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Royal Dutch Shell’s Deepwater Strength

Dividend Stream: Nov. 30, 2017


  • Royal Dutch Shell held its annual analyst day earlier this week.
  • Management expects to generate at least $25 billion in excess cash flow by 2019.
  • Despite rising share prices, Shell can still be picked up here.
  • This idea was discussed in more depth with members of my private investing community, Streaming Income.

The recovery in oil and gas is in full swing. While benchmark crude oil prices have gone up across the board, Brent is now $63 per barrel, the catalyst for this recovery comes more in the fact that oil producers have done such a good job in bringing costs down.

Nowhere is that more starkly noticeable than in offshore, deepwater drilling, where dayrates for state-of-the-art rigs have gone from as high as $700,000 three years ago to just $250,000 or so. As onshore rig counts creep higher, cost inflation is once again becoming a fact of life in select onshore shale plays. With deepwater drilling, however, there are still many rigs ‘stacked’ in harbors across the world just waiting to come out and get activated, thereby keeping development and operational costs down.

For this reason, I’ve been recommending some of the bigger offshore oil producers, which are often large, integrated companies. I’ve been a big fan of BP Plc (BP), which is the biggest producer in the Gulf of Mexico. Today I’d like to talk about BP’s counterpart on the European continent; Royal Dutch Shell (RDS.A). Like BP, Shell is a big player in deepwater drilling. It is the third biggest producer in the North Sea and is investing heavily in offshore Brazil. Much like BP, Shell is a fully integrated oil company and pays a generous dividend.

Earlier this week Shell gave its annual analyst meeting, which included guidance for next year. This article takes a look at that guidance, not least because a big chunk of Shell’s growth capital budget is going toward deepwater platforms across the world. This article also takes a look at what should matter most to income investors; cash flow and valuation.

Sustainable high yield

If you’re looking for yield these days, the best place to go is the big, integrated oil names in my opinion, specifically BP and Shell. Both of these stocks offer a (still) high yield, with dividends that have already withstood the worst of times and whose companies are now in full-on recovery mode.

This is best illustrated by looking at actual cash flow. Over the last four quarters, Shell generated $37.5 billion in operating cash flow, of which $21.4 billion was spent in capital expenditure. That left $16.1 billion in free cash flow and a dividend of $10.9 billion. And remember, that was over the last twelve months, when oil prices were generally lower and climbing higher. With the way things are going, the next twelve months will be better than the previous.

In light of all this, Shell is now able to cancel its dilutive ‘scrip’ dividend program (whereby investors receive shares in lieu of cash). In the coming years, assuming Brent Crude remains, on average, $60 per barrel, Shell expects to generate a whopping $25 billion – $30 billion in annual free cash flow. If you’re an income investor, your eyes should be lighting up right now.

How does Shell accomplish this? Well, much the same way its peers have: Permanently reducing costs, both capital expenditure costs and operational costs.


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