Jun. 30, 2018 12:54 AM ET
- Renewal of assets with great focus on the future.
- Natural gas as energy source will continue to grow.
- Share buybacks and generous dividends.
Royal Dutch Shell (NYSE:RDS.A) (NYSE:RDS.B) has been actively focusing on what kind of business it wants to be involved in. Part of this activity is to change the composition of its assets. It has been selling plants and oil licenses, and invested where it wants to position the company.
Disposals have also been done to reduce the total debt level. Much of the debt came from the $35 billion acquisition of BG Group back in March of 2016.
Early this year, Shell communicated that its plans were to leave oil and gas operations in as many as 10 countries and instead focus more heavily on gas-rich Australia and shale opportunities in the United States.
This streamlining of our portfolio is part of our ongoing effort to raise efficiency through reduced costs and concentrating on our most competitive businesses. – CEO Ben van Beurden
The company had earmarked $30 billion as its divestment target for 2016 to 2018, and has made good progress so far.
Divestments included oil sands interests in Alberta, Canada, in line with what other oil majors such as Exxon Mobil (NYSE:XOM) and Equinor (NYSE:EQNR) had done. In effect, the company reduced its stake from 60% to 10% and gained $7.25 billion in the process. The environmental impact of extracting oil from bitumen/tar sand is challenging to say the least and must have been one of the main reasons why it exited this business.
Onshore upstream operations in Gabon were sold for $628 million. The buyer was Assala Energy Holdings Ltd., which is a portfolio company of The Carlyle Group (NASDAQ:CG). These oil fields were quite mature. Shell’s production in Gabon was around 55,000 barrel per day of oil equivalent. Production reached a peak of 365,000 barrel per day in 1996 and had steadily declined thereafter. To top it up, the country also suffers from political unrest. Not something very conducive for further investments.
Shell also sold a number of assets in the UK North Sea in 2017. These are also mature assets and therefore not considered a high priority going forward. Last week, it was also reported that Shell sold off part of its two oilfields in the NCS (Norwegian Continental Shelf). Those two fields produce 22,000 barrels of oil per day. The buyer of these two fields is a small Norwegian oil exploration company called OKEA. The price for the stake was $556 million.
Last year, the company also sold its remaining shares in Woodside Petroleum in Australia. Originally, Shell had held 40% of this major Australian LNG exporter, but over the years, it had been reduced. This last sale gave proceeds of $479 million.
Shell has had several joint ventures with Saudi Aramco. One of them was the Motiva joint venture in the United States. This was on the request from Saudi Aramco, as it is preparing for its IPO. Other divestments in Saudi Arabia included Shell’s interest in a petrochemical joint venture.
Shell is currently in discussions to sell its remaining interests in New Zealand. These interests include the Maui (83.75%) and Pohokura (48%) natural gas fields. It is also an operator with an approximate 61% interest in an exploration license in the Great South Basin. The business is under strategic review. During 2017, Shell already sold its 50% interest in the Kapuni gas field in New Zealand.
A refinery in Fredericia, Denmark, with a capacity to handle 70,000 barrels of product per day, has been on the chopping block for quite some time. Negotiations stalled last year, as it was reported that the company had been offered only $80 million for the plant.
Recently, Shell handed over all its operation at the Majnoon oil field in Iraq. It was producing 235,000 barrels of oil per day.
Shell is on schedule to execute divestments at an average rate of more than $5 billion a year until at least 2020.
Investing and Growing
Shell’s growth priorities currently are deepwater in upstream, and chemicals in downstream. Capital investment in 2017 was $24 billion.
The largest deepwater resources are held in the U.S. Gulf of Mexico and in Brazil.
In January this year, Shell announced the largest discovery in the U.S. Gulf of Mexico over the last decade. It is located at the Whale deepwater well, where it encountered more than 1,400 ft. of oil-bearing pay. In April, the company gave the green light to start the Vito project in the Gulf of Mexico. It is expected to be completed and start operation by 2021. Shell estimates that the cost of developing this field has been reduced by 70% from its original price, and claims that its break-even price is as low as $35 per barrel. It has a proven reserve of 300 million barrels.
U.S. shale production is one of the areas of growth for Shell in the next decade. However, most of the current output from the shale is natural gas, where profit margins are lower, so the majority of its budget for at least the next two years is earmarked for new oil resources. These are particularly in the Permian basin. Shell has earmarked $2 to $3 billion a year for shale until 2020, which is roughly 10% of its total planned yearly capital spending. The company aims to raise its total shale production by 200,000 BOE/day to 500,000 BOE/day by 2020.
