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Shell’s Positioning For Better Russia And Iran Relations Is Part Of Its Global Gas Strategy

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Screen Shot 2015-06-18 at 22.09.48Zoltan Ban: 23 July 2015

Summary

  • Shell has been showing long-term interest in moving more towards natural gas for a while, with natural gas production surpassing its oil production in 2013.
  • Aside from its major acquisition of BG group, it is forming an alliance with Gazprom and is looking to be among the first in Iran.
  • The overall big picture suggests that Shell is giving up on North American shale gas and focusing on being a major player in conventional gas and LNG.

Before Royal Dutch Shell (RDS.A, RDS.B) acquired BG Group, it was already a major player in the gas industry. Its upstream production has been more than half natural gas since 2013 already. It is constantly looking to expand its downstream presence, with plans such as the ethylene plant it wants to build in Pennsylvania, in order to take advantage of the cheap gas in the North-Eastern part of the United States. It also has a gas to liquids plant in Qatar, which is the world’s biggest. It should be no surprise then to see Shell actively involved in setting up a tighter partnership with both Russia and Iran.

All major global oil companies are embracing a turn towards natural gas as their future and Shell is ahead of the pack in this respect. Between the two of them Iran and Russia control about 44% of the world’s proven natural gas reserves. In a world which is increasingly realizing the need to cut down on greenhouse emissions, the dominant position of these two countries cannot be ignored. The oil reserves that are to be found within these two countries are not to be scoffed at either. I personally have some doubts about Iran’s reserve claims, which I am sure are as inflated as the claims of its other OPEC peers. Even so, it does have a formidable reserve base of conventional, easy to extract crude oil. Russia’s official reserves may not make it in the official top five globally, but I think there is very little doubt about the potential of new discoveries given that there are still significant parts of the country which have not yet been thoroughly explored.

Oil may be the great strategic global fuel that everyone talks about, but natural gas is in fact increasingly a fuel that is much coveted around the world, due in large part to the fact that it is cleaner-burning. It will therefore become more and more important.

Europeans like to make a great deal out of the fact that the old continent managed to keep emissions bellow 1990 levels. Some of it is indeed due to conservation, efficiency as well as a large increase in renewable energy use. The following chart will however shed some light on the one factor which had the most effect on curbing emissions, without which Europe’s feat could not have been achieved.

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As we can see from the chart, coal consumption in Europe declined very significantly since 1990. A decline in coal demand of over 40% was accompanied by an increase in gas demand of roughly the same magnitude. It did more in fact to curb emissions than all the other measures combined. It is the equivalent of cutting about 250 million tons of coal consumption, given that natural gas only releases one third the emissions that coal does and most coal consumption decline came due to substitution with gas. European coal consumption declined by almost half a billion tons compared to 1990.

At the 2015 climate conference which will be held in Paris, a call will be made to participants to make a pledge to take action in order to curb emissions. Developed world members will be urged to reduce emissions, while developing world members, many of which are still in the process of industrialization, will be urged to reduce their emissions level per unit of GDP produced, in order to avoid countries like India for instance adding as much to global emissions as China did in the past few decades.

In order to make any meaningful difference in terms of emissions goals, replacing coal consumption with natural gas consumption is crucial in the developed world and keeping coal demand growth in check is also crucial in the developing world. Shell is betting heavily on this, to a greater extent than all other major oil & gas companies.

Shell-Gazprom alliance

There was very little coverage in the Western mainstream media on the St. Petersburg Economic Forum. It is perhaps because it would run counter to the image painted by the media and Western officials of Russia being isolated from the rest of the world, due to the Ukraine conflict. Reality is however that major international companies cannot afford to stay away from Russia, especially when it comes to energy.

The forum was in fact very productive in terms of singings of deals and agreements. Among the highlights, an extension of the Nord Stream pipeline was agreed to between Gazprom (OTCPK:OGZPY) and a number of Western companies, including Shell. This agreement is flying under the mainstream media radar and we are not hearing much rhetoric in regards to the evil of Russian gas like we did last year with South Stream from political elites either. This means that it will most likely be built. It will add another 55 billion cubic meters of capacity to the already existing 55 billion cubic meter capacity that Nord Stream already has.

While Shell’s participation in the Nord Stream expansion project is important, by far the most important news that came out from the forum is the announcement of the creation of a Gazprom-Shell global alliance. There are few details in regards to what this will mean for both companies, but we do know that aside from the Nord Stream collaboration, there is also a plan to expand the $20 billion Sakhalin LNG project, as well as a swap of upstream assets, which has not been detailed.

It will take a while to get a clear view of what this will all mean for Shell, but for now we can say with confidence that it will increase its presence in Russia, we just don’t know the magnitude of this increase just yet. One thing that is clear is that Gazprom is very excited about this, calling it an event that only happens once every five to ten years. This means that the deal is very significant.

Iran

It is still early to speculate on the specific benefits that the lifting of sanctions against Iran will have on Shell. We do know however that Shell is one of the companies that continued to do business right up to the time when it could no longer do so due to the sanctions imposed on Iran. Shell signaled that it is eager to settle the $2.3 billion it owes to Iran as soon as possible in order to clear the way for business to normalize. It seems Shell is one of the companies that is well-positioned to take advantage of the end of sanctions on Iran. It has previous ties and is eager to be early on the scene as the sanctions unwind and it becomes possible to do business once again.

Iran has been interested in exporting its natural gas for a long time now. It has been pushing for a pipeline to India. It was hoping for a possible pipeline to carry its gas to the EU market as well. Geopolitical realities have been keeping these hopes from becoming reality. Iran therefore remains a very insignificant natural gas exporter, despite its vast reserves. Its net gas exports in 2013 were only 140 Bcf (4 Bcm).

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Iran wants to change this as soon as possible, that is why I think Shell is smart to position itself as a potential early partner in this endeavor.

The bigger picture

Shell is not only expanding its presence in the global natural gas market, it is also divesting from projects which do not show much promise. Shell was particularly eager to divest from shale projects worth $3.1 billion last year, which was mainly in shale gas. I think it will be a while before shale gas producers will show some actual profits, therefore Shell is in effect cutting its losses from an industry that has proven to be mainly geared towards accumulating debt.

Natural gas sells for two or even three times more in Europe and Asia, while some of the assets that Shell can potentially acquire through its recent repositioning are significantly cheaper to produce. Looking at Shell’s decisions in the last few years, including the recent major merger with BG group, as well as an ever-tighter partnership with Gazprom, which is the largest natural gas company on the planet by far, we are increasingly getting an intriguing picture. Shell is poised to become a dominant force in global natural gas, with its influence only surpassed in the future by Russia’s Gazprom. Shell is looking to be big in natural gas and be profitable. It is increasingly looking like it will succeed.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

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