Royal Dutch Shell (RDSA)

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WHAT HAS CHANGED?

  1. Royal Dutch Shell’s Energy Transition Strategy

Earlier in May, Royal Dutch Shell highlighted the energy transition strategy to transform its offerings consistent with the net-zero emission targets. In 2020, the company’s revenues declined by 47%(y-o-y) to $183 billion resulting in a net loss of $21 billion. Thus, the company reported $34 billion of cash from operations which assisted $17 billion of capital expenses and $9.4 billion of dividends & stock repurchases.

Per the new strategy, Shell is targeting a higher share of capital expenditure towards its growth and transition businesses instead of the conventional upstream business. As the company progresses from net debt of more than $65 billion (at present) towards the net debt of less than $65 billion, the cash capital expenditure is slated to increase from $22 billion to $27 billion.

POTENTIAL UPSIDE & DOWNSIDE TO TREFIS PRICE

Below are some of the key value drivers for Shell that present opportunities for a significant upside or downside to the current Trefis price estimate for the company:

  • Downstream EBITDA Margin: Shell's Downstream EBITDA Margin remained relatively stable at around 1.4-1.8% between 2009 and 2012. In 2013, the company's downstream profitability increased to 2.3% despite lower gasoline crack spreads globally due to overcapacity. This was primarily due to portfolio actions taken by Shell over the past few years to divest not-so profitable assets and improve its operational efficiency. The figure jumped to 6.3% in 2014, before dropping to 5.3% in 2015. It rose slightly to 5.5% in 2016, and further to 6.3% in 2017.
    Going forward, we expect Shell's Downstream EBITDA Margin to grow slightly and stabilize at around 7% by the end of our forecast period as the company increases its advantaged crude (primarily cheaper Canadian crude) processing capacity in North America. However, if Shell's Downstream EBITDA margin does not improve, and instead declines to around 6% in the long run because of slower demand growth and increasing global refining overcapacity, there could be a 10% downside to our current price estimate for the company.

  • Upstream EBITDA Margin: Shell's Upstream EBITDA Margin declined from around 62.7% in 2008 to just over 45.9% in 2009 as oil prices decreased sharply because of the great recession in 2009. However, between 2009 and 2012, the company's upstream cash profitability increased to around 54.6% on a surge in global crude oil prices. In 2013, oil prices remained high, but Shell's E&P margin declined to just 48.5%, primarily because of a sharp (70% y-o-y) increase in exploration expense. In 2014, the company's upstream margin dropped further to 40.9% due to the impact of lower commodity prices. However, it recovered to 44% in 2015 and 46% in 2016 due to lower exploration expense. Recovery continued in 2017 as well and the figure stood at 51%
    Going forward, we expect Consolidated Subsidiaries E&P EBITDA Margin to further improve, given the stability in oil prices around current levels. Thereafter, we expect it to gradually increase to around 54% by the end of our forecast period. However, if the company's exploration success ratio deteriorates significantly and global crude oil prices remain around $50 per barrel even in the long run, it could impact the margins and there could be a 6% downside to our current price estimate for Shell.

For additional details, select a driver above or select a division from the interactive Trefis split for Shell at the top of the page.

BUSINESS SUMMARY

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.

The difference between Shell's reported sales revenue and the figures used in our model is primarily because we add back intersegment sales in order to arrive at divisional EBITDA margins.

SOURCES OF VALUE

Shell's downstream operations contributes more than 55% to the company's value, according to our estimates. The company's upstream operations, which include crude oil and natural gas liquids and the natural gas division, contributes roughly 25% of the company's total value while integrated gas accounts for 20%, by our estimates. Below, we highlight the key sources of value for the company's upstream operations:

Large base of proved hydrocarbon reserves

Proved reserves is an extremely critical metric for an oil and gas exploration and production company. It represents the total quantity of technically and economically recoverable oil and gas reserves owned by the company at a given point in time. It directly impacts the company's production growth outlook. More than 50% of Shell's reserves are located in Europe and Asia, and almost half of them are liquids (crude oil, natural gas liquids, bitumen, and synthetic crude oil). Shell currently holds enough reserves to produce oil and gas for the next 12 years at the the current production rate.

Leadership position in the global LNG market

The LNG industry gained momentum, so much so that the industry that was barely 110 million tons (MT) in size in 2000 has grown more than 1.5 times in the last 15 years. This is primarily due to the fact that natural gas imports by the Asia-Pacific countries that rely mostly on LNG (~80%) are growing much faster than the rest of the world. While the demand for natural gas has grown at about 2% since 2000, the demand for LNG has out-paced that of gas, expanding at an average annual rate of around 6% over the last 15 years, reaching about 265 MT in 2016.

Shell's close competitor, Chevron, expects the global LNG demand to double by 2025, creating a supply shortfall of around 150 MTPA. Shell being the world's largest supplier of LNG, with more than 8% share of the global installed LNG capacity, expects to further improve its leadership position by increasing its LNG capacity with the Gorgon, Prelude, and Elba projects under construction.

KEY TRENDS

Divestment of not-so-profitable assets

Shell has been actively pursuing the divestment of its not-so-profitable 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. The company generated more than $40 billion in proceeds from these divestitures during the 2010-2015 period. Additionally, Royal Dutch Shell plans to raise $50 billion from asset sales between 2014 and 2018 in order to ride out the commodity downturn and also finance its takeover of BG Group.

Peak oil

It is estimated that a large part of the world's oil reserves have already been discovered. Recent statistics have indicated that global consumption has been outpacing reserve additions. Peak oil is a commonly used term to describe the point at which world oil output will reach a maximum and decline afterward.

However, many institutions such as the International Energy Agency (IEA) believe that peak oil will not occur for another 25 years at the very least. Many governments across the world are promoting alternative energy measures to ensure that the supply and demand of energy will be met at all times to come.

Improvements in technology

Due to limited underlying growth in product demand, there has been a movement in recent years towards increasing the complexity of refineries rather than expanding capacity. In the U.S., no new refineries have been built since 1980, however, improvements in process design and technology has seen capacity increase around 1% per year.

The early refineries that were established were mainly used to process light sweet crude resulting in an increase in demand for light sweet crude. As a result of higher oil prices in recent times, heavy crude oil is becoming more economically attractive. In addition, interest in the development of new cost effective methods for extracting and transporting heavy crude oil for refining into valuable light and middle distillate fuels is also increasing.

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