tion. As a result, they envis­aged pos­si­ble sup­ply short­ages and a sub­stan­tial increase in the price of oil, which would gen­er­ate eco­nom­ic shocks. For New­land and Wack, the future rep­re­sent­ed by the type A sce­nar­ios appeared to be the most like­ly. How­ev­er, these results diverged sharply from the implic­it vision of the world that pre­vailed at the time at Shell. As they stood, these sce­nar­ios were dif­fi­cult for top man­age­ment to accept.

A new fam­i­ly of sce­nar­ios was there­fore devised: type B sce­nar­ios. These sce­nar­ios pre­dict­ed a more benign future, with no major changes. How­ev­er, in order to make such a pre­dic­tion, the sce­nar­ios had to be based on implau­si­ble assump­tions and involve high­ly improb­a­ble sit­u­a­tions. The implau­si­bil­i­ty of the assump­tions and the improb­a­bil­i­ty of the sit­u­a­tions in the B sce­nar­ios forced Shell’s man­age­ment to realise just how dif­fer­ent and dra­mat­i­cal­ly dis­rupt­ed the world would inevitably be. The New­land and Wack sce­nar­ios quick­ly attract­ed the atten­tion of Shell’s man­age­ment because they con­sid­er­ably altered the usu­al ana­lyt­i­cal frame­works. Man­age­ment then took two deci­sions: to use sce­nario plan­ning in the cen­tral offices and oper­a­tional units, and to com­mu­ni­cate the results to the gov­ern­ments of the main oil-con­sum­ing coun­tries. The sce­nar­ios were then cir­cu­lat­ed to the busi­ness units so that they could assess their strate­gies in rela­tion to the two sets of scenarios.

For Jan Choufo­er, co-ordi­na­tor of Shell’s refin­ery activ­i­ties, these sce­nar­ios pro­vid­ed sup­port for his idea in the event of a sharp rise in the price of oil. His strat­e­gy was based on dis­tin­guish­ing between three types of prod­uct derived from crude oil¹⁷: light fuels (propane, butane), medi­um fuels (petrol, paraf­fin, diesel) and heavy fuels (fuel oil, bitu­men). He quick­ly realised that light and medi­um fuels had a unique val­ue because there were no easy sub­sti­tutes. For exam­ple, the petrol used in car engines could not be replaced by any oth­er sub­stance. Con­verse­ly, heavy fuels could be replaced quick­ly. Fuel oil for heat­ing could eas­i­ly be replaced by coal or gas. Heavy fuels there­fore had to be sold at a com­pet­i­tive price, while light fuels could be sold at a high­er price.

In addi­tion, thanks to an indus­tri­al process known as “crack­ing”, refin­ers were able to pro­duce light prod­ucts from heavy prod­ucts. Jan Choufo­er then pro­posed devel­op­ing addi­tion­al crack­ing capac­i­ty to con­vert heavy fuels into light fuels on a mas­sive scale. In the event of a sup­ply cri­sis or explo­sion in oil prices, the strat­e­gy was to reduce sales of heavy fuels, leave cus­tomers for these prod­ucts to the com­pe­ti­tion, and rapid­ly con­vert heavy prod­ucts into light prod­ucts. This extreme­ly cost­ly strat­e­gy, known as the “upgrad­ing pol­i­cy”, became very attrac­tive when there was a sig­nif­i­cant imbal­ance between demand for light and heavy prod­ucts. When oil and light prod­uct prices rose, it even became extreme­ly prof­itable. So when the oil price cri­sis hit, Shell was ready to act.

At Shell, the val­ue of sce­nar­ios has nev­er been in pre­dict­ing the future. The val­ue of sce­nar­ios lies above all in the way they enable us to mod­i­fy, amend and trans­form our visions of a world in the mak­ing. The key to the suc­cess of sce­nario plan­ning is not the iden­ti­fi­ca­tion of a future event, but its abil­i­ty to elic­it action in response to a new per­cep­tion of the future¹⁸. This suc­cess, how­ev­er, depends on the inte­gra­tion of sce­nar­ios into organ­i­sa­tion­al process­es and rou­tines such as strat­e­gy devel­op­ment, risk man­age­ment, inno­va­tion and pub­lic affairs¹⁹.