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Royal Dutch Shell Vs BP plc: Who’s Better Equipped to Tackle the Downturn?


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By Muhammad Ali Khawar on Jul 15, 2016 at 10:04 am EST

Royal Dutch Shell plc. (ADR) (NYSE:RDS.A) finally closed its $52 billion merger with BG group in February. The deal is considered as one of the largest mergers in the oil and gas sector and is expected to help Shell diversify its operations and benefit from cost synergies.

The Shell-BG merger comes at a time when oil prices have plummeted significantly. Oil prices that once traded over $110 per barrel have now tumbled to as low as $50 per barrel. Last year, when Shell approached BG for the first time, many criticized the deal especially because of the 50% premium Shell was willing to pay in a depressed crude environment.

However, the CEO of Shell Ben Van Beurden stayed firm on the merger and indicated it as an important step to drive the company out of the oil downturn. Here we take a look at how this multi-billion dollar merger has impacted Shell’s liquidity and debt profile and compare its performance with a similar European integrated oil and gas company, BP plc. (ADR) (NYSE:BP).

Why we are Comparing Shell with BP?

While we could compare other European oil majors, we are using Shell and BP because of their commonalities. Both Shell and BP have experienced huge cash outflows in recent times.

For Shell, the obvious reason is its recent merger with BG. Shell will use only $10 billion of its cash and fill the gap through debt. The increased leverage and interest repayments will also be a burden on the company, especially in times of low oil prices.

BP, on the other hand, has also lost a lot of cash lately. The London-based company was involved in a major oil spill, which released some 3.2 million barrels of oil in the Gulf of Mexico. BP was slapped a $20 billion penalty and also had to cover for damages. The company had expected the costs to be around $57 billion. However, in the latest development, the company mentioned that the cost would rise by $5.2 billion to $61.6 billion after recording a pre-tax charge.

Shell vs BP Financials

The most important measures to assess the performance of energy companies are debt and liquidity. Due to lucrative oil prices, oil giants were able to obtain large debt financing. However, when the industry moved toward a downturn, the large debt loads started to haunt these companies.

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As shown in the table, both Shell and BP have experienced a sharp increase in debt over the past one year. However, Shell’s debt has increased more than BP’s. It is worth mentioning here that Mr. Beurden took massive debt in anticipation of higher oil prices.

Mr. Beurden has been expecting oil prices to rebound since 2015. Last year in October, Mr. Beurden mentioned signs of rebalance, only to see the West Texas Intermediate (WTI) hit its 12-year low, just a few months later.

In the case oil prices continue to remain depressed, things would not be bright for both the companies. While BP would generally suffer more, Shell would also be impacted due to more debt. This can be explained by assessing the profitability ratio of both the companies.

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The return to common equity is a ratio that can be boosted by taking on more debt, in a booming industry. However, in an industry downturn, leverage can hurt the company and cause the ratio to decrease. Despite, Mr. Beurden’s optimistic view of the market, the industry hasn’t showed any major signs of recovery, which has adversely impacted Shell’s return on equity in the first quarter of 2016, as it took on more debt to acquire BG. BP’s return on equity ratio has also decreased due to the increasing leverage since last year.

Final Thoughts

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Shell appears more stable than BP. Recall that BP just got hit with a pre-tax charge related to the spill. The company has tried to increase exposure in LNG of late and has signed an $8 billion expansion deal for the Tangguh LNG project in Indonesia.

These projects and expansions would further weigh on BP’s debt and cash profile. Shell on the other hand, has mostly invested through BG and is now awaiting returns. The deal is likely to bring in synergies of over $4 billion and help Shell become the largest LNG company of the world.

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