Factors That Will Drive Royal Dutch Shell’s Value In The Near Term
Royal Dutch Shell (NYSE:RDS.A), the European integrated energy company, has had a good year so far. On the one hand, commodity prices have witnessed a rebound, causing the company’s price realizations, and in turn upstream revenues, to improve. On the other hand, the company has efficiently managed its operations and lowered its break-even price, which has bolstered its profitability and returns. In order to sustain this growth momentum, Shell continues to invest in new high-margin projects that will allow it to leverage the recovery in the markets in the coming years. In this note, we discuss Shell’s robust portfolio of projects, which is expected to contribute significantly to its cash flows and valuation in the next few years.
We have a price estimate of $67 per share for Royal Dutch Shell, which is in line with its current market price. View our interactive dashboard – Royal Dutch Shell’s Price Estimate and modify the key drivers to visualize their impact on its valuation.
Robust Pipeline Of Projects
Shell has invested in a number of upstream projects over the last few years across business lines to ramp up its production and improve its profitability. The company expects these new projects to deliver an additional 1 million barrels of oil equivalent a day (boed) production capacity by 2018. Also, the company believes that the economics of these projects are much superior to its existing projects, and hence, estimates these projects to contribute roughly $10 billion in cash flows by 2018 and $15 billion by the end of 2020, assuming oil prices stay around $60 per barrel.
So far, Shell has successfully delivered several major projects, adding about 500,000 boed of average production to its existing capacity. Some of the projects that have recently come online include Prelude FLNG (floating liquefied natural gas) project, oil and gas projects in Bonga North West and Cardamom, and deepwater projects in Malaysia, Brazil, Norway, and Philippines. Based on the company’s estimates, the current return on average capital employed (ROACE) on these projects is around 5%, generating about $5 billion in incremental cash flows. However, the ramp of these projects, coupled with the start-up of newer projects, will cause the company’s incremental cash flows to rise to $10 billion in 2018, and its ROACE to increase to 10% by 2020, at $60 per barrel oil prices.
Potential Upside In The LNG Market
Before 2016, Shell’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.
Given the rising demand for LNG, Shell’s estimates the LNG supply capacity 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. This implies that the growing LNG supply is being largely absorbed by the rising demand. However, 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. 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, which will not only allow it to efficiently manage its cash flows in a 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.
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