Integrated Gas To Drive Royal Dutch Shell’s Value Going Forward

by Trefis Team
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With the growing inclination towards the use of cleaner and environment-friendly sources of energy, natural gas has emerged as a preferred choice of fuel worldwide. However, due to the challenges related to the transportation and storage of gas, the demand for liquefied natural gas (LNG) has grown faster than the demand for natural gas over the last decade. As a result, natural gas producers, particularly in the US, have been expanding their LNG operations to capitalize on the booming demand for the commodity. Royal Dutch Shell (NYSE:RDS.A) is one such integrated energy company that has been increasing its presence in the gas markets with an aim to create a strong holding in the industry and delivering exceptional returns. In this note, we discuss how Shell’s integrated gas business will drive its value in the long term.

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Shell’s Presence In The LNG Market

Shell has been in the LNG market for more than 50 years, and is currently managing and operating more than 90 carriers worldwide. Before 2016, the company’s LNG business was divided into its upstream and trading divisions, depending upon the nature of operations. However, post the acquisition of the BG Group in February 2016, the company created a separate division known as “Integrated Gas” to manage its LNG operations.

The BG Group deal strengthened Shell’s position as the largest independent producer and marketer of LNG globally, as the company holds the highest liquefaction capacity in the industry, surpassing its closest competitors, Exxon and BP. Post the deal, the company has witnessed a jump in its LNG liquefaction and sales volumes. Further, the deal has been generating synergies much higher than what was previously anticipated by the company. As a result, the company’s cash flows from the division have also improved notably since the completion of the deal. Thus, we figure that the company’s strategy to acquire BG Group to penetrate deeper into the LNG market and enhance its returns is working.

Future of LNG Markets

As the demand for LNG continues to grow, large integrated companies have been actively investing in the construction of LNG projects and their related infrastructure. According to Shell’s estimates, the LNG supply capacity is expected to grow by more than 50% between 2015 and 2020. Of this, roughly 50% of the new supply capacity has already become operational in the last couple of years, primarily in the US and Australia. Thus, at present the growing LNG supply is being largely absorbed by the rising demand.

However, given the huge capital involved and the regulatory difficulties in receiving approvals for the construction of LNG projects, Shell expects the LNG demand to surpass its supply in the early years of the next decade. This would create a situation of under supply in the markets, which could lead to a rise in LNG prices. As a result, Shell has been actively assessing opportunities to invest in its LNG projects that are cost-effective and will enable the company to leverage the anticipated surge in prices post 2020.

At present, Shell categorizes its integrated gas division as a “cash engine” that funds its dividend and capital spending needs. However, given the expected demand-supply mismatch in the coming years, the integrated company plans to invest around $4-$5 billion each year over the next three years to build a robust pipeline of LNG projects. This will not only allow the company to efficiently manage its cash flows in the current weak price environment, but will also equip it to take advantage of the dis-equilibrium in the LNG markets in the future years. If the dynamics of the LNG markets pan out as expected, Shell’s integrated gas division will be a key driver of its value in the long term.

Shell’s Pre-FID Portfolio

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