Shell’s Huge Opportunity in Natural Gas

Though it faces some major near-term challenges, Royal Dutch Shell’s leadership position in LNG should drive strong and steady returns over the long term.

Jan 8, 2014 at 10:09AM

With natural gas expected to be the fastest-growing major fuel source over the next two decades, energy companies are investing heavily in the equipment and facilities required to produce, store, and transport gas.

Amongst the integrated oil majors, Royal Dutch Shell (NYSE:RDS-A) has already emerged as one of the dominant players in natural gas, having invested heavily in liquefied natural gas (LNG) projects around the world. It recently solidified that leadership position by adding even more LNG assets to its large and growing portfolio. Let's take a closer look.

Purchase of Repsol's LNG assets
Last week, Shell announced that it had completed the acquisition of Spanish oil and gas company Repsol's LNG business outside North America for $3.8 billion in cash, less than the $4.4 billion purchase price originally agreed upon in February 2013.

The reduced purchase price reflects changes in the value of the acquired assets, including adjustments such as the portfolio's financial performance and changes in working capital since October 2012, as well as Repsol's sale of a 25% interest in a power plant in Bilbao to London-based BP (NYSE:BP) in October 2013.

The assets being considered include liquefaction facilities in Trinidad & Tobago and Peru. As part of the deal, Shell will also assume $1.6 billion of liabilities related to leases for LNG ship charters, which are expected to significantly boost Shell's LNG shipping capacity.

The transaction is important because it will boost Shell's already massive global LNG portfolio by giving the company an additional 7.2 million tonnes per annum (mtpa) of directly managed LNG volumes. Over the past few years, Shell has aggressively expanded its natural gas business in a bet that LNG demand will double by 2025.

Shell's formidable gas portfolio
The company has already spent more than $40 billion on LNG facilities and related services and is currently one of the largest LNG producers in the world. Indeed, earnings from Shell's integrated gas division, which includes its various LNG and gas-to-liquids (GTL) projects, have nearly quadrupled over the past five years, and now account for more than 40% of the company's total earnings.

Once it acquires Repsol's LNG assets, Shell will have 26 mtpa of direct liquefaction capacity. It's also in the process of building three major LNG projects in Australia, which are expected to boost total liquefaction capacity by an additional 7 mtpa. For instance, the massive Gorgon LNG project off the coast of Western Australia -- operated  by Chevron (NYSE:CVX) with a 47% interest and being developed by Shell and Exxon (NYSE:XOM), with each holding a 25% stake -- alone will boost Shell's net production by about 112,500 barrels of oil equivalent per day when it comes online in mid-2015.

Not only is Shell investing heavily in LNG projects, it's also a major innovator in the field, currently building the Prelude Floating LNG project off Australia's northwest coast -- the world's first floating LNG facility. Shell reckons that by pursuing a floating facility, as opposed to a land-based facility, it can tap remote offshore gas fields that would otherwise remain undeveloped.

While these projects' high levels of capital intensity and technical complexity make them vulnerable to cost overruns and completion delays, they could pay off handsomely in the long run thanks to their unique production profiles. Because LNG projects produce at flat levels for extremely long periods of time, they should generate strong and stable revenues and cash flows for decades to come, while requiring relatively little capital spending once operational.

The bottom line
Though Shell still has a host of major challenges to address, including a poorly performing North American business and an uncompetitive downstream segment, the company's extensive investments in LNG should provide a big boost to earnings and cash flow over the long run. Furthermore, new high-margin projects slated to come online this year should help generate $175-$200 billion in cash flow over the period 2012-2015, which, in combination with additional asset sales this year and in 2015, should allow the company to keep growing its dividend at a modest pace over the next several years.

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Fool contributor Arjun Sreekumar has no position in any stocks mentioned. The Motley Fool recommends Chevron. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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