In Brazil, the offshore oil production comes from up to 15 Floating Production Storage Offloading, “FPSO,” tankers anchored off the coast in deepwater. Last year Shell won three 35-year production sharing contracts for pre-salt blocks located in the Santos basin. These are important as they hold large quantity of oil in these reservoirs.
On a smaller scale, in 2016, Shell created a new business unit called “New Energies”. Last year this unit acquired NewMotion, one of Europe’s largest electric vehicle charging providers. At the end of the year, the company also agreed to buy First Utility, a household energy provider in the UK. It has estimated that the capital investment in New Energies to be between $1 billion and $2 billion a year from this year until 2020.
In January 2018, Shell also bought a 43.83% interest in Silicon Ranch Corporation, a leading US developer, owner, and operator of solar assets.
More Liquefied Natural Gas
The immediate future of energy generation is presently gas. Coal will be replaced with gas. The most economical way to transport gas over long distances is through LNG. I have written several articles here on SA about how you can invest in this sector. The latest article was Dynagas LNG Partners: Update Of Current Events. Other similar companies are Golar LNG (GLNG), Teekay LNG Partners (TGP) and GasLog Partners (GLOP). These 3 companies have formed a pool where they pool their resources to achieve a better economy of scale and better utilization of their ships.
In 2017, the global LNG market grew by 29 million tonnes, which was an increase of 11.2% year on year. Long-term contracted LNG prices in the Asia-Pacific region generally increased in 2017. Looking ahead, Shell expects gas markets in North America, Europe, and Asia Pacific to be well supplied over the next few years, despite the expectation of demand growth in the Middle East and Asia.
Shell is very focused on LNG. It has built a floating liquefied natural gas (FLNG) facility called “Prelude”, which is the largest ship in the world. It safely arrived at the coast of Western Australia back in September last year. This is a significant engineering achievement, and I would encourage you to check out a YouTube video to get an understanding of the complexity of this project. Earlier this month, “Prelude” FLNG received LNG from Shell’s own LNG carrier “Gallina” as part of the cooling process before start-up.
The Prelude FLNG is now testing its systems in preparation for first gas from Shell’s Prelude field, which holds ~3 trillion cubic feet of natural gas, in combination with the adjacent Concerto field. Shell expects to begin generating revenue from the multi-billion-dollar project sometime this year.
In Canada, the joint venture is also evaluating an investment in an LNG export facility in Kitimat on the west coast of Canada. Bearing in mind that large volumes of LNG are exported to Asia, this location would mean shorter sea voyages compared to those coming from the U.S. east coast and the U.S gulf area.
A takeaway from 2017 Annual Report
The company distributed $15.6 billion to shareholders in the form of dividends in 2017, including the scrip shares.
Shell CEO Ben van Beurden said the company has raised its outlook for annual free cash flow to between $30 billion and $35 billion by 2020 at a Brent crude oil price of $60 a barrel. This is $5 billion more than the outlook range we gave in June 2016. This includes the impact of acquisitions and proceeds from divestments while excluding free cash flow from assets after planned divestments.
It has confirmed its intention to undertake a share buyback program of at least $25 billion between the years of 2017 and 2020.
Debt reduction remains a priority, and after this program is completed, Shell expects to continue divestments at an average rate of more than $5 billion a year until at least 2020.
Proven oil and gas reserves (in million barrel oil equivalents) have been falling, as can be seen from the following graph:
Taking into account Shell’s production of 1,206 million BOE, of which 38 million BOE was consumed in operations, its reserves actually decreased by 863 million BOE last year. That is why large discoveries are important going forward.
With regard to cost control, Shell, like other oil majors, has squeezed out as much as it can from operating expenses. From 2014, when Brent crude fell to $40, this was absolutely necessary. This cost-cutting exercise was felt by all its suppliers and contractors, of whom one of our companies is one.
Shell’s approach is that oil and gas prices may stay low forever. This has, according to it, embedded a disciplined cost management, with an outlook of spending less than $38 billion a year on operating expenses, based on the assets it has in operation and planned to come online.
The company is not only generously distributing profits, but it is also investing heavily for the future.
Shell is now a more competitive and a more focused company than it was in the past. At a price north of $70 for the B Class shares, it is no longer cheap.
But as the Oracle of Omaha Warren Buffett once said:
It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.
The world’s population and economies are growing. With it, the demand for energy will also grow. Royal Dutch Shell is in an excellent position to deliver this energy in the future and make a handsome profit doing so. Furthermore, and most importantly, it has a proven track record of sharing the profit with all its shareholders.
Disclosure: I am/we are long RDS.B.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.