Oil Major Shell Plans To Shrink As Oil Rebounds

By Nick Cunningham – Jan 03, 2017, 3:07 PM CST

Oil prices are rising and the industry is poised for a rebound, with U.S. shale spending set to soar in 2017. But for Royal Dutch Shell, this year will be much more mundane as years of high spending and ballooning deficits force the Anglo-Dutch oil major to retrench.

Even as the New Year promises to bring a sharp improvement in the finances of oil companies across the world, including Shell, not everyone will approach the rebound in the oil market in the same way. Smaller U.S. shale companies, with assets concentrated in some highly profitable areas such as the Permian, are planning to sharply increase spending and drilling. But the oil majors are less nimble, having assets diversified upstream and downstream, spread out across the globe. They were able to weather the oil price downturn better than their smaller peers, but they respond much more slowly to fluctuations in the oil market. That stability is a feature for many investors looking to avoid volatility, but it also means that 2017 may not bring much excitement from the majors.

Shell, more so than some of its peers, will be seeking a smaller footprint this year. After spending more than $50 billion on BG Group, the war chest is running a little low. On top of that, Shell has seen its debt pile swell to an astonishing $78 billion, much more than other oil majors. That is 40 percent more than the $46.2 billion in debt that ExxonMobil reported at the end of the third quarter of 2016. Shell’s gearing ratio – a ratio of debt to equity – topped 29 percent, which is also higher than its peers.

The hefty price that paid for BG Group, Shell insists, will ultimately prove to be worthwhile. The acquisition was a long-term play on LNG, with sizable assets in Australia and East Africa. Shell is now one of the largest exporters of LNG in the world, and the company is betting on rising demand for gas, particularly in China, for decades to come. Shell has run up its debt in order to position itself as the dominant global gas supplier, a move that company executives believe that bet will pay off big-time in the years ahead.

But while it waits to see returns on those investments, Shell will have to tighten its belt in the interim. Even before the purchase of BG Group, Shell had laid out a multiyear divestment program in order to pay down debt. The $50 billion price tag for BG Group has put a much greater urgency on cutting costs, shrinking its footprint, and selling off assets to raise cash. Shell is in the midst of a three-year, $30 billion divestment scheme that runs from 2016 to 2018, but the pace of asset disposal is running behind the company’s targets. According to the Wall Street Journal, Shell only sold off $5 billion in assets in 2016, a bit shy of the $6 to $8 billion it had hoped for.

Shell’s debt problems are a worry for shareholders. Paying down debt and selling off the least productive assets are integral to preserving the company’s sacrosanct dividend policy. Shell insists its dividend will not change, but reining in debt will be key to convincing shareholders that that is the case.

“Shell’s high net debt and the slow progress against its divestment plan are the last major concerns for investors, with the view that it remains the key risk for a dividend cut,” Sanford C. Bernstein, a research firm, wrote in a recent note to clients.

Shell insists it will hit its divestment targets, an indication that asset sales could pick up pace this year. Shell has oil and gas producing assets across the globe are potentially on the chopping block, including in New Zealand, Iraq, Thailand, Gabon and the UK’s North Sea.

Meanwhile, as Shell is trying to shrink, its British counterpart BP is looking to grow with the oil market rebound. BP inked a rash of deals at the end of 2016, announcing plans to spend billions of dollars on oil projects in Abu Dhabi, Mauritania and Senegal, offshore Egypt, and the U.S. Gulf of Mexico. BP and Shell are at different points in their evolution – BP already went through a half-decade of retrenchment after the 2010 Deepwater Horizon disaster, a period of time in which Shell embarked upon a spending spree. Now Shell is cutting back and BP is ready to grow. “It’s time for BP to start growing,” Dudley told Bloomberg TV a few weeks ago. “We’ve walked through so many difficulties in the U.S. that I think the company now is well-positioned for growth.”

If oil prices continue to rise in 2017, it will tend to lift all boats in the energy sector. But that does not mean that every company will use that improvement to pursue growth or step up drilling activity.

By Nick Cunningham of Oilprice.com

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