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Shell Has Underperformed, But It Could Be The Only Oil Major That Emerges Bigger From The Downturn

Screen Shot 2015-12-07 at 05.03.19

Screen Shot 2015-12-06 at 08.56.47

Screen Shot 2015-11-20 at 08.55.47…the company’s profits plummeted 70% from last year to $1.77 billion…

Sarfaraz A. Khan: Sunday, Dec 6, 2015


  • The oil major Royal Dutch Shell is closing in on its biggest-ever merger with the UK based oil and gas producer BG Group.
  • Shell has been the worst performing stock in its peer group and now offers an above average yield of 7.8%.
  • But Shell is generating enough cash from operations and asset sales to cover its spending.
  • More importantly, Shell could be the only oil major that emerges even bigger from the downturn.

The oil major Royal Dutch Shell (NYSE:RDS.A) (NYSE:RDS.B) is closing in on its biggest ever merger with the UK based oil and gas producer BG Group (OTCQX:BRGYY). On Wednesday, the Anglo-Dutch oil producer revealed that it has received a green signal from Australia’s Foreign Investment Review Board following an approval from the country’s anti-trust regulator received last month. The BG Group is one of the major players in Australia’s rising LNG sector where the company has invested more than $20 billion on developing the Queensland Curtis LNG plant.

The latest approval has come with a condition that Shell commits to engage with the Australian Taxation Office in a transparent manner in order to prevent any future disputes. The proposed merger has already received the nod from relevant authorities in Brazil and Europe, meaning most of the regulatory hurdles have been overcome. The next step is getting an approval from China’s Ministry of Commerce which will also likely come in the near future since Shell has said that the regulatory process in the country has been moving forward smoothly and it expects to close the deal by early 2016.

Further positive news could provide respite to Shell whose American Depositary Receipts have declined 28% this year. In fact, Shell has been the worst performing stock in its peer group –which includes Exxon Mobil (NYSE:XOM), Chevron (NYSE:CVX), BP (NYSE:BP) and Total (NYSE:TOT) – all of whom have also outperformed most of the other exploration and production stocks as represented by the SPDR S&P Oil & Gas E&P ETF (NYSEARCA:XOP). Thanks to the drop, Shell currently offers an above-average yield of 7.8%.

In its recent third quarter results, Shell reported its biggest loss in more than a decade, due in large part to one-time charges of $7.9 billion related to the abandoned Canadian oil sands and Alaska exploration projects as well as impairment charges. Excluding these one-off items, the company’s profits plummeted 70% from last year to $1.77 billion, missing the consensus estimate by a big margin of $1.15 billion.

But I believe that this weakness could be a buying opportunity. That’s because firstly, Shell is one of the rare oil majors that is still generating enough cash from operations and asset sales to cover all of its capital spending. In the first three quarters of this year, the company reported a positive cash flow balance of $121 million. This comes at a time when nearly every other large-cap oil and gas producer has reported a deficit. That says a lot about Shell’s position in the downturn and the safety of its dividends.

So far, Shell is the only oil major that has used the downturn as an opportunity to make a large acquisition, which could allow it to significantly grow the size and scale of its operations. BG Group did come with a hefty price tag of $70 billion. That price was agreed at a time (in April) when oil was expected to recover to more than $70 a barrel by 2016. Since then, the crude pricing environment has exacerbated and the industry has embraced a “lower-for-longer” scenario. Some analysts, including those from Citi, expect WTI to average just $55 a barrel by the fourth quarter of 2016. Consequently, some investors are concerned that Shell may have overpaid for the British company. However, it is unlikely that Shell is actually going to pay $70 billion since nearly two-third of that value was based on the price of Shell B shares which have declined by more than 20% since the beginning of April.

It is worth mentioning here that Shell has planned to undergo a major divestiture drive which will fuel its buyback program. This should have a positive impact on the company’s shares, particularly due to the dilution which will come with BG Group acquisition. The company will significantly reduce equity by spending $25 billion between 2017 and 2020 to buy back shares.

The merger has clear advantages for Shell. Firstly, the merger would boost the future prospects of Shell’s Arrow gas venture in Queensland. The company acquired Arrow Energy, which has significant coal seam gas reserves, for $3.5 billion by partnering with PetroChina (NYSE:PTR) in 2010. But Shell cancelled its plans to construct a new LNG plant earlier this year, which meant that it had to rely on someone else’s LNG terminal if it wanted to export the gas to foreign buyers. But following the merger, Shell can supply the gas from its reserves in Queensland to BG Group’s Queensland plant.

Shell will also add BG Group’s lucrative assets in Brazil to its portfolio, particularly the company’s offshore wells in the Santos Basin which have one of the best flow rates in the industry. Currently, Shell’s operations in the country are significantly smaller than BG Group. In addition to this, the merged company will also create value for the shareholders through cost cutting measures and synergies of $3.5 billion by 2018.


Shell is moving closer towards its merger with BG Group, which could create significant advantages for the company in the long run. This will allow Shell to exploit the Arrow gas assets sooner than it would have done on its own and significantly grow deepwater reserves while creating value for shareholders through cost saving measures and synergy. Currently, the company is handling the challenging market conditions quite well, as evident in the positive cash flows. And with other oil majors largely staying on the sidelines of M&A activity, Shell could be the only oil major that emerges as a significantly bigger player from the downturn.

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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