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North America's Onshore Even Lower Priority for Shell

North America’s onshore is even less appealing to Royal Dutch Shell plc than it was a year ago, and as commodity prices have fallen, the oil major has elected to decrease capital spending and move its resources elsewhere.

The company, which issued its fourth quarter results on Thursday, has deferred close to $15 billion worth of projects over the next three years in light of the commodity plunge. Capital expenditures for 2015 are set at the same level as 2014, around $35 billion. However, Shell has reduced its unconventional spending by about 20%, or $200 million.

Asked about how profitable U.S. unconventional plays are for Shell, CEO Ben van Beurden was reticent. He spent almost two hours discussing the company’s performance during a conference call. One fact that emerged was a $1.2 billion loss in Shell’s North American resource plays last year.

"On the shale breakeven [price], I think it's a bit of a mixed picture. If you talk about our own breakeven price, it’s probably a little bit too early to say. A lot of the positions we have are still very immature, so we are working on how we will bring them into development and we’ll have to just see the cost will be, and also what we can take out of the contracting offers…in that environment."

Shell operates in the Permian Basin, Canada and Appalachia.

"It's obvious that with the low prices we have at the moment that a lot of the opportunities aren't as attractive, and therefore you will see that with quite a bit of the flexibility that we have in our capital program has been exercised, and the reason is the shale plays," said van Beurden. In North America, Shell also is able to be a “little bit more flexible” with its capital spending. "There’s a fair chance that you can catch up later," whereas with a deepwater project, licenses require moving ahead "or you lose it."

Delaying resource spending in North American "means the maturity of this program will be postponed," said the CEO. "It is, after all, a significant amount of capital on the books, which can only make a positive return...if we can generate more cash than depreciation. That basically means more investment will bring it into positive territory. If we defer the investment program for good reasons, we also defer the moment of breakeven."

Shell also isn't taking unconventional drilling off the table. It just isn't enthusiastic about drilling today in North America -- or anywhere.

"I think we made good progress in North America in restructuring in 2014...In recent years the company had taken up quite a bit of acreage and options in a number of countries around the world. But in many cases, we have seen pretty mixed well results and also a few above-ground issues," he said. "And we expect frankly to exit from quite a few positions." He did not identify what areas Shell may exit.

"But North American resource plays remained at a loss of $1.2 billion in 2014."

When oil prices were $100/bbl and above, North America's exploration and production operators were borrowing money to secure more acreage and more rigs. However, with the bottom falling out of the commodity market, refinancing is going to be a challenge, CFO Simon Henry said.

North America's onshore resource base, for Shell at any rate, remains too immature to pour a lot of money into at this point, and it plans to reduce spending by about 20%, or $200 million this year. Shell has the luxury of picking and choosing where it wants to work, Henry said.

"The breakeven from liquids from shale is probably lower than we thought," he said when asked about breakeven shale prices in North America's onshore. "There's a lot of hedging in place, forward production, over the next 18 months. But hedging starts to roll off, from what we can tell, in the next three month's time. The hedging will roll off, and a lot of the investment has been done with other people's money.

"Six months ago, that was called high-yield debt...It's been renamed correctly as 'junk.' Refinancing that is the big challenge. You don't just invest at breakeven. When you're repaying high-yield debt, you have to get a return, and a return to shareholders. How that plays out will be important."

Shell is forecasting growth in North American liquids plays this year, but at $60/bbl, it won't grow beyond this year. Oil was trading below $50 on Thursday.

"How far it comes down will depend on price movements," said Henry. "And you can't get those hedges in place again. You can't afford to do so...The costs are quite a bit lower, to be fair, for good operators on the good acreage, but most people are not on the good acreage to breakeven..."

Shell is "working hard to get a much more competitive cost structure," but the onshore doesn't match the long-term value of the Gulf of Mexico portfolio, van Beurden told analysts. One analyst questioned him about why Shell would budget more for expensive offshore projects during difficult price environments when the onshore might have a quicker payday.

"To some extent, it's impossible to compare the two," van Beurden said. "They are fundamentally different. In an unconventional position, yeah, one could say, you have a lower risk on investment, one well at a time, and maybe it's more predictable, but also, it's a smaller margin to play with. It's more flexible, more rateable, but it needs continuous capex injections to keep it going...We have four existing assets on the balance sheet in North America, worth about $20 billion. How much more can they bring into productive use? We can play around with that a little bit..."

Meanwhile, the Appomattox project in the deepwater by itself is a $20 billion project "in one gulp," said the CEO (see Daily GPI,Sept. 9, 2014;April 29, 2011). "Therefore, you take a big swallow and prepare yourself to see that through. Once it's in operation, it's completely different. It has very, very high cash margin, very little to keep it in operation, and incredibly high productive yields compared to unconventionals...

"You have to have a little bit of both to match your profile. Unless you are a midsize E&P in the U.S., you cannot, just say, have an unconventional profile. You have to mix it. You have to understand how much to have in different buckets, when to bite off some, how much to nibble a bit...It's more than simple economics coming into it..."

North America's onshore is "a difficult area," van Beurden said. "But we are determined to stay, to get it right and to make it a strong business for our shareholders. But overall, resources plays are an area where we are continuing to dial down the spending because we can and we have to, to moderate our growth and implement our capital ceiling across the company."

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