We all knew that Royal Dutch Shell's (RDS.A) (RDS.B) management had big plans to transform the company post-BG Group merger, but I don't think we anticipated it to happen this quickly. Not only has the company executed tens of billions in asset sales over the past several months, but the company's cash flows from operations seem to suggest that management is wringing out a lot of inefficiencies that have plagued Shell's returns for years.
As you might expect, management took the opportunity to take a bit of a victory lap on its most recent earnings conference call by touting things like better-than-expected cash flow and meeting its divestment goals sooner than predicted, but there were some other points on the call that were much more interesting. Here's a set of quotes from Shell CFO Jessica Uhl that could have some longer-term impacts on the company.
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Spending less than anticipated
During the most recent oil price downturn, Shell's management was quick to either delay or outright nix some of the major capital projects it had in the queue in order to save cash. When the company announced its earnings report, the company's capital spending thus far in 2017 was looking much lighter than originally budgeted. So when asked whether this was just a low quarter or if we can expect total capital spending to come in lower than expected from less investing, Uhl eased any concerns that it was backing off from sanctioning projects and that this was more an effect of things costing less than expected.
[A]s I mentioned earlier, we're continuously challenging the organization in a responsible way to look for further opportunity to become more capital-efficient. So will we continue to try and drive that number down from a capital efficiency standpoint? Yes. But in terms of sanctioning work or going through with projects, we remain committed to our current growth program and the current capital investment levels that we've indicated.
Less of an oil and gas producer in the future
A key factor in looking at any company that produces oil and gas is looking at their reserve life. Basically, it's a determination of how long the company can keep its current production going based on the total size of its reserves. Shell's current reserve life is quite short -- at least compared to its integrated oil and gas peers. When asked if this was a product of oil prices -- which are a major determining factor in reserve life -- or if the company was running low on new oil, Uhl assured that the company's future is much more than just production.
I do believe that reserve life is not necessarily the most meaningful metric to understand our business and the potential for value creation. We've got a Downstream business that generates significant earnings -- significant cash flows that is not tied to that metric. In Integrated Gas, increasingly, there's opportunities to grow that business without necessarily the resource base specifically tied to it. And then in the unconventionals business, you have a conversion of resources to reserves, which doesn't show up in the reserve space. So I think, in general, it's a more nuanced conversation in terms of understanding what drives value and cash for the business and reserves not necessarily being the right or the complete metric. We're very comfortable, as I said, with our current growth agenda and projects we're bringing on stream to address decline, to address portfolio changes.
This is an interesting thought. What this suggests is that Shell is somewhat OK with being more of a refining, chemical, liquefied natural gas, and retail business than a pure oil producer. This also seems to jibe with a previous Shell statement where the company said it plans to spend $1 billion a year on renewable energy projects starting in 2020. Perhaps this is the earliest sign that the company really is planning for a future after fossil fuels.
Will it meet its share repurchase goal?
As is the case whenever a CFO is around for questions, several analysts asked about the current cash priorities for the company. Specifically, they wanted to know about Shell's plans to buy back stock. When it started to put together its post-BG Group plan, a large component of it involved a significant share repurchase program to offset the dilution from the acquisition.
That share repurchase program was supposed to start in 2017, but oil prices haven't cooperated and there hasn't been enough cash coming in the door for Shell to meet all its objectives. With this in mind, one analyst asked Uhl what the priorities are for cash and what could fall to the wayside if oil prices remain low.
[O]n the buyback question, our intent is unchanged, so we are -- we remain committed to that repurchase number. Indeed, it was tied to a price assumption, and prices have trended lower than what was originally envisioned. But what you're seeing is complete focus in terms of the delivery of this business, the delivery of our strategy, the delivery of the synergies and the entire strategic rationale around that transaction. With that playing through and with consistent cash flow delivery, as I said before, paying down the debt, getting gearing to 20%, taking off the scrip and then looking to repurchase is our agenda, and we will do what we can in terms of creating the conditions for that to happen sooner rather than later.
The reason for selling oil sands?
Shell's recent deal to sell its oil sands mining business was a bit of a surprise. The company was expected to rid itself of some assets that didn't fit as well with its combined portfolio with BG Group and was looking to raise some cash to pay down debt and buy back shares. What was surprising about the oil sands sale was that it was such a large asset that seemingly fit into the business.
As a result, there were some questions about the rationale for unloading $7.25 billion in oil sands assets to Canadian Natural Resources and whether there were some secondary reasons such as trying to lower its carbon footprint. Here's what Uhl had to say in response.
[T]hinking about our portfolio and our company and where we can create competitive advantage, we did not see that company -- that business sitting in our portfolio over the long term. Now, there's pieces of that business, the integrated value chain piece and the relationship with Downstream and the upgrader, where we do see value, we do see the ability for us to create differentiated value, and that portion of the value chain we have retained. So I think it's a story around being clear what your strategy is, where you're going to create competitive advantage and having your divestment program and your portfolio program match that.
Since this conference call, Shell announced that it plans to sell about $4.1 billion in Canadian Natural Resources that came as part of the original deal. Shell is actually part of a larger list of companies unloading oil sands assets and Canadian oil companies snatching them up. From a portfolio management perspective, this makes a lot of sense. Most oil sands operations are much more like a mining operation than oil and gas extraction, so many of the things conventional oil producers are good at don't quite apply here. Investors shouldn't be surprised if we see even more of these deals in the future, although there are much fewer deals like this left to do.
