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Royal Dutch Shell’s Arctic Bucket Of Ice Has Melted, Yield Is Now North Of 8%

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Screen Shot 2015-09-13 at 14.19.16Sep. 29, 2015

Summary

* The Burger J well test results were a dud, no major reserves found.

 

* Shell puts Arctic drilling on hold indefinitely, which further reduces future capex.

 

* Dividend yield tops the 8% mark.

Royal Dutch Shell (RDS.A / RDS.B) was always upbeat about the prospects of drilling in the Arctic, targeting resources that could be 10 times greater than the sum of oil and gas produced so far in the North Sea. Somewhat puzzling, the Anglo-Dutch multinational pressed on with its plans even though rivals Exxon Mobil (NYSE:XOM), BP (NYSE:BP), Chevron (NYSE:CVX) and ConocoPhilips (NYSE:COP) had all suspended activity in the area.

Despite big concerns from environmentalists and shareholders, and earlier misadventures in the region, the company argued it was just too big a prize to avoid the Arctic.

In a way, Shell’s defiant push into the Arctic was understandable given the company’s need to up its game due to its poor reserve replacement ratio, and had the company succeeded it would indeed be in a pole position to explore one of the last, untapped reserves on Earth.

But now that the test results are in, the company line on Arctic drilling seems to have changed.

Burger J prospect test results were a dud

An update about Shell’s off-shore Alaska exploration reveals the recent drilling effort in the Chukchi Sea was far from a success. Tests results from the Burger J exploration well, approximately 150 miles from Barrow, Alaska, in about 150 feet of ice-cold water, urged the company to stop further exploration in the Burger prospect.

Shell found indications of oil and gas in the test results of the 6800 feet deep well, but not enough to warrant further exploration.

Even if the test results had been positive, the project would not have added to Shell’s bottom line anytime soon. Ann Pickard, Shell’s top executive for the Arctic, explained earlier this year that production wouldn’t start until 2030. She referred to Chukchi Sea oil as “competitive” at oil prices of $70 a barrel in 2030 and “a smashing success” at $110.

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Royal Dutch Shell’s Arctic Bucket Of Ice Has Melted, Yield Is Now North Of 8%

Sep. 29, 2015 4:48 PM ET  |  6 comments  |  About: Royal Dutch Shell plc (RDS.B), Includes: RDS.A

googleoff: indexDisclosure: I am/we are long RDS.B. (More…)googleon: index

Summary

The Burger J well test results were a dud, no major reserves found.

Shell puts Arctic drilling on hold indefinitely, which further reduces future capex.

Dividend yield tops the 8% mark.

Royal Dutch Shell (RDS.A / RDS.B) was always upbeat about the prospects of drilling in the Arctic, targeting resources that could be 10 times greater than the sum of oil and gas produced so far in the North Sea. Somewhat puzzling, the Anglo-Dutch multinational pressed on with its plans even though rivals Exxon Mobil (NYSE:XOM), BP (NYSE:BP), Chevron (NYSE:CVX) and ConocoPhilips (NYSE:COP) had all suspended activity in the area.

Despite big concerns from environmentalists and shareholders, and earlier misadventures in the region, the company argued it was just too big a prize to avoid the Arctic.

In a way, Shell’s defiant push into the Arctic was understandable given the company’s need to up its game due to its poor reserve replacement ratio, and had the company succeeded it would indeed be in a pole position to explore one of the last, untapped reserves on Earth.

But now that the test results are in, the company line on Arctic drilling seems to have changed.

Image source: Royal Dutch Shell

Burger J prospect test results were a dud

An update about Shell’s off-shore Alaska exploration reveals the recent drilling effort in the Chukchi Sea was far from a success. Tests results from the Burger J exploration well, approximately 150 miles from Barrow, Alaska, in about 150 feet of ice-cold water, urged the company to stop further exploration in the Burger prospect.

Shell found indications of oil and gas in the test results of the 6800 feet deep well, but not enough to warrant further exploration.

Even if the test results had been positive, the project would not have added to Shell’s bottom line anytime soon. Ann Pickard, Shell’s top executive for the Arctic, explained earlier this year that production wouldn’t start until 2030. She referred to Chukchi Sea oil as “competitive” at oil prices of $70 a barrel in 2030 and “a smashing success” at $110.

Source: Royal Dutch Shell

Offshore Alaska drilling plans halted for foreseeable future

The press release has a far less optimistic tune than the plans Shell shared earlier this year. Shell’s Arctic adventure has come to a brusk halt, the project is deemed too expensive given the current oil market environment and Shell now also sees too much risk in the “challenging and unpredictable federal regulatory environment in offshore Alaska.”

While Shell believes the Arctic will continue to play an important role in its future, any exploration activity in off-shore Alaska has been ceased for the foreseeable future.

