Shell 2Q Earnings: Thicker Downstream Margins To Partially Offset The Impact of Lower Oil Prices
Royal Dutch Shell Plc. (NYSE:RDSA) is scheduled to announce its 2015 second-quarter earnings on July 30. [1] We expect lower crude oil prices to weigh significantly on the company’s upstream earnings. Benchmark crude oil prices have fallen sharply over the past 12 months on rising supplies amid slower demand growth. The average Brent crude oil spot price declined by more than $48 per barrel, or almost 44% year-on-year, during the second quarter. This is expected to result in thinner operating margins on Shell’s spot crude oil sales. However, thicker refining margins and higher trading income, due to increased volatility in commodity prices, is expected to partially offset the impact of lower oil prices on the company’s overall performance. During the earnings conference call, we will be looking for an update on Shell’s ongoing divestment program, its operating strategy under the changed crude oil price environment, and the progress made so far on its recently announced merger with BG Group.
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. We currently have a $59/share price estimate for Shell, which is almost 14.1x our 2015 full-year adjusted diluted EPS estimate of $4.19 for the company.
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Lower Oil Prices To Weigh On Upstream Earnings
Lower oil prices are expected to have a significant impact on Shell’s second-quarter upstream earnings. According to the company’s recent earnings call presentation, 65% of its upstream revenues are directly linked to crude oil prices, and a $10 per barrel decline in Brent crude oil prices is expected to translate into a $3.3 billion earnings impact on an annual basis. This means that depending upon the overall lag between fluctuations in spot prices and their impact on Shell’s upstream earnings because of the average tenure of pricing contracts, the company’s second-quarter upstream earnings could potentially decline by around $3.96 billion, just because of the year-on-year decline in Brent crude oil prices. Lower Henry Hub natural gas prices in the U.S. will further eat into the company’s upstream earnings for the three-month period ending June 30, 2015. Overall, we expect lower price realizations to result in a decline of approximately $4.2 billion or $1.33 per share in Shell’s second-quarter upstream earnings, compared to the year-ago quarter. [2]
Thicker Refining Margins To Boost Downstream Results
We expect Shell’s downstream margins to receive a significant boost from thicker refining margins during the second quarter, primarily driven by an improved refining environment in Asia, higher refinery operating rates globally, and a reduced exposure to less-profitable downstream assets as a result of the ongoing divestment program. Shell’s refining business turned profitable last year on higher operating rates and an improved refining margin environment in most regions of the world it operates in. The company’s overall refinery availability increased from 92% in 2013 to 94% last year, which increased the operating leverage, resulting in higher operating margins. Moreover, Shell has been actively pursuing the divestment of its not-so-profitable downstream assets over the past few years and it plans to continue doing so in the near future, in order to increase the profitability of its overall portfolio. Since 2010, the company has generated around $10 billion in proceeds from such transactions. Recent downstream divestments completed by Shell include refinery sales in the U.K., France, Germany, Norway, and Czech Republic. During the first quarter, Shell’s adjusted downstream net income increased by around 68% year-on-year because of the combined effect of these factors. We expect to see a similar performance during the second quarter. [3]
In addition to refining crude oil for various petroleum fuel products, Shell’s downstream business also includes trading and marketing of crude oil and refined petroleum products, as well as the production of chemicals for use in several downstream industries. The income from trading operations depends largely on the level of volatility in commodity prices. Given the recent spike in the volatility of benchmark crude oil prices, we expect Shell’s trading operations to also boost its downstream margins during the second quarter. However, lower chemical earnings, due to disrupted operations at the Moerdijk petrochemicals plant in the Netherlands, are expected to weigh on Shell’s downstream results during the quarter. Some manufacturing units at the plant remained shut for a large part of the quarter for repair and maintenance, after an explosion and resulting fire that took place in June of last year. [4]
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Notes:- Press Release, shell.com [↩]
- Fourth Quarter 2014 Earnings Presentation, shell.com [↩]
- Shell First Quarter 2015 Results, shell.com [↩]
- Shell 2014 20-F Filing, sec.gov [↩]