Image Source: Royal Dutch Shell via Flickr.com.
Last quarter was a pretty rough one for Royal Dutch Shell (NYSE: RDS-A) (NYSE: RDS-B). The company was forced to take more than $7.9 billion in charges to the income statement to write down some abandoned development projects, and its oil and gas production in the Americas continues to be a bit of a headache.
Management was well aware of how these results looked, and so on its most recent conference call its executives acknowledged these weaknesses but also had some things to say that any investor in Shell should be aware of. Here are five quotes from the most recent conference call that provide some juicy tidbits into how to view this company over the long term.
Down, but not completely out, of Alaska
Earlier this fall, Shell announced that it was suspending all drilling operations in the Chukchi Sea off the coast of Alaska, citing a dry well and an even drier market for oil and gas. According to CEO Ben van Beurden, the company learned a lot of lessons from the experience. At the same time, though, they aren't completely labeling its Alaska program as "do not resuscitate":
We've completed the 2015 drilling season. We drilled the Burger J well to its target depth. This well was completed safely. It was on schedule in what is probably the most regulated and high-profile exploration province in the world. But it was a dry hole. And we are currently in the process of safely demobilizing from Alaska. And while Burger turned out to be uneconomic, there are, of course, other potential prospects in our Chukchi leasehold as well as other areas offshore of Alaska. However, due to the high cost and the challenging and unpredictable regulatory environment, we have decided to cease further exploration activity offshore of Alaska for the foreseeable future.
With oil and gas prices where they are today, it's hard to imagine Shell returning to this part of the world anytime soon. If oil prices were to spike for some unforeseen reason, though, then it could just as quickly go back on the table.
We want to be a cost leader, not just profitable at a cost
Many of Shell's peers in the integrated oil and gas space use a certain price of oil for making budget decisions on new investments. Shell, on the other hand, takes another approach. As explained by van Beurden:
The reality is, of course, that we don't know when this process plays out, how it plays out, at what level it stabilizes and whether or not there will be sort of remaining volatility as a result of all of this. So the way we are looking at projects now is not so much with here is the screening value, but it's really how can we make sure that all our projects that we are considering are resilient, are completely competitive in their class to a point that we are clearly ahead of the rest. Because if the industry needs to exist, it needs to make a profit, and we want to be ahead of the curve, so to speak.
What he is saying here is that rather than have each investment clear some single price point hurdle, Shell looks at similar projects in terms of size and scope, and looks to be on the lower end of the cost curve of that asset class. The obvious benefit to this is that it helps a company be more adaptive to the environment in which it's operating, but the downside is the fact that it is a much more complex decision-making process.
The BG Group price isn't set
One thing that CFO Simon Henry wanted to remind analysts and investors of is that Shell has not yet paid for the acquisition of BG Group (NASDAQOTH: BRGYY). And thanks to the way the deal is structured, the price tag has actually gone down since the announcement back in April. Henry said:
We're getting a lot of questions around pricing and the value of the deal. But just to be clear, the deal was deliberately structured back in April as 70% equity, 30% cash. The equity ratio share per share is fixed. So as oil price and therefore share prices have varied, the deal offer varies as well. So on the day of the announcement it was $70 billion for the common equity. Four weeks ago that amount had readjusted to $56 billion; therefore, a 20% reduction. As of this week, it's in the low $60 billion, so more than a 10% reduction.
Granted, the only reason Shell is getting a lower price tag is because its shares are down that much. If stock prices were for some reason to shoot up -- not sure why that would happen, but it's not out of the realm of possibilities -- then the price tag for BG would jump right back up again.
Don't rule out our buyback program just yet
Another component of the BG deal that seemed pretty attractive to investors is the company said it plans to execute a $25 billion stock repurchase plan starting in 2017. Of course, the price of oil and gas hasn't exactly cooperated since that announcement, so some analysts were starting to ask if this program was still on the table. So, Henry wanted to clarify Shell's position on the whole thing:
[I]f the oil price stays at a low level because the marginal cost gets set at such a low level, then the buyback program is going to be more challenging to execute, but the determination to do so over a period is completely unchanged. It is an essential part of the offering to shareholders post the completion of the BG deal. First we address the debt characteristics, the rating, and secondly we return cash to shareholders. And that's a fundamental principle that we'll apply whatever the price happens to be as we go forward.
If oil prices were to remain at the lows we have seen in 2015, it's hard to imagine Shell being able to execute this share repurchase program. Then again, we're still a way off from when the repurchase program would start, so there isn't any point in getting too worked up because of it yet.
We can be profitable in U.S. shale if done the right way
A critique of Shell and many other integrated oil and gas companies was that they have not been able to be profitable in North American shale because they were late to the game. It also meant that they needed to spend a lot to get their operations up and running in these regions. Today, though, thanks to earlier investments and a better understanding of these reservoirs, the company anticipates continued spending in shale. According to Henry:
We've reduced investment below $3 billion, in fact it's close to $2.5 billion at the moment. We're active in the Permian, in the Marcellus, both Utica in West Canada and the Groundbirch and in the Duvernay liquids play and in Argentina. We're effectively running at a sort of care and maintain with the possible exception of some of the Permian activity at the moment. If the oil price stays where it is, we will benefit because we're taking costs out almost on a daily basis, particularly away from the well pad. At the well pad we are pretty competitive today. And in our evacuation costs, getting the molecules to market, we are reasonably competitive as well. But there is a cost away from there that we are still working to take down.
In other interviews, van Beurden has referred to this as "drill to fill," where the company produces enough oil and gas in these regions to fully utilize the existing infrastructure. Any more than that, where new projects need to be done, and it becomes uneconomical again. So, chances are if oil prices remain in this range through 2016, Shell will probably just keep production at the same rates in these regions to maximize what it already has and doesn't need to overcommit to capital projects.