“The Shell Alaska team has operated safely and exceptionally well in every aspect of this year’s exploration program,” said Marvin Odum, Director, Shell Upstream Americas. “Shell continues to see important exploration potential in the basin, and the area is likely to ultimately be of strategic importance to Alaska and the US. However, this is a clearly disappointing exploration outcome for this part of the basin.”

While this year’s drilling window is now closed, the company intended to continue drilling next year so it certainly feels like this is a major defeat in Shell’s long-term agenda.

Write offs are incoming

The poorer-than-anticipated prospects of drilling in the Chukchi Sea will be reflected on Shell’s balance sheet. No exact details were shared, but Shell warned it expects to take financial charges as a result of the poor exploration results. At present, Shell’s Alaska position is valued at around $3.0 billion, with around a further $1.1 billion of future contractual commitments. An update will be provided with the Q3 2015 results — but it won’t be pretty.

What it means for investors

Leaving the Arctic for the foreseeable future cuts into Shell’s future prospects. The firm hoped to find sizeable reserves in the region but will now have to make up for it elsewhere. The Burger J prospect was believed to hold up to 4.3 billion barrels of recoverable oil, a figure almost four times as high as Shell’s yearly production in terms of barrels of oil equivalent.

Investors can take solace in the fact that giving up on the expensive Arctic off-shore drilling plans will save Shell nearly $1 billion a year, which goes some way into ensuring the dividend remains safe in the current tough market conditions.

On the bright side, giving up on the Chukchi Sea also removes some of the risk involved with investing in Shell as many investors feared the project was too dangerous to pursue because a spill in the region could be catastrophic for the company. Environmentalists fumed about Arctic drilling and the project cost Shell a lot of negative press.

This downside has now been removed but it feels sour that after spending over $7 billion on its Arctic adventure, the company has little to show for it and leaves the region, tail between legs.

However, Shell’s reserve replacement rate will benefit from the BG takeover and perhaps the Arctic no-show will prompt the company to focus on taking over lower-risk and lower-cost projects in Brazil from ailing Petrobas.

Shell’s dividend yield is now north of 8 percent

The weak oil market is sending the dividend yield of Big Oil shares higher and higher. Astonishingly, the dividend yield of Royal Dutch Shell and BP has now soared over the 8 percent mark. Shell’s ADR pays out a quarterly dividend of 94 cents per share, the company has frozen the payout and promises to pay out at least the same amount next year.

While the current market environment is no easy sailing, Shell’s management will do everything it can to safeguard the dividend until the oil market roars again. This means investors can expect further capex reduction, restructuring, dilution (scrip dividend) and higher borrowing if oil stays this low for a prolonged time. Abandoning the Chukchi Sea plays into this, as this retreat will bring Shell’s annual exploration capex down to around $3 billion next year, versus $4.2 billion in 2014.

Shell has not cut its dividend since World War 2 and Ben van Beurden does not want to be remembered as the CEO that had to cut the company’s iconic dividend:

“We have a very long-term dividend policy and I’m not minded to change that,” van Beurden said in an interview today with Bloomberg Television. “The dividend is an iconic item at Shell and I will do everything to protect it.”

At the end of Q2 2015, Shell’s gearing stood at only 12.7 percent, which is very low compared to most commodity and oil companies. This gives the company lots of room to take on debt, but gearing is expected to increase to over 20 percent if the BG Group takeover goes ahead. The company has an AA- debt rating from S&P so it should have access to relatively cheap debt.

While I do not think the dividend is in immediate jeopardy, investors should take into account that it could be if oil stays this low or plunges even lower for more than a handful quarters.

The table below provides a brief overview of the dividend yield of the most common Big Oil shares. It is interesting to note that even after a 50 percent dividend cut, Shell would still have a higher yield than Exxon Mobil.

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With a dividend yield of 8.19% you can get your initial investment back in 12.21 years. If you reinvest your dividends and if the oil market strengthens again, Royal Dutch Shell offers good prospects to give new shareholders a very fast road towards an impressive double-digit yield on cost.

When you reinvest dividends in a company with a very high starting yield you can get a good yield on cost growth even without any dividend growth. The table below is a fictional example of what would happen if Shell’s share price and dividend remained the same for the next 10 years, assuming you reinvest the dividends annually. It is a highly hypothetical scenario, of course, Shell’s earnings, dividend and stock price are likely to very widely over this period of time.

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Conclusion

Continued low oil pricing, the tough regulatory environment and the poor test results of its Chukchi Sea drilling effort have melted Shell’s Arctic ambitions. While the future of the oil industry is uncertain, I continue to believe Shell is one of the better picks among the majors. With a dividend yield now north of 8%, Shell certainly pays you handsomely to wait out the storm.

Disclosure: I am/we are long RDS.B. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

SOURCE

royaldutchshellplc.com and its sister websites royaldutchshellgroup.com, shellnazihistory.com, royaldutchshell.website, johndonovan.website, shellnews.net, shell2004.com, shellshareholders.org, don-marketing.com and cybergriping.com are all owned by John Donovan. There is also a Wikipedia article: royaldutchshellplc.com

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