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Shell Profits Soar 140% as Efficiencies Trump Commodity Prices

With a plethora of natural gas and oil prospects lined up for development through the 2020s, Royal Dutch Shell plc is keeping a relentless focus on improving efficiencies to stay above the fray if commodity prices were to sink again, CEO Ben van Beurden said Thursday.

The Shell chief and CFO Jessica Uhl laid out full-year 2017 and fourth quarter results during a webcast from London. Shell’s forte, integrated and liquefied natural gas (LNG) took a share of the discussion, as well as expanding Gulf of Mexico (GOM) plans, both in U.S. and Mexico deepwater. However, there was scant discussion about unconventional plays or petrochemical projects.

Shell’s “relentless focus on value achievements and our competitiveness meant that we were able to deliver very strong earnings from a high graded portfolio,” van Beurden said. “We had record LNG liquefaction but also record LNG sales volumes” during 2017, lifted by a thirsty Asia-Pacific market.

Shell last year was able to deliver nearly the same amount of cash flow as when oil was trending above $100/bbl, van Beurden noted.

“In 2017, we delivered $39 billion in cash flow from operations, excluding working capital, and that is a $55 oil price environment,” he said. “It's a number, which is 60% higher than in 2015,” when oil prices plummeted. “In fact it's close to the 2014 number, when the oil price was at $99/bbl.”

The delivery at a lower oil price “illustrates the cash generating capabilities of our current portfolio, with each of our businesses successfully following a strategy...focused on operational excellence.”

The strong momentum at lower prices, combined with capital efficiencies, gives management confidence that it can deliver a higher outlook to 2020 than it projected in November.

“The performance delivered around $28 billion in free cash flow in 2017 with oil at $54/bbl,” he said. “By 2020 we expect to deliver between $25-30 billion in organic free cash flow. That's an oil price of $60/bbl in real terms 2026.”

While the forecast may appear ambitious, Shell’s performance last year offers confidence that it’s a realistic goal, he said.

“We have close to $10 billion in cash flow from new projects yet to be delivered in the '18 to '20 timeframe, growth across our portfolio and continued cash delivery from operational improvements.” Last year was “a great year. There is also plenty more for us to do…”

Shell made its case on Wednesday to expect strong growth ahead from U.S. and Mexico GOM deepwater.

GOM Success

The European-based supermajor added to its estimable portfolio as the high bidder for nine blocks in Mexico’s Round 2.4 offshore auction, which offered 19 total. Shell also announced the Whale discovery in U.S. GOM waters, in Alaminos Canyon Block 772, which is adjacent to its operated Silvertip field and about 10 miles from its operated Perdido platform.

The Whale prospect is “expected to be one of the largest U.S. Gulf of Mexico exploration finds in the past decade,” van Beurden said. “This major higher-end discovery offers a combination of materiality and proximity to existing infrastructure, and it adds to our previous exploration success in the Perdido area…

“This discovery of course strengthens our confidence in our exploration strategy focused on near-field explorations seeking not only material volumes, but also short lead times between discovery and development.”

The successful Mexico auction only adds to Shell’s optimism, he said.

“I can assure you, there will be more to come on this in the coming years.” Mexico deepwater is seen as an important portfolio driver into the 2020s.

“We are very happy with Mexico, as you can imagine, with nine blocks out of 19...awarded,” he said. “We were going after 13, so that was a pretty good result...We had an extremely disciplined process to get to the bid parameters…” to determine exactly what blocks on which to bid.

“Needless to say, we had a little bit of an inside track...which we didn't want to disclose,” related to capturing more potential value near the Perdido platform.

“We had very clearly staked out what would be the Tier 1 acreage, the Tier 2 acreage and the Tier 3 acreage,” with “really good parameters for lifecycle breakeven prices…On that basis, we did indeed win all the Tier 1 positions...I think we've won everything that we were going after, which was good.”

