Dynamic Opportunities

Zacks Investment Research
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Royal Dutch Shell (RDS-A, RDS-B) is one of the largest integrated energy firms in the world, with a strong and diversified portfolio of development projects that offer attractive long-term opportunities. The company’s decision to acquire BG Group, the United Kingdom’s third-largest energy player, for $70 billion is a huge positive.

This is because Shell will be able to boost its oil and gas reserves by almost 25% and will benefit from BG Group’s big natural gas projects throughout the world. However, the oil price slump has affected Shell’s earnings and cash flows, in particular at its upstream unit. Moreover, Shell’s American Depository Receipts (ADRs) are expected to remain soft due to its major natural gas focus and lofty capital spending.

Royal Dutch Shell divides its operations into three major segments: Upstream, Downstream, and Corporate. The group’s Upstream business finds and extracts crude oil and natural gas, often in joint ventures with international and national oil companies. This segment accounted for the major portion (approximately 72%) of Royal Dutch Shell’s 2014 earnings.

The Downstream unit processes crude oil into a slew of refined products, which are moved and marketed worldwide for domestic, industrial and transport use. The Corporate segment covers the key support functions, comprising holdings and treasury, headquarters, central functions and Shell insurance companies.

In 2014, Royal Dutch Shell’s oil and gas production (including oil sands) averaged 3.080 million oil-equivalent barrels per day (MMBOE/d), of which 48% was liquid. As of year-end 2014, the group had approximately 13.1 billion oil-equivalent barrels per day (BBOE/d) in proved reserves and a combined refining capacity of approximately 3.3 million barrels per day (MMBbls/d), of which roughly 40% is located in Europe and Africa, 35% in the Americas and 25% in Asia and Oceania.

On July 1, 2015, Royal Dutch Shell PLC announced its decision to proceed with the Gulf of Mexico (GoM) based Appomattox deepwater project, although the business scenario looks challenging with crude prices still at low levels. Per the company, the development will likely be operational by the end of this decade.

The project includes the installation and construction of a floating platform in the GoM. Initially, the platform will produce oil and gas from the Appomattox and Vicksburg fields. Shell estimates peak per-day production capacity from the project at roughly 175,000 barrels of oil equivalent (BOE), not too far from the company’s total 2014 GoM daily output of 225,000 BOE. Investors should note that this development is the eighth and the largest deepwater platform [operated] by the company in the GoM.

The company added that its improved design techniques, savings in the supply chain and a lesser number of required wells for upstream operations have helped it in reducing the project cost by 20%.

Lydia Rainforth, CFA
Barclays
+44 (0)20-3134-6669
[email protected]

Royal Dutch Shell’s proposed acquisition of BG Group should enhance the group’s free-cash-flow profile in almost any oil price environment and adds further scale in both liquefied natural gas (LNG) and deep water Brazil. Yet with the planned closing of the deal not until early 2016, it is important that the stand-alone Shell business continues to deliver on CEO Ben Van Beurden’s drive to improve efficiency.

Encouragingly, the group announced a further reduction in capital expenditures with its Q2 results and for the first time provided a numerical indication of the cost savings it expects to achieve for its own business in 2015. Shell is no exception to the squeeze in cash flow that the industry is experiencing, but it perhaps has more levers than most to pull to withstand the downturn.

We see the investment case for Royal Dutch Shell as compelling, and we rate the stock Overweight with a 2850 British Pence (p) per share price target.

RDS outlined the positive steps that it is taking to respond to what could be a prolonged period of lower oil prices. This includes a near 10% reduction in capital expenditure to $30 billion compared to the figure of “less than $33 billion” in April. On operating costs, the company highlighted that it expects to reduce operating expenses by $4 billion in 2015 with more to come in 2016.

We estimate that in [the first half of 2015] group operating expenses were down $3 billion year-over-year, and although this is likely helped by favorable foreign exchange moves, it does suggest that Shell’s guidance could prove conservative.

Tim Winter, CFA
Gabelli and Company
314-238-1314
[email protected]