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Royal Dutch Shell Withdrawing from Downstream?


From a contributor…

Responding to the comment that RDS is withdrawing from downstream, as evidenced by the withdrawal from Greece.

The Greece assets were acquired in 2000 in a swap with parts of the UK portfolio such as a terminal and unwanted (‘tail’) stations, the real driver for the deal was a local management desire for increased scale and to get a ‘seat at the table’ in the then SEOP organisation. the internal justification process – 501/502 as it was then known – was flawed in that the economics of the deal were questionable and the proposals put forward did not add up properly. There was a significant mistake in the analysis which omitted the actual opportunity cost of losing the UK assets.

There was no clear strategy at that point (2000 onwards) for the downstream portfolio – in truth ‘more profitable downstream’ was only an afterthought even in 2004 after the Reserves crisis – and the deal only worked with a long-term NPV calculation of twenty plus years to recover the quite expensive rebranding exercises that were put in place. The deal also fell foul of local practices and unforeseen dealer strength which pushed up the purchase price. The post-project review that should have highlighted these issues was in fact operated by one of the local management team in Athens who pushed the deal through, somewhat against the principles of audit generally and good practice.

Whilst these issues were identified and documented, they were quietly filed away in the time honoured manner in Shell and never published. One particular comment from an SEG-level manager at the time was ‘the deal was signed off at CMD level so there is no way we can go back and highlight these problems’. This person and their internal boss/client were incidentally ex-Enron; not sure what happened to that company but I am sure they would never do such a thing.

The bottom line is that the deal to sell Greece now is probably a net loss to RDS, certainly a fail against the 15% ROACE target from the halcyon days of Sir Phillip but there is no ongoing function or capability to actually monitor these activities and their real profitability. Behind this deal and the ongoing ‘drip drip’ of smaller scale asset sales in the downstream portfolio lies a need to gain extraordinary (i.e. non-operating) income to support the dividend policy as the core businesses are not sufficiently profitable in their current state. Interestingly however – and very much an age-old business school MBA problem from yonks ago – the ‘death by a thousand cuts’ approach exacerbates this situation in the downstream rather than resolves it as the main issue is the overhead cost base – hint… big white building by the Thames in London – as opposed to the regional operations which in most cases piece by piece are reasonably well run.

The link here of course is also to the main story this week showing a large increase in reserves and production predicted for the next five years. This was of course the very mandate to which van der Veer and Brinded signed up back in 2004 immediately after the reserves issue in order to placate the markets and salvage the RDS reputation and share price. The ‘hockey stick’ effect was predicted with a large increase late in the five year plan to 2009. Amusingly, this prediction has proven largely accurate – there has been a hockey stick effect but the curve dips down alarmingly rather than up.

To be fair to RDS and its leadership, most of the majors are in this situation and RDS are simply doing what they can… sitting and waiting and hoping for a big discovery (or three) that will get them out of jail. The cost base is massively inflated, specifically around the head office and non-core operations such as HR and Finance in particular and employment law in Europe (as opposed to the US and UK) means RDS is in a particularly difficult place. And its likely to get worse before it gets better.

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