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Royal Dutch Shell Looks To Curtail Capital Spending On Current Down Cycle In Global Oil Prices

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Screen Shot 2015-11-20 at 08.55.47Trefis Team Contributor: DEC 30, 2015 

Oil & Gas companies across the globe are choosing to curtail capital expenditures even though it might mean the loss of growth in future production. Royal Dutch Shell Plc. is also adopting this strategy and recently announced that it is revising its capital spending estimates for 2016. This announcement is the latest in a spate of cost cutting decisions the company has taken in the wake of the extended period of low crude oil prices. We believe that this is the right way forward for Royal Dutch Shell in the near term, and these measures will be beneficial in maintaining the company’s cash profit margins till oil prices begin to recover in the long run.

Our price target for Royal Dutch Shell stands at $62, implying a premium of more than 30% to the market.

See Our Complete Analysis for Royal Dutch Shell Plc.

Royal Dutch Shell Continues To Reduce Its Spending Levels

Royal Dutch Shell revised its 2016 estimates for its capital spending program. As Royal Dutch Shell expects the merger with BG Group Plc. to close soon, the company’s estimates account for the total capital spending of the post-merger combination. Royal Dutch Shell estimates that the Shell-BG combo will spend $33 billion next year. The 2016 budget is around 30% lower than what Royal Dutch Shell & BG will be spending in 2015. In addition to revising 2016 targets, Royal Dutch Shell has strived to cut down on its capital spending in 2015 itself. Capital investment for the first nine months of 2015 amounted to $21.0 billion, close to a 25% reduction over the prior year period. Royal Dutch Shell has also reduced 2015′s full year forecast by $1 billion to $29 billion. The company also plans to save $7 billion in operating costs by 2016. Additionally, Royal Dutch Shell is actively seeking to divest its non-core assets. The company had earlier announced 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.

We believe that such cost cutting measures will be beneficial in maintaining Royal Dutch Shell’s cash profit margins till oil prices start recovering in the long run. This will help the company in comfortably maintaining its dividends in the years to come. According to our estimates, Capex as a % of Upstream Revenues has spiked significantly in 2015 due to the substantial decline in revenues this year. However, this figure will come down during the next two years as the CapEx figure will decrease in absolute terms. Beyond 2017, we expect the company’s upstream revenue growth to outpace its net investments in the upstream business, leading to a gradual decline in Capex as a % of Upstream Revenues.

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Decision To Reduce Near Term Capital Spending Makes Sense In Current Oil Price Environment

Capital investment is an essential part of the functioning of integrated oil & gas companies. Companies invest billions in capital and exploratory projects in order to replenish their existing reserves and make new discoveries. However, the catastrophic fall in global crude prices has completely changed the working dynamics for the oil & gas players. These companies are taking measures to reduce their capital spending and overall costs in order to be able to better steer through this commodity trough. A recent report from Tudor Pickering Holt estimates that the world’s oil companies have canceled or delayed final investment decisions on about 150 projects that could negatively affect the world’s daily hydrocarbon production by around 19 million barrels of oil equivalent in the coming years. Even though the spending cuts will leave a gap in production for the next few years, they are a necessary evil. The Wall Street Journal estimated that capital investments, share buybacks, and dividends at four of the biggest integrated oil & gas companies Royal Dutch Shell Plc. , Chevron , BP Plc., and Exxon Mobil had outstripped cash flow by more than a combined $20 billion in the first half of 2015. As all of these companies are mature companies, it is very difficult for them to reduce dividends and buybacks without upsetting their shareholders. The most logical step is reducing their pace of investments and these companies have adjusted their spending targets for the next few years accordingly.

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