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Royal Dutch Shell (NYSE: RDS-A ) , Europe's largest oil company by market capitalization, reported largely disappointing second-quarter financial results along with the rest of the oil majors. But despite its poor quarterly performance, some of the company's investments, especially in LNG, could pay off handsomely over the long run. Let's take a closer look.
Shell's disappointing second quarter
In the second quarter, Shell reported a 20% year-over-year decline in earnings, which fell from $5.7 billion a year ago to $4.6 billion, well below the $6 billion profit analysts were expecting. The main culprits behind the earnings decline, as identified by Shell's CEO Peter Voser, were "higher costs, exploration charges, adverse currency exchange rate effects and challenges in Nigeria."
Shell also took a $2.1 billion impairment charge during the quarter when it wrote down the value of its North American "liquids-rich" shale assets based on its most recent exploration and appraisal drilling results. Meanwhile, the company's total oil and gas production fell by roughly 1.3% to 3.01 million barrels of oil equivalent a day, affected by the loss of production from its troubled Nigeria operations.
Shell's peers didn't fare much better either, though. ExxonMobil (NYSE: XOM ) reported a 1.9% year-over-year production decline in the second quarter, while Chevron (NYSE: CVX ) and BP (NYSE: BP ) both said their output fell by 1.5%. Total (NYSE: TOT ) , however, saw its production rise 1% to 2.29 million barrels of oil equivalent a day, the French oil major's first output gain in three years.
Shell's longer-term catalysts for growth
Despite this disappointing performance, however, I think Shell's future looks brighter than it has in quite some time. That's partly because it has a leading position in natural gas, especially in liquefied natural gas (LNG). As it stands, the company is one of the largest global producers of LNG, having already spent more than $40 billion on LNG production facilities, storage terminals, and related services.
Some of its biggest projects to date include its Nigeria LNG venture, its Northwest Shelf project in Australia, and its ambitious $12 billion Prelude floating LNG project in Australia. It also has LNG supply projects that are either operational or under construction in seven countries around the globe, with major interests in two regasification plants in Altamira, Mexico and Hazira, India.
While these LNG projects won't offer the kind of returns oil projects could, they're less risky and offer more stable revenue streams due to the fact that much of their production is sold through long-term contracts. Hence, the cash flows from these projects can be used to fund some of Shell's higher-risk and higher-return oil ventures.
In addition, Shell's commitment to asset sales should continue to provide additional cash for it to sustain its massive capital spending program. The company recently announced plans to sell about 106,000 leasehold acres in the Eagle Ford shale, as well as divest 600,000 acres in the Mississippi Lime play of Kansas, and is actively reviewing its poor performing businesses, especially in North American and Nigeria. Over the past three years, the company has divested some $21 billion worth of assets.
The bottom line
All told, if Shell can improve its operational efficiency, especially in its struggling North American oil and gas exploration and production business, and rectify its operations in Alaska and Nigeria, it may just end up doing quite well, not only over the next couple of years, but also in the much longer term.
In the near term, the company's investments in five major projects, including Kashagan Phase 1, Mars-B, Cardamom, Repsol LNG, and Gumusut-Kakap, which are scheduled to start up over the next 18 months, should help it generate cash flows of $175 billion to $200 billion in the 2012-15 period. And over the longer term, its leading position in global LNG projects should deliver solid and dependable cash flows for decades into the future.
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