The Gulf of Mexico Is Crucial to Royal Dutch Shell's Future

Royal Dutch Shell is taking an axe to capital expenditures and is undergoing a wave of asset divestments. As a result, its existing projects like the Gulf of Mexico become even more crucial for production growth.

Mar 13, 2014 at 11:38AM

For all intents and purposes, it's crunch time for integrated oil and gas major Royal Dutch Shell (NYSE:RDS-B). That's because the European energy giant is on a self-prescribed path of financial restriction. It's preparing to unload billions worth of assets in the coming years to become a leaner, more efficient company.

As a result, in order to keep investors satisfied with its production levels, Shell will rely heavily on existing projects since it's cutting exploratory expenses going forward. One of Shell's major projects which the company has high hopes for is the Gulf of Mexico. The company is ramping up production there, which is why the Gulf should be a focal point for Shell investors.

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Finding life on Mars
Royal Dutch Shell recently started production from the second platform on its Mars development in the deep-water Gulf of Mexico. The platform, known as Olympus, is Shell's seventh, and largest, in the Gulf of Mexico. It's the first one to represent a major expansion of an existing program. Shell has invested heavily in new infrastructure there, and for good reason.

Shell management has warned investors to expect radical changes to the company's business structure coming soon. First and foremost on management's docket is to aggressively cut costs and sell off assets deemed non-critical to the company's future. In particular, new CEO Ben van Beurden set three key priorities for the future. These include restructuring, enhancing efficiency, and aggressive asset sales.

On the topics of disposals and budget spending, Shell intends to divest $15 billion of assets by the end of 2015. It's also going to sharply cut spending. This year, capital expenditures will total approximately $37 billion, down nearly 20% from 2013 levels.

Put simply, Shell needs the Gulf of Mexico to produce in light of the axe it's taking to exploratory spending in the future. Fortunately for the company, the potential of the discovery is very promising. Shell believes its infrastructure upgrades can extend the life of the Mars project to 2050 or beyond. In terms of production, the goal is for the Mars platform to reach a peak of 100,000 barrels of oil equivalents per day in 2016.

That would represent a significant production increase, as Shell produced a total of 237,000 barrels per day in the U.S. last year. On a companywide basis, the potential for the Gulf platform could add 6.5% to the total 1.5 million barrels per day Shell produced last year.

Royal Dutch Shell holds a 71.5% interest in the Mars B development platform, with European energy peer BP (NYSE:BP) operating the remaining 28.5% interest. Shell is wisely adopting BP as a partner, since BP has a well-established presence in the Gulf of Mexico. In fact, in addition to Mars program, BP has made several significant discoveries in the Gulf in recent years, including its Gila well.

Why the Gulf of Mexico is so important
The Gulf of Mexico is the most promising deep-water producing region in the nation. According to the U.S. Energy Information Agency, there are a total of four oil-producing areas in the U.S. that generate at least one million barrels per day. The Gulf of Mexico is one of those four; and, considering how quickly production growth has resumed in the aftermath of the 2010 oil spill, the Gulf's production is even more impressive.

For Royal Dutch Shell, this year represents a crucial time to execute on its Gulf drilling program, considering how drastically Royal Dutch Shell is cutting costs and selling off assets. Shell will have to be extremely efficient this year if it's to generate satisfactory production levels. With billions in divestments over the past couple of years and billions more in store, the Gulf of Mexico represents is best chance to keep upstream results going in the right direction.

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Bob Ciura owns shares of BP p.l.c. (ADR). The Motley Fool has no position in any of the stocks mentioned. 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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