Investors are Unsure about Shell's Strategy to Expand its LNG Business

---

Written by John Egan for Industrial Info Resources (Sugar Land, Texas)--Investors don't seem to think much of Royal Dutch Shell's (NYSE:RDS.A) (The Hague, Netherlands) expanded commitment to liquefied natural gas (LNG), signaled in part by its $70 billion acquisition of BG Group Plc (London: BG) (Reading, England) earlier this year. But the company insists it sees a lot of long-term value in the global LNG trade, and that the BG deal will drive changes that will position it favorably for years to come.

Shell executives met with analysts, investors and bankers a month ago in London to discuss how they were reshaping the oil giant. Since announcing its acquisition of BG in April, shares of Shell have fallen about 15%, while the company's peer index of energy and minerals stocks have dropped about 5%, according to the CNN Money website.

With operations around the world and an employee base of about 94,000, Shell has a broader range of businesses than LNG. It is one of the world's largest integrated oil companies, with global interests in both exploration & production and refining & marketing. But the company has foundered in many of its high-risk overseas exploration ventures, and profits at the downstream business remain notoriously fickle. When oil prices are high, Shell makes most of its money on its upstream activities, like most of its peer integrated oil companies. When crude oil prices fall, profitability typically shifts to the downstream business.

Expanding its LNG business is an effort to build a natural gas business with long-term demand growth but with less volatility than its upstream and downstream oil businesses. The company referred to its acquisition of BG as a way to accelerate its LNG and deepwater strategy and jump to the top of the global LNG business. Although U.K.-based BG is only a midsize oil company, it is a major player in LNG. The deal gives Shell a world-leading position in producing and trading LNG. Excluding the BG acquisition, Shell reportedly has spent nearly $70 billion on LNG projects in recent years, a sum that includes its investments in gas-to-liquids projects.

But investors and analysts haven't warmed to the company's LNG strategy as much as management had hoped. That may be partly because the dynamics of the global LNG market have shifted a lot over the last 12 months, potentially undercutting profits there. For more on that, see November 24, 2015, article -- Dynamic Global Market Forces Take Toll on North American LNG Projects.

At its November 3 meeting with analysts, investors and bankers, Shell officials tried to drum up enthusiasm for the company's LNG investments as well as its efforts to shed peripheral assets and focus its capital spending .At that meeting, executives discussed the moves they had taken, and would continue to take, to make Shell more competitive in a low crude-oil price environment. Chief Executive Officer Ben van Beurden, Shell's chief executive, told analysts the company had:

• Reduced capital and operating costs by a total of $11 billion in 2015, with more cuts to come in 2016
• Sold $19 billion of assets between January 2014 and September 2015, with plans to sell another $30 billion of assets over the 2016-2018 timeframe once it fully integrates the BG acquisition
• Decided to stop work on Carmon Creek, an 80,000 barrel per day in-situ heavy oil project in Alberta, Canada.
• Backed away from drilling in the Arctic Ocean
• Laid off around 7,500 employees and contractors

"Only the most competitive projects are going ahead," van Beurden said November 3, adding that the company has made only two major final investment decisions so far in 2015. "And many potential projects have been purposely delayed or they have been rephased or they have been cancelled all together."

"We're looking at a low net-present value (NPV) breakeven for projects here ... less than $70 a barrel and typically we find these numbers closer to $50 a barrel," van Beurden said. "Only the most attractive and the most affordable projects can go ahead. We're planning on a prolonged downturn and we're responding with urgency and with determination."

He concluded: "I'm determined that Shell will emerge as a more focused and a more competitive company as a result of the recommended combination with BG. BG rejuvenates our upstream portfolio, deepwater, integrated gas possessions that offer attractive returns and attractive cash flows, and have growth potential. These are industries where we already do have a leading capability and leading technologies. We are reshaping the company, and this will accelerate once the transaction is done."

At the same meeting, Shell Chief Financial Officer Simon Henry outlined the company's view of the LNG business. "The global LNG market is strong, it is broad, and it is growing," he said. "The fundamentals of this market look as robust now as in the past to us. Shell is investing to develop new LNG demand through offtake contracts and new LNG regasification projects."

Global demand for LNG has risen by about 8% per year since 2000, to the current level of some 240 million tons per annum (MTPA), Henry continued. "And we expect that growth to continue to around 460 million tons per annum by 2030," an annual growth rate of about 5% per year. He suggested finding enough supply, rather than dealing with an over-supplied market, was the biggest challenge facing LNG.

Henry predicted the current LNG market, consisting of about 30 importing nations and 20 exporting nations, would grow to as many as 50 importing nations and 25 exporting nations by the early years of the 2020s. "Those are the long-term trends," Henry said. "In the shorter-term, it is important to remember that demand is always going to be broadly the same as supply. There has been very little supply growth in the last five years. That is such a change right now with more than 100 MTPA of new LNG supplies coming on stream around the world before 2020."

LNG will account for the bulk of revenue and earnings in Shell's soon-to-be established Integrated Gas (IG) business unit. Henry told investors the underlying earnings from that business totaled $10.4 billion last year, a 470% increase over 2009. The business earned 18% percent on capital employed. Despite lower revenues and earnings this year for its IG business, that unit still generated about 41% of Shell's earnings and 21% of its cash flow over the prior 12 months.

Henry forecast significant growth in LNG volumes for Shell. The company has increased its LNG volumes by 40% over the last five years, and by 2018 its volumes are expected to grow another 70%--to 44 MTPA from 25.6 MTPA at yearend 2014. He said 85% to 90% of the volumes were priced on long-term contracts.

Citing research from Bernstein Research in London, The New York Times reported that Shell will be the world's largest LNG company in 2020, with about 18% of global volumes. Although Qatar currently exports more LNG than Shell is expected to, the Middle Eastern nation divides its LNG business into two companies, the Times noted. Bernstein Research projected Shell could increase earnings by $1 billion per year with its expanded commitment to LNG.

"The LNG business has never been for the faint of heart," remarked Jesus Davis, vice president of research for the Oil & Gas Production, Pipelines and Terminals Industries. "But investors and markets reward first-mover and pure-play companies. For example, shares of Cheniere Energy [(NYSE:LNG) (Houston, Texas)] have risen by over 800% since 2010, when it was a lonely voice talking about exporting LNG. Who knows--Shell's deepening commitment to LNG could have the same effect on its stock price."

Industrial Info Resources (IIR), with global headquarters in Sugar Land, Texas, five offices in North America and 10 international offices, is the leading provider of global market intelligence specializing in the industrial process, heavy manufacturing and energy markets. Industrial Info's quality-assurance philosophy, the Living Forward Reporting Principle™, provides up-to-the-minute intelligence on what's happening now, while constantly keeping track of future opportunities. Follow IIR on: Facebook - Twitter - LinkedIn. For more information on our coverage, send inquiries to info@industrialinfo.com or visit us online at www.industrialinfo.com.