Initiating Coverage Of Shell: $76.50 Trefis Price Estimate
We are initiating coverage of Royal Dutch Shell Plc. (NYSE:RDSA) with a $76.50 per share price estimate, which values it at 12.2x our 2014 GAAP diluted EPS estimate of $6.27 for the company. Shell is an integrated oil and gas company that is registered in England and Wales and headquartered in The Hague, the Netherlands. It has a strong global presence. The company is involved in the principal aspects of the oil and gas industry (exploration and production of hydrocarbons, refining and marketing of petroleum products and chemicals manufacturing) in more than 70 countries worldwide. This geographical diversity of Shell partially insulates it from operational and financial risks arising from regional regulatory and geopolitical uncertainties.
In our analysis, we have broken down the company’s operations into 3 segments:
- Crude Oil, NGLs and Other Liquids – In this division, we consolidate the financial performance of Shell’s crude oil, natural gas liquids, bitumen and synthetic crude oil production operations.
- Natural Gas – This division values Shell’s natural gas production, and other upstream operations like processing and transportation of hydrocarbons.
- Refined Products and Chemicals – This division values Shell’s downstream operations that include production of refined petroleum products and chemicals.
See Our Complete Analysis for Royal Dutch Shell Plc.
Below, we discuss the key value drivers and challenges to growth for Shell.
Key Value Drivers
- Large Base of Proved Reserves:
The amount of proved hydrocarbon reserves is an extremely critical metric for any oil and gas exploration and production company. It directly impacts the company’s production growth outlook, as it represents the total quantity of technically and economically recoverable oil and gas reserves owned by the company at a given point in time.
Shell’s proved hydrocarbon reserves stood at 13.9 billion barrels of oil equivalent at the end of 2013. Around 54.5% of these reserves are located in Europe and Asia and 47.5% of them are liquids (crude oil, natural gas liquids, bitumen and synthetic crude oil). To give some perspective on these numbers, Shell currently holds enough hydrocarbon reserves to produce oil and gas for the next 11.9 years at 2013 production rates. [1]
- Improving Downstream Margins
According to our estimates, Shell’s downstream EBITDA margin has improved significantly over the last couple of years, primarily because of increased focus on trimming down its not-so-profitable refining and marketing assets to boost the profitability of its overall portfolio. Since 2010, the company has generated around $10 billion in proceeds from these divestitures. This year, the company has already announced divestments targeting 180,000 barrels per day of refining capacity and 300,000 barrels per day marketing assets. These assets are primarily located in Norway and Denmark. [2]
In the coming years, we expect Shell’s downstream profitability to improve further on continued restructuring progress and lower crude oil prices. Because of the sharp increase in crude oil production in the U.S., primarily because of increased tight oil development, imports by the world’s largest oil consuming nation have been declining recently. As a result, oil exporting countries like Saudi Arabia are looking for buyers elsewhere and offering discounts to benchmark prices in order to their retain market share. This oversupply scenario is benefiting refineries in Europe and Asia because of which, Shell’s third quarter downstream earnings increased by more than 76% year-on-year. We expect a similar performance during the fourth quarter to boost its full-year downstream EBITDA margins. [2]
- Leading Position in the LNG Market
The share of LNG (liquefied natural gas) in global natural gas trade has grown steadily over the past few years from around 28% in 2008 to 31.5% in 2013. This is primarily due to the fact that natural gas imports by the Asia-Pacific countries that rely mostly on LNG (~80%) are growing much faster than the rest of the world. The global natural gas demand is estimated to have grown by about 2.5% per year since 2000; however, global LNG demand has risen by more than 7% per year over the same period, almost three times faster. (Statistical Review of World Energy 2014, bp.com)) Chevron expects the global LNG demand to double by 2025, creating a supply shortfall of around 150 MTPA. [3] Shell, the world’s largest private player in the global LNG market that makes up more than 8% of the total installed LNG capacity worldwide, expects to further improve its leadership position by increasing its LNG capacity with the Gorgon, Prelude and Elba projects under construction currently. [2]
Key Challenges To Growth
- Lower Crude Oil Prices
Global benchmark crude oil prices have declined sharply since June this year on slower demand growth and growing supplies from tight oil production in the U.S. The growth in demand for crude oil has been slowing down recently due to moderating economic growth in emerging markets such as China and India and signs of a slower economic recovery in the Euro-zone. In China, the rate of growth in demand for petroleum products has fallen to almost half of what it was a year ago. As a result, the International Energy Agency (IEA) expects the growth in global oil demand this year to hit a 5-year low. It expects demand, which stood at around 91.7 million barrels per day last year, to increase by just around 0.74 million barrels per day this year. Going forward, we expect crude oil prices to continue to remain weak and increase gradually beyond 2016, when we expect the growth in U.S. tight oil production to peak out. [4]
- Rising Upstream Capital Expenditures
Extraction of oil and gas is a capital-intensive business. Like other big oil companies, Shell’s upstream capital expenditures have also increased substantially over the past few years. The company spent $39.2 billion last year, up from $28.5 billion in 2008, on leasing rigs, floating oil platforms and installing pipelines in a bid to reverse the decline in production. As a percentage of total upstream revenues, its net upstream capital expenditures increased from 29.3% in 2008 to almost 39.4% in 2013, primarily because of higher development costs and increased acquisitions. According to a recent study by Evaluate Energy, finding and development costs for major integrated oil and gas companies have increased from below $10 to over $20 per barrel of oil equivalent over the past decade. This poses a significant challenge for Shell as it plans to increase its net upstream production amid lower crude oil prices. [1]
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Notes:- Shell 2013 20-F Filing, sec.gov [↩] [↩]
- Royal Dutch Shell Plc. Third Quarter 2014 Results Announcement, shell.com [↩] [↩] [↩]
- 3Q 2013 Chevron Earnings Conference Call, chevron.com [↩]
- IEA Releases Oil Market Report for November, iea.org [↩]