Shell’s Downstream Operations Continue To Drive Its Profitability
Royal Dutch Shell (NYSE:RDS.A), the European integrated energy company, posted a notable improvement in its June quarter 2017 earnings on 27th July 2017((Royal Dutch Shell Announces June Quarter 2017 Results, 27th July 2017, www.shell.com)), despite the slowdown in the recovery of commodity prices during the quarter. While the oil and gas company has witnessed a remarkable recovery in its upstream operations on a year-on-year basis, its downstream business, particularly refining and chemicals, continued to account for a majority of its profits. Strong results from its downstream operations, coupled with its consistent efforts to bring down its operating costs and capital spending, enabled the company to report adjusted earnings of 86 cents, beating the market expectations by a huge margin. Going forward, Shell will continue to work towards reshaping itself by focusing on improving its capital efficiency, reducing its costs, delivering on new projects, and completing its divestment program.
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Key Operational Highlights
- Shell has seen notable growth in its deep-water and integrated gas business since its acquisition of the BG Group. Assuming the exchange rates at the time of BG acquisition, the company expects to achieve $4.5 billion in synergies by the end of 2017.
- Shell’s integrated gas adjusted earnings for the June quarter stood at $1.2 billion, 35% higher compared to the same quarter of last year. This growth in earnings was largely driven by higher realized oil, gas, and LNG prices, higher LNG volumes, and lower operating expenses, partially offset by the impact of lower production volumes.
- The company’s upstream division reported adjusted earnings of $339 million in 2Q’17, as opposed to a loss of $1.3 billion in 2Q’16. This was backed by higher price realization, increased production, and lower depreciation (due to divestments).
- Shell’s downstream operations continued to dominate its profitability in this quarter as well. Its downstream operations, particularly refining and chemicals, witnessed positive industry trends during the quarter, resulting in earnings of $2.5 billion in 2Q’17 versus $1.8 billion in the year ago quarter.
Pulling Levers To Survive The Downturn
As mentioned earlier, Shell has been focused at maneuvering four main levers (described below) to weather the ongoing commodity slowdown.
- Divestment – So far, Shell has completed asset sales worth $15 billion in the 2016-2017 time frame, and has received a sum of $11.5 billion in cash for these deals. It has further announced sales of $7 billion, which are likely to be closed by the end of the year, taking the total of its divestment program to $25 billion. The company indicates that it has another $4 billion worth of deals in the pipeline, implying that it is on track to achieve its divestment target of $30 billion by the end of 2018.
- Capital Investment – Given the slump in the commodity prices, Shell has reduced its capital spending (including BG Group) by $20 billion between 2014 and 2016. Since the outlook for the markets is still uncertain, the company plans to restrict its capital investment to $25 billion in 2017, and in the range of $25 to $30 billion between 2018 and 2020.
- Operating Costs – Since 2014, Shell has managed to reduce its operating costs by roughly $11 billion, or more than 20%. This has enabled the company to sustain its margins in this slowdown. For the current year, the company expects to keep its operating costs below $40 billion.
- Delivery of New Projects – Shell has a robust portfolio of projects that have either become operational or are expected to come on-stream soon. Some of the projects that are now producing include Stones deep-water oil and gas project in the Gulf of Mexico (GOM), the Kashagan field in Kazakhstan, and Queensland Curtis Liquefied Natural Gas (QCLNG) plant in Australia. The company is on track to deliver on these ongoing projects, which are expected to produce more than 1 million barrels of oil equivalent per day, and contribute $10 billion in cash flows by 2018.
Overall, we believe that Shell’s focus on the pulling of its four main levers will enable it to reshape its operations and emerge out of the ongoing commodity slump.
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