One of the go-to measures of growth for any company in the oil and gas business is production guidance. Even for companies that have considerable assets in other parts of the value chain, production growth over a set period can give investors a relatively good gauge of what the company plans to do. One oil executive that doesn't seem to believe in that idea anymore is Royal Dutch Shell (RDS.A) (RDS.B) CEO Ben Van Beurden.
Let's look at why he said that and what investors should be focusing on instead to gauge Royal Dutch Shell's success over the next several years.
A new focus
Shell is perhaps the most diversified of the integrated oil and gas companies. It has an incredibly large portfolio of assets in every part of the oil and gas value chain. Shell, historically, also had a reputation as the company that would take on the more challenging (aka, expensive) projects to grow the business, which also made it produce some of the worst rates of return among its peers.
RDS.B Return on Invested Capital (TTM) data by YCharts.
To Van Beurden's credit, ever since he stepped into the CEO role in 2014, he has emphasized improving cash flow, capital returns, and investing for value instead of volume. This past quarter, he took that sentiment so far as to say that he doesn't intend to give production growth guidance in the foreseeable future when asked specifically about guidance from an analyst.
If you were referring to production and production growth, then, yeah, we have been abandoning that practice some time ago as we thought and saw it was sort of increasingly irrelevant and actually in some cases quite unhelpful because we felt that not only us but perhaps others would be tempted to chase barrels for barrels' sake, which we believe is not the right way to manage the company.
So, ultimately, we give -- we have given guidance of course on the amount of cash we expect to produce, particularly a free cash flow, which I think is a much more meaningful measure for you to go by. Of course, we referenced that at a certain oil price outlook; otherwise, that would be relatively meaningless as well, so it's $25 billion to $30 billion of free cash flow at $60 Brent.
The cynical approach is to say that Shell just doesn't have any great growth prospects over the next few years, and so it isn't giving production guidance to cover it up. I don't think that is necessarily the case, though, as Shell intends to spend $25 billion to $30 billion annually across its entire portfolio. Putting that much money into the business is going to generate growth, it just may not necessarily come from upstream production. Or, as Van Beurden put it:
So, I have no inclination or intention to somehow go back to getting production forecasts. Again, because I think they are increasingly irrelevant in a business that is also of course, very much driven by other emerging strategic themes like petrochemicals, like oil products, integrated gas, which doesn't always come with big barrels associated with it. And over time perhaps also power.
Image source: Getty Images.
That last one is especially interesting because Shell is making some significant investments in alternative energy and power lately. It has previously said that it intends to spend $1 billion to $2 billion annually on alternative energy, with expectations for returns in a relatively short amount of time. Granted, it's only 3% to 8% of total capital spending, but it goes to show that Shell is looking outside of production growth for improved returns down the road.
A harder, but better, way to measure growth
Production growth numbers have been a rather easy way to gauge what kind of potential a company has in the future. As Shell's management points out, though, it doesn't necessarily reflect the value the company can generate for shareholders. How do you know that the projected production growth can be achieved without spending too much? How do you include the contributions from other parts of the business? For a company as large and diverse as Shell, these are important questions.
Just because management is giving up on production guidance doesn't mean it doesn't have growth prospects ahead of it. If the company can generate the $25 billion to $30 billion in free cash flow as promised and return it to shareholders through its already peer-leading dividend yield of 5.5%, and through its scheduled share repurchase program, then it will be hard to see investors making too much of a fuss about there being no production guidance.
