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Shell Sells Gulf Of Mexico Asset, But Faces A Tough Road Ahead

Screen Shot 2016-08-31 at 23.13.17Sarfaraz A. Khan: Aug. 31, 2016 3:20 PM ET

Summary

  • Royal Dutch Shell has agreed to sell its Brutus/Glider assets in the U.S. GoM to EnVen Energy for $425 million in cash.
  • The asset sale is a small step in the right direction which will improve Shell’s cash reserves.
  • The company, however, has made little progress toward achieving its target of selling $6Bn to $8Bn assets this year and $30Bn by 2018.

Royal Dutch Shell (RDS.A, RDS.B) has recently agreed to sell its Brutus/Glider assets in the U.S. Gulf of Mexico to Houston-based EnVen Energy for $425 million in cash. Shell was pumping 25,000 barrels of oil per day from these offshore properties, which was equivalent to 5.8% of the oil giant’s Gulf of Mexico production or less than 1% of its total production.

The asset sale is a small step in the right direction which will improve Shell’s cash reserves which stood at $15.2 billion at the end of June. Shell intends to sell $6 billion to $8 billion of assets this year. Overall, the company aims to dispose $30 billion of assets, spread in 5 to 10 countries and representing 10% of its production, by 2018. That will allow the company to reduce its debt which has ballooned following the $53 billion takeover of BG Group.

Soaring levels of debt has been one of the biggest problems for oil majors Exxon Mobil (NYSE:XOM), Shell, BP (NYSE:BP) and Chevron (NYSE:CVX). In the downturn, the four energy giants have seen their liabilities climb to record highs, with a combined debt, net of cash of cash, of $184 billion.

Shell, however, has the highest level of debt and the most levered balance sheet in this group. The Anglo-Dutch company has seen its total debt climb to $90.3 billion at the end of June, twice as large as $43.8 billion in Q1 2015, prior to its takeover of BG Group. Moreover, its leverage, measured in terms of net-debt ratio, has climbed to 28.1% and is just 1.9 percentage points below the mark which Shell considers uncomfortable.

Also, Shell pays a generous dividend which is reflected in its 7.6% yield. It spends roughly $2.5 billion in each quarter on dividend payments. But since the company does not generate enough cash flows to self-fund its capital expenditure and dividends, it has used additional borrowings to fund a large chunk of its dividends (this was evident in Q2-2016).

In other words, the company does not generate any excess cash flows which could be used to reduce its debt load. Rather, it is using the debt to fund dividends which is further damaging its financial health. Without any support from cash flows, the only way Shell can meaningfully reduce its debt is through asset sales. The problem, however, is that Shell has made little progress on the asset sale front despite making big promises.

So far this year, Shell has sold just $2 billion of assets, which means that it has to announce disposals of at least $4 billion over the next four months in order to deliver on its promise for 2016. More importantly, even if Shell meets this year’s target, it will have to figure out a way to close up to four times as much asset sales over the next 24 months. And what makes this an even bigger challenge is that Shell itself is not too optimistic around the near-term future of oil prices.

Recently, on the backdrop of the Offshore Northern Seas conference in Norway, some industry experts, particularly IHS Markit’s Vice Chairman and Pulitzer Prize winning author Daniel Yergin, said that the oil market would balance this year, but Shell’s chief energy adviser Wim Thomas was cautious.

During an interview to Reuters on the sidelines of the conference, Thomas said that the potential increase in global oil supplies, driven by resumption of operations in Libya and Nigeria and increase in production in Iraq and Iran, could delay a recovery. The market may not rebalance until the second half of 2017, according to Thomas. And this scenario can be disrupted by weak demand from China and India or an uptake in US crude production as shale drillers bring rigs back online. On the other hand, I believe that if OPEC members change their strategy of maintaining market share and agree to cap production, then that can have lift oil prices. The future of oil, therefore, remains highly uncertain. In this environment, Shell will find it difficult to sell $30 billion of assets by 2018.

Clearly, Shell’s CEO Ben Van Beurden has work cut out for him.

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Additional disclosure: I own shares of funds that may hold a long position in all of the companies mentioned in the article.

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