Why Royal Dutch Shell Is Selling Downstream Assets

Royal Dutch Shell (NYSE: RDS-A  ) has finally found a buyer for its downstream assets in Australia, as the Anglo-Dutch oil major embarks on a major restructuring of its global refining business and plans to sell billions of dollars worth of assets over the next two years. 

Shell sells Australian refinery and retail network
Shell today announced that it has reached a binding agreement to sell its 120,000 barrel-per-day Geelong oil refinery and network of some 870 Australian retail outlets to Vitol, one of the world's largest energy and commodity trading firms, for approximately A$2.9 billion (U.S. $2.6 billion).

The company had been seeking a buyer for the underperforming refinery since April 2012. Refineries in Australia, many of which are older and smaller, are simply not generating sufficient returns for Shell and other oil majors because of weak margins and intense competition from newer, larger refineries in other regions.

Geelong, for instance, had extremely thin margins because it was designed to process more expensive light crude oil from the nearby Bass Strait. The only option to revive Geelong's competitiveness would have been to upgrade the facility to process cheaper heavy crude oil -- a highly expensive alternative whose costs simply didn't outweigh the potential returns.

Refining weakness common among oil majors
Shell is not the only oil major suffering from an underperforming downstream segment. In fact, all of its peers, including Total (NYSE: TOT  ) , ExxonMobil (NYSE: XOM  ) , Chevron (NYSE: CVX  ) , and BP (NYSE: BP  ) , blamed weak refining margins for disappointing financial performances last year. Exxon's fourth-quarter downstream earnings plunged by $852 million to $916 million, while Chevron's international downstream earnings plunged by nearly 80% to $125 million.

Refining margins have deteriorated because of global refining overcapacity and weaker demand for gasoline and diesel in the developed world, especially in Europe, where demand for refined products has fallen by nearly 2 million barrels per day since 2008. At the same time, the construction of newer and larger refineries in Asia and the Middle East has put intense pressure on older, smaller plants in places such as Australia and Europe.

As a result, many oil majors are scaling back their downstream operations in these regions. BP, for instance, is considering selling its network of Australian petrol stations, as well as its refineries in Queensland and western Australia, as the British oil giant seeks to raise $10 billion in asset sale proceeds over the next two years.

What's next for Shell?
The sale of Shell's Geelong refinery and local retail network in Australia is part of The Hague-based oil major's broader asset sale strategy to raise much-needed cash in order to offset its high level of spending. The company expects to sell about $15 billion worth of assets through 2015.

New CEO Ben van Beurden has identified the company's global downstream business as one of two key business segments -- along with its North American shale oil and gas business -- that will be restructured in coming years. The company has vowed to concentrate only on its most profitable businesses, while restructuring those that have been chronic underperformers.

As Shell scales back its global refining business, divests noncore assets, and focuses on its highest-value opportunities over the next few years, its return on capital and financial performance should gradually improve. Furthermore, the start-up of several high-margin oil projects, such as Mars B and Cardamom in the Gulf of Mexico, should provide a big boost to cash flow over the next couple of years, which could mean additional dividend increases.

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