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Shell’s ‘Hard Look’ At Nigeria – All Bark No Bite

Shell’s ‘Hard Look’ At Nigeria – All Bark No Bite

Dilya Safine, CFA: Feb. 08, 2021 4:50 PM ET Royal Dutch Shell plc

Summary

  • Shell’s comments on its Q4 call about “taking a hard look” at its onshore Nigeria assets prompted concerns that it might look to exit the region.
  • I estimate that its onshore Nigerian assets to be worth at least 6% of its stock price, as well as the backbone for its offshore and LNG expansions.
  • I believe that Shell’s comments are aimed at achieving more favorable terms for its other contract negotiations. More details at its Analyst Day.

Q4 Earnings: Comments on Nigeria Raise Alarms

On its 4Q’20 earnings call, Shell CEO Ben van Beurden called the company’s Nigerian assets a “headache” and said it is time to “take a hard look” at the company’s operations in the country. He cited frequent incidents of oil theft and operational challenges in the Niger Delta, blaming the leaks that his company had been forced to clean and compensate for on pipeline sabotage. These comments raised alarms that Shell (NYSE:RDS.A)(NYSE:RDS.B) might look to exit the country, and the stock fell as a result. RDS is expected to provide additional detail on its operations during its Strategy Day this week. However, I believe that the company is unlikely to halt its operations in the region, as it would have a material impact on its valuation and impact other areas of its business, as I explain below.

Shell’s Nigeria Assets Valuation

These issues are nothing new: RDS made similar statements in 2018, yet this did not stop the company from renewing 16 leases in Nigeria the same year. In fact, Shell went to court to ensure the renewal of its Nigerian leases. Granted, the global oil markets outlook was brighter in 2018 than now, but companies make investment decisions based on long-term projections anyway. Shell is the operator of most of its Nigerian assets, and could have withdrawn from the region long ago if that was indeed its intention. I believe that these statements are intended to exert pressure on the Nigerian government, which receives 65% of its revenue from oil & gas sales.

Nevertheless, I analyze Shell’s Nigerian assets below to determine the impact a withdrawal from the region would mean for the company and shareholders.

Shell’s operations in Nigeria can be characterized as:

  • onshore (including shallow water production) – ran by SPDC (Shell Petroleum Development Company), where RDS has a 30% stake
  • offshore – ran by SNEPCO (Shell Nigeria Exploration & Production Company) where RDS has a 100% stake.

Van Beurden’s comments apply to Shell’s onshore oil & gas assets only, as theft and sabotage are less of an issue offshore. In 2020, SPDC produced 156k boe/d (42% oil), down 11% from the year before. Assuming no additional investment in the region, I assume a 5% per year average production decline through 2038, when the onshore leases expire. RDS does not break down its profits by region, but it is reasonable to assume operating costs below the company average after Shell reallocated capital from other regions to Nigeria during the downturn citing lower costs. I back-tested my model based on the disclosed $392M of income taxes SPDC paid in 2019. The same report shows no infrastructure improvement spending in Nigeria, thus I assume that maintenance spending is included in operating costs. Overall, I estimate the value of Shell’s onshore oil & gas assets at ~$2.30/share, or 6% of its share price. This is not a huge portion of its valuation, but not insignificant either, particularly taking into account that is requires no additional investment.

In addition, SPDC supplies natural gas to Shell’s NLNG project, as well as the pipeline infrastructure to move oil and gas produced from its deepwater fields, most notably the 200k Bonga field. While the $10B Bonga SW expansion was postponed in the current downturn, Shell took FID on the 7th train at its NLNG project last year. Start-up of the 8 mtpa (1.0 Bcf/d) project is expected in 2024, further expanding Shell’s reliance on its onshore natural gas fields to feed the plant. Further, the company’s shift towards clean energy makes the need for existing cash flow producing assets all the more important in the near term, given renewables’ uncertain financial outlook.

Meanwhile, the government of Nigeria – highly dependent on fossil fuel exports for revenue – is under pressure from the combination of lower oil prices and being forced to reduce output to adhere to OPEC’s production cuts. In addition, energy companies have delayed nearly $60B worth of projects recently, which doesn’t put the country in the best position as it looks to renegotiate the terms of its oil and gas contracts. Shell is one of the companies whose project terms are up for renegotiation, as well as one of the largest operators in the country. It is likely that the recent management statements could be aimed at achieving more attractive terms. Another alternative for the company is to gradually reduce its stake in its onshore fields, perhaps selling it to Nigeria’s state-owned NNPC.

More Info at Analyst Day

Overall, I believe that despite all the issues and negative press, Shell’s “hard look” at its assets in the Niger Delta will result in the decision to continue operating in the country, perhaps with a reduced onshore stake and/or more favorable terms for its offshore projects. The price of existing the country is too high, and the company does not have any viable alternatives to generate FCF as it focuses on renewable energy projects. I expect RDS to provide more details on its operations, including the status of Nigerian onshore and offshore assets, during its 2021 Strategy Day later this week.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.

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