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There’s a Wheeler-Dealer Inside Shell

By Chris Hughes: 30 JULY 2020: BLOOMBERG OPINION

The oil major has shown it can play the markets like a commodity trader. But investors can’t trust that bumper oil-trading profits are repeatable.

Sharp swings in the crude price have been an unmitigated pain for the oil industry, right? Not entirely. The silver lining has been a lucrative environment for the oil majors’ trading operations. This was on stark display in the second-quarter performance of Royal Dutch Shell Plc. But it creates a challenge for investors. How do you value this unpredictable and opaque source of income?

Shell warned last month that its three-month earnings, released Thursday, would include a colossal impairment charge reflecting the impact of the pandemic on energy demand and prices. That writedown came in at $17 billion after tax. Strip this and other one-offs out of the equation, and Shell made a $638 million net profit, confounding predictions of an underlying loss.

Oil and gas prices fell but this was offset by aggressive cost and capital-expenditure reductions plus a “very strong” trading result. Shell doesn’t gather trading profits across divisions into a single number. But earnings from refining and trading in its oil products unit were $1.5 billion in the second quarter. That compares with just $52 million in the same period last year. That’s pretty indicative.

The result reflects the fact that Shell has the physical resources to exploit a disconnect between cheap spot prices and more expensive future oil prices. It has the storage capacity to stockpile crude and capitalize on this arbitrage, as Bloomberg News’s Javier Blas explains here

Having access to a wealth of oil-market data should give Shell a nose for when trading counterparties can’t afford to negotiate too hard, and a feeling for the state of supply in all corners of the market. It’s that kind of expertise that lies behind the success of trading houses such as Glencore Plc. It translates into the ability to be a price maker in trades, rather than a price taker. Shell’s results suggest it has more of this capability than the market envisaged.

How beneficial is this for shareholders? They don’t invest in Shell because it’s a trader. Clearly, it made a difference this quarter. Shell’s free cash flow, adjusting for a big working capital swing, was about $4 billion. The group’s quarterly commitments for shareholder payouts and debt interest payments were about $2.5 billion, after Shell cut its dividend in April. There’s some headroom there in case Brent crude slips back below $40 a barrel again. But the volatile trading result makes it harder for investors to believe that this reflects a new steady-state performance.

Suppose trading income were to revert to more normal levels this year, could cost and capex cuts pick up the slack? Probably not by much. Shell’s underlying operating expenses in the quarter were 20% lower year-on-year. That comes after a multi-year efficiency program. Cash capex fell by a third. Much more and Shell surely risks cutting into bone, and falling behind in investing in the transition to cleaner energy.

Shell has proved it can make a profit even in this environment. But shareholders can’t put much value on the trading arm without more clarity on the moving parts. The shares were little changed after its surprisingly good result. Small wonder investors aren’t betting this will endure.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:
Chris Hughes at [email protected]

To contact the editor responsible for this story:
James Boxell at [email protected]


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