The past year was an extremely rough one for integrated major Royal Dutch Shell (NYSE: RDS-B) due to poor refining conditions and lower production. Going forward, it's embarking on an era of strict capital discipline, which seems admirable on the surface. However, the flip side of the idea is that energy companies such as Royal Dutch Shell need to maintain capital expenditures in order to continue traditional exploration and production activities that fuel profit growth. That's why Shell's strategy might not pay off in 2014.
Shell's strategy: Squeeze more out of existing projects
It goes without saying that it's critical for a global energy super-major to expand on its core discovery, exploration, and production activities to grow its upstream profits. Royal Dutch Shell is taking a different approach this year. It's going to severely cut its capital budget and instead hopes to squeeze growth out of its existing assets. The company is hoping that new technologies and operational efficiencies will extend the productive lives of its assets and extend their profitability.
In North America, Shell will restructure its upstream resource plays instead of significantly acquiring new lands for production. Shell recently began production from its seventh and largest deepwater platform in the Gulf of Mexico. It's hoping its new infrastructure there will boost overall production by 100,000 barrels per day by 2016. This would be significant, since Shell produced 424,000 barrels of oil equivalent per day in the U.S. in all of 2013. So there is hope that efficiency gains can pay off.
By comparison, ExxonMobil (NYSE: XOM) isn't shifting strategy in North America. It plans to continue investing in North America, particularly at its massive Kearl oil sands project. Development there is now 70% complete, and ExxonMobil hopes to increase its production by 160,000 barrels per day initially.
At the same time, Royal Dutch Shell's decision to unload a massive amount of assets is a troubling sign. Shell's fire sale casts into doubt how effective it can be in producing growth this year, even with its promising projects. Shell recently suspended drilling in the Arctic. It's also selling a stake in a liquefied natural gas project in Australia for $1.1 billion and may also consider unloading an interest in a U.S. pipeline project. These actions are part of a broader initiative in which Shell intends to sell $15 billion worth of assets over the next two years.
In addition, Royal Dutch Shell will reduce capital expenditures to around $37 billion this year, down from $46 billion the year before. In percentage terms, that represents a nearly 20% decline, which makes it reasonable to question how it can grow earnings with such profound spending cuts. This is a much harsher decline than many other integrated super-majors.
Chevron (NYSE: CVX) is cutting its 2014 budget by just 5%. It will spend nearly $40 billion this year, approximately 90% of which will be devoted to upstream oil and gas exploration and production projects. This includes $4 billion for major resource acquisitions. By contrast, Shell will devote half that much to acquisitions in 2014.
Cash returns and efficiency gains may not be enough
Instead of expanding exploration and production, Royal Dutch Shell has decided to curtail capital expenditures in the upcoming year. Instead, it intends to provide returns to shareholders with good-old-fashioned cash. Shell's board of directors recently issued a statement that it expects the first-quarter 2014 dividend will be increased about 4%.
Even with its dividend bump, Shell is fairly bearish on its near-term future. In the first quarter of 2014, management expects continued challenges due to supply disruptions in Nigeria, increased exploration charges, and reduced production due to asset sales.
More troubling for investors is whether Shell's poor outlook for its first-quarter results will extend through the remainder of the year. Unless it can truly reap considerable production expansion out of its existing projects, it's hard to believe Shell can grow given its sizable divestment program and harsh budget cuts.
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