The past couple years have been busy ones for Royal Dutch Shell's (NYSE:RDS-A) (NYSE:RDS-B) management. Trying to steer the company through the turbulent oil and gas downturn while trying to bring a $50 billion acquisition into the fold is far from easy. Based on the company's most recent results and some of the comments management made on its latest conference call, it appears that it's actually working.
Here are six quotes from Shell's call that show the progress the company has made over the past several years and where management sees it going from here.
The king of cost-cutting?
Every single oil company that has reported earnings recently has highlighted in one form or another its own cost-saving initiatives. Of all those presentations, I think Shell CEO Ben van Beurden's comments have been the most impressive. He stated:
Compared to 2014, and that's including BG, our underlying operating cost has been reduced by $10 billion on an annual basis. And our capital investments has been reduced by $20 billion on an annual basis. And at the end of '16, we are running the underlying operating cost of the combination of Shell and BG below $40 billion. So that is lower than what we used to run Shell on as a stand-alone company less than 24 months ago. And in '17, it's expected to be lower again. So this is a cost takeout performance that, in my mind, is absolutely leading in the industry.
That's a lot of cost savings. Keep in mind two things when looking at those numbers, though. One is that Shell likely had the most fat to trim of all the integrated majors in the first place. For several years now, the company has consistently underperformed in terms of returns on capital employed. The other thing to remember is that some of that cost savings came from divestments. So while those numbers are impressive and possibly the best in big oil, they are also indicative of where Shell was coming from.
BG working out so far
The marriage of BG Group and Shell is still less than a year old. So far, based on what management is saying, it's working out well.
This slide above is what CFO Simon Henry is referring to as he describes not only why Shell felt it had to do the deal when it did, buy also how well it has performed thus far. Henry said:
You can see on this slide the growth from the BG portfolio since we announced that deal. In Australia, 70%; in Brazil, 100%. BG was free cash flow positive for the last year. I don't think we would have got that company if we left that deal another year with that kind of performance could come. We knew it was coming. So delivering the real value from BG deal did require the swift and effective integration; getting the best value from these projects, which we are now; but importantly, learning and then applying the best working practices from BG or from Shell and putting them across the whole of the company. As a result, two years ago, we said $2.5 billion. We actually pretty much did that last year, 2016. We now expect $4.5 billion pre-tax basis by 2018. So we did the three-year target in one. And this year, in '17, we should get to around $4 billion of the synergies delivered. It'll be almost impossible to measure thereafter because we are so closely integrated now.
Biggest growth over the next decade
One of the biggest investment opportunities for the combined BG and Shell is their combined portfolios in Brazil. According to Henry, the existing positions and the ones currently under development have an opportunity to deliver a lot of additional production, as well as strong cash flow generation:
[T]he really important area for growth is Brazil from BG. In the Santos pre-salt basin, last year, three new FPSOs [Floating Production Storage and Offloading] started up floating production storage units. The last one started pretty close to the end of the year, so all three of them are actually still ramping up into 2017, more to come. Breakeven prices in Brazil across the board, below -- well below $40 a barrel. So the worldwide deepwater production in Q4, as we're seeing that ramp up, was 725,000 barrels a day. That's up by more than 50% in 1 year. We're delivering that growth now, not sometime in the future, maybe. It's going into the bottom line now. Well on our way to 900,000 barrels a day by 2020. That growth is coming from projects already sanctioned, primarily Brazil. And of course, Appomattox in the U.S. should be delivering by then. So that's a business that will be a significant free cash contributor throughout the '20s.
A lot of upside in shale, too
Shell's two largest rivals have been touting their positions in shale drilling, especially in the Permian Basin in Texas, as it has emerged as one of the most economically viable places to drill for shale. For some time, Shell has been pretty mum on its potential. This conference call, though, Henry explained the massive potential the company has in shale and even the Permian Basin:
We continue to improve the capabilities, the competitiveness because we focus on a small number, basically five core positions, including Argentina. Following the divestment that we announced in the fourth quarter in Western Canada shales, we now have around 11 billion barrels of discovered and prospective resource within the portfolio, advantaged positions in the Permian and Fox Creek in Western Canada and in Argentina. That's 11 billion barrels [of] potential production. Just as an aside on the reserves, less than 300 million of that is actually booked today in proved reserves.
Shell has been taking development of these assets very slowly because it wants to make sure it is accessing these shale basins cost-effectively. Now that it seems to have a handle on things in the Permian Basin and a formation in Canada it calls Fox Creek, it believes it can bump production from shale by 140,000 barrels per day by 2020. It also expects to spend between $2 billion and $3 billion annually on shale development for the foreseeable future.
Huge opportunity in liquefied natural gas still out there
In acquiring BG, Shell is also making a huge bet on the long-term profitability of liquefied natural gas (LNG). Today, that seems to be working out well, as both van Beurden and Henry mentioned how it is a major cash flow engine for the company. On top of its current capacity in the portfolio, van Beurden sees ample room to grow that position because LNG will be one of the major growth drivers of the industry in the coming years. He said:
We certainly believe in the potential of LNG supply and LNG demand to grow. We still think that gas demand will grow twice as fast as oil demand, and LNG will grow twice as fast as gas on average. And if that, indeed, plays true, we will see that there is a much larger market for us to participate in and therefore, an ability to grow our absolute position without growing our share of the market.
Shell's large footprint in LNG also means it has a large footprint in China. Not surprisingly, van Beurden sees this as a major market for LNG:
I think China will remain a very significant growth opportunity for us, for LNG and for natural gas. Think about it again, China's energy mix, about 6% of it is natural gas. They have clear ambitions to grow that to 10%, 15% and ultimately, I suppose, to something that is much more like what we have in Europe or in the U.S., 25% to 30%. That, of course, is a massive amount of gas if you think of it. A lot of it will, of course, come as pipeline gas, but an awful lot also as LNG. So we still see a very strong growth in natural gas going forward. Will that happen sort of organically and automatically, et cetera? Yes, to a large extent. But for those of you who did pay attention to what China announces, I think this morning they announced another 54 gigawatts of power stations, coal-fired power stations being canceled. I don't think that will all be replaced by wind farms. I think there will be a very significant amount of natural gas replacement for that as well. And if they were all replaced by wind farms, we will look at that as well, of course. But it -- without kidding, so we see, indeed, a tremendous potential in China.
Three is little doubt that China's power demand is going to grow immensely in the coming years. Whether or not that demand is filled with natural gas and LNG is yet to be seen. Shell is making a big bet on it, so investors should certainly watch how it all plays out over the next several years.