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Shell Juggling Short-Term Investor Expectations, Long-Term Projects

Royal Dutch Shell plc's investors may pay the most attention to quarterly results, but even disappointments can't distract management from long-term projects to enrich the natural gas and oil portfolio, according to CFO Simon Henry.

Speaking last week at the Deloitte Extractive Industries Executive Dinner Debate in London, the financial chief described the long- and short-term cycles facing the energy industry, which include political, investment and media cycles. He argued that international energy companies like Shell have to deliver current projects on time and on budget, but they also must have the "courage to make decisions in the good times and the bad," and tweak business strategies constantly. It's not made any easier with slumbering commodity prices.

"There are two long-term cycles which stand out for me," Henry said. "The first is the cyclical nature of supply and demand in the global energy system," which over the last two hundred years shows it takes a long time to change, as energy sources were upgraded from wood and peat to oil and gas.

The demand cycle today has been upended by technology and innovation, as well as "the need to reduce the impact on the environment," he said. In areas with no historic exploration activity, it may take a decade before production begins. Renewable projects require similar planning, with design to start-up also taking years.

Even as it plans long-term energy projects, the industry is managing several short-term cycles too.

"The first one worth mentioning is the political cycle," which "at best...looks ahead to the next election," Henry said. "This has an impact on businesses, as the regulatory or tax environments may shift from government to government."

The investment cycle is another consideration, and in the current climate, most investors have limited patience when it comes to returns. Their interest in companies like Shell is driven mostly by quarterly results, which of late have not been impressive. Shell recorded $7.9 billion in charges for 3Q2015 (see Daily GPIOct. 29). This year it also has laid off thousands of employees and canceled projects worldwide (see Daily GPIJuly 30).

Before online newspapers, investors had a day or so to digest unwelcome news. That's no longer true with the 24-hour media cycle, Henry said.

Shell used to report its results at 7 a.m. and wait a day to read the reaction. Now "it's old news" by lunchtime. "This means any shift in attitude from investors and commentators is reported immediately and reflected in our share price."

Addressing the various cycles takes patience, with challenges and potential pitfalls.

"First of all, it's critical for companies to focus on delivering current projects exceptionally well; on time and on budget," Henry said. "This may seem, as my kids would say, a 'no brainer.' But it's important on two fronts. One, it addresses the short-term investor and media cycles. It sustains trust that Shell manages investors' capital well, over the cycle. And two, it will result in operational cash flow which can, among other things, be used to fund long-term investments."

Delivering projects well comes down to innovation and collaboration, which "must be a constant mantra inside every employee's head."

Major energy companies also have to have "courage" to make decisions throughout the oil price cycle, he said. "Sometimes, short-term cycles put pressure on companies not to make big investments when the price of oil is low. But given the length of time projects take from inception to first production, companies must make investments in the good times as well as the bad."

Shell has made the biggest acquisition in the industry to date this year with a proposed $69.6 billion takeover of UK-based BG Group plc, a deal that is awaiting a few regulatory approvals (see Daily GPINov. 19). The acquisition has been questioned by some analysts and investors because of the drain on Shell's current financial resources.

"There are no guarantees in this business," Henry said. "We crunch the numbers. We do all the necessary due diligence. We look at how technologies and markets are changing. We look at how competitive it is against our portfolio of assets. Then, and only then, do we make a call on whether or not to invest."

At times expectations fail to hit the mark, especially in high-risk exploration. Henry cited Shell's decision to cease exploration offshore Alaska earlier this year after spending years and billions of dollars (see Daily GPISept. 28). At other times, plans are better than expected, such as being an early entrant into oilsands in Canada in 1999 when the price of oil was less than $15/bbl.

"Are the short-term cycles important? Absolutely. But they shouldn't distract from the long-term intent," Henry said. "The overarching challenge for international energy companies is to find a balance between addressing short-term concerns, while remaining focused on the future. That, as they say, is the long and the short of it."

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