How Has Shell Managed To Improve Its Profitability Despite The Volatility In Commodity Markets?

by Trefis Team
-9.31%
Downside
69.83
Market
63.33
Trefis
RDSA
Royal Dutch Shell Plc.
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Much like most of the oil and gas companies, Royal Dutch Shell (NYSE:RDS.A), the European integrated energy company, has seen a dip in its profitability over the last three years due to the plunge in commodity prices. However, unlike some of its peers, the company has emerged strongly from the oil slump in the last few quarters, with its stock currently trading 15% higher compared to the start of the year. The company’s efforts to streamline its operations and organizational structure, coupled with the gradual recovery in commodity prices in the last 2-3 quarters, have allowed the oil major to bring down its operational costs, thereby improving its profits as well as returns. Below, we discuss how Shell has managed to reduce its operational costs to enhance its profitability. We have a price estimate of $63 per share for Royal Dutch Shell, which is in line with its current market price.

See Our Complete Analysis On Royal Dutch Shell Here

One of the obvious outcomes of a down cycle is the transformation of the cost structure of the industry. Thus, over the last three years, the oil and gas industry has seen a majority of its players revamping their cost structure in order to remain afloat. Royal Dutch Shell, for instance, has managed to bring down its underlying operating costs from a little less than $50 billion (including the BG Group) in 2014 to almost $38 billion in the most recent quarter of 2017 (4Q rolling costs), representing a reduction of more than 20% over the last three years.

Shell has fulfilled this herculean task by simplification, standardization, and digitalization of data, processes, and IT solutions. This has not only enabled the company to control its overheads cost but also improved safety and efficiency throughout the organization. In addition, the oil and gas producer is using advanced monitoring and analytical tools to bring about operational efficiency improvements and significant cost reductions across all its businesses.

Further, the company has outsourced some of its non-core activities to offshore business centers in India, Poland, the Philippines, and Malaysia with an aim to lower costs and promote innovation, while its in-house employees can concentrate on more crucial and immediate activities. Apart from these cost reduction measures, Shell has successfully integrated the operations of BG Group acquired in 2016. Leveraging the efficient workforce and skilled laborers from the acquired company, the company had lowered its full-time employees (FTE) from 98,000 in early 2016 to around 85,000 in mid-2017, a decline of more than 13% in the last 15-18 months.

 

 

 

 

 

 

Despite achieving a notable drop in its operating costs, Shell plans to explore other areas of further improvement. For example, the company aspires to bring down its all-in LNG supply unit costs for its new projects to around $5 MMBTU. Also, the integrated company foresees plant utilization as one of the areas which can be further improved to enhance value delivery. For this, the company is assessing growth opportunities in LNG projects that can enable it to improve its cost competitiveness, while maintaining its leadership position in the market. If Shell continues to optimize its cost structure through its relentless efforts, we expect its profitability, and, in turn, valuation to improve considerably in the coming quarters.

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