While the Mexico auction proved a winner, van Beurden was quizzed about other prospects that may add to the reserves portfolio, a key metric for every exploration and production company.

Shell’s near-term focus is tied to its LNG prowess and to deepwater exploration, with petrochemicals and “new energies,” i.e. alternatives, also growing.

Not Sweating The Reserves

When asked how Shell plans to keep its reserves bucket full, van Beurden admitted that reserves additions are not at the top of his to-do list.

“I think I've said it here before, and it's not because I do not have a reservoir engineering background, but I am somehow less obsessed with the reserves and reserve life,” the CEO said. “For me, it's all about the longevity and the running room in the business from a cash perspective...For instance, on the deepwater business...it is important for me to understand where is the stack of opportunities that we have in the pipeline?

“When is that going to run out and when will this business ultimately decline unless I do something about it?”
The management team laid out its strategic deepwater plan for the board on Wednesday, he noted.

“By 2026, you will see that if we have no success, nowhere and don't add to it, this business will go into decline. So that's a reason why we are working now well in advance on restocking the opportunity set, participating in Mexico and Brazil. We will continue to look at other opportunities” and a “modest amount of frontier exploration.”

By 2026 or so, “we will be ready to start up another tranche and another hedge of new projects. That's the way I look at it and that's the only sensible way I look at it. I'm not going to look at some sort of ratio for the deepwater business which is completely meaningless.

“I will not make any better decisions as a result of a particular number, particularly in deepwater. But the numbers are all distorted by the way we have to account for the reserves.”
The same is true, he said, for many of Shell’s other businesses.

“I have no hesitation to say that all our strategic things have tremendous running room well into the 2020s. If there are going to be issues with some of them, it is going to be toward the end of the 2020s. These are just the normal business needs to be addressed.”

Shell doesn’t want to have projects “sitting on the shelf for 10 years,” he added. “That would be a very bad use of capital, and our assets as well. So a certain degree just-in-time management is appropriate, not to the point that it becomes sort of a constraint…”

Because Shell is an integrated producer, a significant portion of its cash flow is from other products beyond oil and gas, including chemicals. The new energies business, i.e. alternatives, also are a growing part of the strategy, offering “another form of resilience…”

While he’s in charge, the focus is not to be on “myopically obsessed metrics that are meaningless, and that's the way I like to run the business anyway.”

Shell’s current cost of supplies (CCS), an earnings metric used by European-based operators that mirrors U.S. net, totaled $4.3 billion (46 cents/share) in 4Q2017, 140% higher than year-ago profits of $1.8 billion (19 cents) and sequential profits of $4.1 billion.

Shell took a one-time charge of $2 billion during 4Q2017 related to the impact of newly enacted U.S. tax reform legislation.

Integrated gas profits climbed year/year in 4Q2017 to $1.63 billion from $907 million and from sequential earnings of $1.28 billion.

Cash flow from operating activities declined by 21% year/year to $7.3 billion, impacted by negative working capital movements of $1.1 billion. Excluding working capital effects, cash flow was $8.4 billion.

Shell earned $15.8 billion for the full year, up 119% from year-ago profits of $7.2 billion, reflecting increased contributions from all businesses. Full-year profits benefited mainly from higher realized oil, gas and LNG prices, improved refining performance and higher production from new fields, which offset the impact of field declines and divestments.

Capital expenditures in 2018 again are set to be $25-30 billion, “with the soft floor and a very hard ceiling” said van Beurden. “And this holds even in a high oil price environment.”

What’s driving the belief that Shell can capitalize is the sharp reduction in underlying operating expenses, which last year declined by 13% from 2016 to around $38 billion.

“We have now reduced operating expenses on a full rolling basis for 12 consecutive quarters,” said the CEO. “We will continue to be intensely focused on the competitiveness of our cost base...Of course, the portfolio changes and growth, et cetera, may affect the cost base...But I can also show you that our focus on cost will go on without compromising our focus on safety and integrity.” 

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