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Royal Dutch Shell plc’s $20bn U-turn Is Great News For Shareholders

You can be sure Shell was unsure. The company was set to spend an estimated $20bn on a gas-to-liquid plant, a figure already much higher than previous $12.5bn cost estimate made just a few months ago. But Shell has changed its mind. Now it’s spending $0 on the project. It’s pulled away from it entirely.

Giant resource companies like miners and integrated oil behemoths don’t have a great track record of prudently stewarding capital for the benefit of their shareholders.

Quite the opposite — they have a reputation for blowing money in booms and going near-bust in downturns.

I’ve even heard mining bosses accused of ‘being addicted to big holes in the ground’. For oil and gas companies, the equivalent is perhaps platforms and refineries as far as the eye can see, like an environmentalist’s worse nightmare.

Recently, though, the majors have been talking a new game. The bosses at Royal Dutch Shell (LSE: RDSB) (NYSE: RDS-B.US) for example have claimed that returns for shareholders are now their top priority — ahead of the old growth at all costs way of doing business.

It sounds logical, but it’s been hard to square with what the company has actually been doing — which is spending its way towards a $130bn goal for net investments over 2012-2015, including acquisitions as well as capital expenditure.

In October it said it would spend $45bn this year alone!

You can be sure Shell was unsure

All this makes Shell’s recent change of plan in Louisiana so encouraging. The company was set to spend an estimated $20bn on a gas-to-liquid plant, a figure already much higher than previous $12.5bn cost estimate made just a few months ago.

But Shell has changed its mind. Now it’s spending $0 on the project. It’s pulled away from it entirely.

Analysts have been quick to speculate about what this means for US energy prices. There’s a rash of projects under way along the Gulf coast that are set to capitalise on the country’s oil and shale gas bonanza. If Shell thinks the numbers don’t stack up, then presumably it thinks petrol prices are set to fall. Equally, it might be worrying that gas prices won’t go much lower – it didn’t own the gas that would have fed the massive facility (unlike a similar one it’s already built — expensively — in Qatar) so it would have been at the market’s mercy when it comes to the going rate for gas.

All fascinating speculation, but I’m more interested in what it means for Shell.

Shell for shareholders

Put simply, I think this is concrete evidence that the company is serious about pursuing the projects with the highest payoff.

Shell had the financial firepower to push forward with this plant — even $20bn isn’t a terrifically big deal for the company.

It would have been the easiest thing in the world to green-light the project and leave someone else to see how the sums stacked up later. In the ‘get big or go home’ world of the oil giants, that’s long been a default option — especially when you’ve set yourself that whopping $130bn spending goal.

But Shell hasn’t done this. CEO Peter Voser said on revealing the news that it was withdrawing its involvement that:

“We are making tough choices here, focusing our efforts and capital on the most attractive opportunities in our world-wide portfolio, to add value for shareholders.”

You wouldn’t have thought it’d need saying, but in the world of resource giants it does.

Exxon-erated

So Shell seems to be changing its spots. It already pays a good dividend equivalent to a yield of 5.3%, and almost every day it buys back more of its cheap-looking shares — the company is on a P/E ratio under 9 — which should be accretive to earnings going forward.

Shell will probably spend much of the $20bn it has freed up here on other projects — it has just got approval from the Canadian government to expand production at its environmentally controversial oil sands project in Alberta, for example. But if it spends it more slowly, and more carefully, that must be a good thing. Caution might not help Shell become the biggest player in the industry, but as shareholders we’re interested at getting the most bangs for our buck.

Besides, prudent capital allocation hasn’t hurt US rival Exxon Mobile Corporation (NYSE: XOM.US). With a market cap of $418bn, Exxon is the biggest listed company in the US but it’s also got an enviable record of making money for shareholders.

Since the turn of the century, Exxon has achieved an average return on capital of 20.7% (according to figures from CapIQ) compared to the 14.2% posted by Shell. Cancelling the Louisiana project may be a significant step in closing that gap for the British-Dutch giant.

Of course, you’ll need to dig further into Shell’s plans to get a handle on whether its new approach will pay off for shareholders. To ensure you know what you’re doing, why not download our FREE report on evaluating companies in the energy sector.

If you want to understand oil and gas shares better, then simply follow that link and let our Foolish analysts get you up to speed.

Owain owns shares in Royal Dutch Shell.

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