By Ron Bousso and Susanna Twidale
LONDON (Reuters) - Royal Dutch Shell wants to build a power business more profitable than the competitive sector's existing players, banking on its global scale and oil and gas income to maximise on the transition to cleaner energy.
Demand for electricity is set to soar as Asian economies grow and electric vehicles replace petrol cars. Shell is under pressure to shed the Oil Majors' century-old business model and position itself for a future with lower use of fossil fuels.
Shell's rivals such as France's Total and Italy's Eni are also expanding their power businesses. But Shell's plans are by far the most ambitious with the largest planned spending on power.
Established power utilities have suffered in recent years as their decades-old model of centralised, predictable energy production and consumption has given way to a more flexible energy system where smaller, nimbler retail challenger brands can often undercut their prices.
Technologies such as home-installed solar panels, battery storage and electric car charging stations are likely to reshape the sector further.
Shell plans to boost spending on its nascent power division to $2 (£1.6 billion) to $3 billion (£2.4 billion) per year by 2025, nearly 10% of its overall spending, betting on rapid growth in demand for electricity from electric vehicles and industry, particularly in developed economies.
The shift will include expanding its presence in renewable energy, power retail and electric vehicle charging stations.
In recent years, Shell acquired UK's First Utility, which it rebranded Shell Energy, German battery storage firm Sonnen as well as several investments in EV charging technologies.
The move into power is critical for Shell to meet its ambition to halve its carbon emissions by 2050 and offset the expected decline in demand for oil as governments phase out petrol cars in the coming decades.
Graphic: Electricity demand - https://tmsnrt.rs/2XXEzSZ
One of the most eye-catching elements of its strategy was the targeting of returns of 8% to 12% after the investment stage, probably around 2030.
Such levels have rarely been seen in the power sector.
Power could be a significant business for Shell, Shell's Maarten Wetselaar, head of integrated gas and new energies, said at a strategy presentation earlier this month.
"It has the scale and longevity that aligns well with Shell, and could one day sit alongside our oil, gas, and chemicals business."
"We are not interested in this business because of the returns that the utility industry traditionally delivers. Instead, we believe we can build a modern integrated power business," he added.
Graphic: Operating profit margins - https://tmsnrt.rs/2XVp1PL
But that could prove tough.
For instance in Britain, a country pinpointed by Shell for further generation and retail expansion, pre-tax supply profit margins for the big six energy retailers averaged around 3% on aggregate from 2009-2017, a report by UK energy regulator Ofgem showed.
Margins achieved from electricity generation were better, averaging 10% on aggregate in 2017, down from 11% a year earlier.
Graphic: Big Six margins - https://tmsnrt.rs/2XZG7vN
Shell is unlikely to make significantly higher returns on the retail supply business than rivals, but it will be able to build up profits through energy trading, said Peter Atherton, an associate at consultancy Cornwall Insight.
Shell has the world's largest trading operations, when including oil and gas, which it said will allow it to supply a range of sources of power from wind, solar and gas to customers.
Trading helps weather cyclical dips in margins in any single business area by taking advantage of short-term changes in the market such as cheaper sources of power.
Power companies have remained profitable but have struggled in recent year, largely due to margins lagging on their retail side, dragging down company-wide profits.
Shell wants to increase its retail customer base from around 700,000 in 2018 to 5 million in 2025 in anticipation of big changes in the way we consume electricity.
Consumers with electric vehicles or home storage will have more control over their electricity consumption, and Shell hopes that by recruiting customers early it will be able to provide them with a host of new services during the energy transition.
Graphic: Shell power growth - https://tmsnrt.rs/2IpCNEN
In recent years, Europe's largest oil and gas companies have increased spending on renewables and power.
France's Total has set out ambitious plans for its power business to reach 7 million customers across France and Belgium -- roughly 15% of the market -- by 2022.
BP is also expanding while U.S. rivals Exxon Mobil and Chevron have largely avoided renewable energy and power.
"The key risk to Shell's strategy is how realistic will these returns be," said Jason Gammel, analyst at Jefferies.
"When there is competition in a sector that historically had low returns it does raise the question if they can deliver returns in the long term."
The Oil Majors are also rapidly growing gas production which is gradually replacing more polluting coal for power generation.
(Editing by Alexandra Hudson)