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Why $55 Brent Is Big News For Shell

In light of material increases in realized upstream prices and an improving downstream sector, Royal Dutch Shell plc’s (NYSE:RDS.A) (NYSE:RDS.B) financials have shown tremendous improvement this year. The worst of the downturn is behind the oil sector, but keep in mind crude prices remain range-bound. That being said, with Brent (global oil benchmark) back over $55/barrel (high end of the range), things are looking brighter and brighter for Royal Dutch Shell every day. Especially when it comes to fully covering Royal Dutch Shell plc Class A and Class B shares’ lofty 6+% yields. Let’s dig in.

When I start a new series on an oil & gas company, I like to first provide a review of its finances to set the tone of what investors should expect. Growth projects and future plans for value creation are all good and well, but that needs to be compared and contrasted with Royal Dutch Shell plc’s current financial situation.

Earnings overview

If you have already been following Shell over the past few years, you may want to skim over this section, but if you haven’t been, this is key information to note as it sets the stage for what I’m getting at.

On an adjusted basis, Shell posted $3.6 billion in net income in Q2 2017, down slightly from $3.8 billion in Q1 due to weaker upstream realizations. However, 1H 2017 earnings were up to $7.4 billion versus $2.6 billion in 1H 2016, a very strong turnaround albeit one off of a very low base.

Investors should note that the adjustments include CCS accounting for its downstream division (reflects changes in commodity prices to provide a better comparison) and don’t include certain corporate level expenses (presumably because they are one-off events, but I would caution that this adjustment can be a tad generous at times).

Downstream (includes petrochemical, refinery & marketing/retail, and trading operations) and Shell’s integrated gas (includes liquefied natural gas and gas-to-liquids operations) division helped keep the energy giant above water during the downturn. While Shell’s upstream division lost almost $3 billion in 1H 2016, its integrated gas division posted almost $1.9 billion in income and its downstream division generated $3.8 billion in earnings (all earnings figures are adjusted). However, it became clear during the bust that weak realizations drag everything down.

Shell’s average liquids (mostly oil) realizations came in at $35/barrel in 1H 2016, down by $11/barrel versus its 2015 average ($46/barrel) which in turn has half of what it was realizing in 2014 ($90/barrel). On the gas front, Shell went from realizing $6.66/Mcf in 2014 to $4.85/Mcf in 2015 to $3.55/Mcf in 1H 2016. Downstream crack spreads were mixed over that time frame (2015 was a banner year for Shell).

When Shell’s 1H 2017 liquids realizations shot up to $47/barrel, its gas realizations jumped to $4.26/Mcf, and in most instances its crack spreads improved, and its finances immediately showed serious improvement. During the first half of this year, Shell’s adjusted income from its upstream division became positive at $879 million, its integrated gas division posted $2.35 billion in earnings, and its downstream assets churned out just over $5 billion in profit. Corporate expenses ($670 million) and non-controlling interests ($219 million) took that down a tad.

The important thing to take away is that Shell’s finances are improving on all fronts. Sure, Q3 saw global oil prices continue moving lower for most of the quarter so Shell’s next earnings report will probably be lackluster, but Brent is now back over $55/barrel heading into Q4.

Brent over $55

One of the most under-reported things in the financial media is that Brent has been on an aggressive upward movement. Over the past three months, Brent has rallied by about $10, equal to a 22% jump. This major development was lost due to WTI (America’s oil benchmark) not doing as well relatively speaking, at least in my view.

Brent at $56 heading into Q4 is a big deal. During 1H, Brent averaged $51.67 with the best quarter coming in Q1 when it averaged $53.69. As of this writing, Brent sits at $56.29, a material improvement that if held will do a lot of good for Shell’s Q4 results.

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