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This European Oil Major Is Eyeing a Turnaround by Cutting Back on US Energy
Posted by: Sarfaraz A. Khan (IP Logged)
Date: March 29, 2014 01:48PM

For the current fiscal year the Anglo-Dutch oil major Royal Dutch Shell (RDS.A) has decided to cut the upstream spending of its American business by 20%. The company will also implement job cuts as it restructures its American operations to make smaller “performance units.”

While some of the smaller energy companies have reported significant growth on the back of the U.S shale boom, the energy majors like Shell have struggled. Moreover, Shell’s recent quarterly performance was also far from satisfactory. The company is now selling assets and prioritizing investments in its lucrative low-cost gas and liquid rich shale acreage.

In these tough times, Shell has planned to increase its Q1 dividend by 4% to $0.47 per share. In the last 12 months, the company’s American depository receipts have risen by 12%. The company has underperformed as compared to other leading European oil majors such as British Petroleum (BP), which is up 14.2%, and Total SA (TOT), which has risen by 37.5% in the corresponding period.

Despite its underperformance, Shell is relatively more expensive than its peers, in terms of trailing P/E ratio. The Bank of America Merrill Lynch has recently reinstated a neutral rating on Shell with a price target of $73.68. The company’s shares closed at $73.29 on Friday.

Declining Profits

In its previous quarterly results, Shell’s net-income equivalent dropped 71% to $2.1 billion as the company battled higher depreciation and exploration expenditure, lower upstream production and weakness in the downstream oil industry. The company’s revenues dropped $116.51 billion a year ago to $109.24 billion.

Underperforming Majors

Smaller energy companies have witnessed significant growth in production by betting on the U.S. shale reserves. For instance, Rex Energy (REXX) has already reported a 49% year-over-year increase in production in its previous quarter and has forecast to take this momentum forward in the current year. The company has grown on the back of higher activity in Marcellus Shale, Ohio Utica and Illinois Basin. Other companies like Southwestern Energy (SWN) and Range Resources (RRC) have also shown double-digit growth in production and have forecast strong growth for the future.

The smaller operators have benefitted from their lower cost structure and quicker decision making.

On the other hand, bigger companies have failed to report any meaningful increase in production from their American unconventional reserves. Moreover, they have taken massive write-offs on their investments in the U.S. shale.

Last year, Shell cut the value of its North American liquid rich shale reserves by $2.1 billion.

Before that, in 2012, BP performed a $2.1 billion write-off of its shale gas acreage while BG Group (BRGYY) reduced the value of its American shale reserves by $1.3 billion. These write-offs were led by the weakness in the natural gas pricing environment.

A Major Headache

Shell has been struggling in the United States as the company’s massive investments, of nearly $24 billion, in the country’s shale oil and gas reserves have failed to materialize. Moreover, the losses from North American shale have completely offset the gains it has made from Canadian oil sands and deepwater operations at the Gulf of Mexico.

Last year, after the re-evaluation of its assets in the U.S., the company has decided to sell nearly 700,000 acres in Texas and Kansas. Moreover, it will reduce its North American onshore workforce by 30%.

Last year, Shell lost nearly $900 million in its American upstream business. For 2014, Shell has forecast another round of losses from this unit. Overall, the company has lost nearly $3 billion in its North American shale oil and gas operations.

Shell owns significant acreage at Marcellus shale, Permian Basin and Duvernay Shale. But the company will divest from its Eagle Ford acreage in Southern Taxes. This is the same formation from where the company took a massive write off (mentioned earlier).

A Turnaround

Shell will reorganize its North American shale operations into a single business in an effort to turn it around.

Moreover, the company has delayed oil exploration plans in Arctic, off the coast of Alaska, by 1 year. Between 2011 and 2013, Shell spent nearly $2 billion in the region, and so far, the company has nothing to show for it.

Following a massive drop in profits in its quarterly results, Shell will cut spending to $37 billion in 2014 from $46 billion last year. The company is cutting its North American expenditure, including acquisition expenditure, by 20% in the current year.

Moreover, it will sell assets worth $15 billion between 2014 and 2015, of which, sales of $4.5 billion have been announced. Several U.S. shale plays and some downstream assets could also be put on sale as Shell thinks that it’s unwise to tie up $80 billion of its capital in its loss-making North American portfolio.

However, if the turnaround fails, then Shell has warned investors that the company could perform more write-downs in the future.

Disclosure: This article was written by Sarfaraz A. Khan, with valuable contribution from Gohar Yousuf, research assistant at Half Bridge Business Review. Neither Sarfaraz A. Khan, nor Gohar Yousuf have any positions in the stock(s) mentioned in this article.



Stocks Discussed: RDS.A, BP, TOT, REXX, SWN, RRC, BRGYY,
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