For Royal Dutch Shell plc (NYSE:RDS.A), drilling in North American shale oil and gas plays has been a losing proposition. Unlike some smaller energy producers that have seen tremendous success in U.S. shale, the Anglo-Dutch oil major's shale business in North America has been unprofitable for the past several quarters.
But as part of Shell's new "fix or divest" strategy, the company is overhauling its shale business by selling off assets and slashing spending. Will the company's efforts pay off?
Shell's challenges with shale
Shell, like many of its big oil peers, was late to the North American shale game, waiting as late as 2010 to purchase acreage in Texas' Eagle Ford shale. By contrast, smaller independent E&Ps such as Continental Resources (NYSE:CLR) and Chesapeake Energy (OTC:CHKA.Q) scooped up shale acreage as early as the mid-2000s -- moves that have proved crucial to their success.
For instance, Continental's foothold in North Dakota's Bakken shale has been the main reason behind the company's exceptional performance, driving 39% and 59% year-over-year growth in production and earnings per share last year. Meanwhile, Chesapeake's large position in the oil-rich Eagle Ford shale drove 32% year-over-year oil production growth last year and fueled a 34% increase in adjusted EBITDA.
Shell's performance in North American shale, by contrast, has been dismal. Despite having invested more than $24 billion into its North American shale business, the unit has been a consistent loss maker because of disappointing drilling results and low natural gas prices. As a result, Shell wrote down the value of its North American shale assets by about $3 billion last year.
Shell's shale overhaul
But, eager to improve its financial performance and boost shareholder returns, Shell has embarked on a major restructuring of its upstream Americas unit. Last year, it announced that it would sell its acreage in Texas' Eagle Ford shale and Kansas' Mississippi Lime play. It also abandoned a shale oil project in Colorado and scrapped plans to construct an expensive gas-to-liquids plant in Louisiana.
In addition to asset sales, Shell recently announced plans to cut upstream Americas spending by 20% this year, including a downsizing of the unit's staff from around 1,800 to 1,400. Going forward, the company plans to shift its focus in North America away from dry gas drilling and toward liquids-rich opportunities, mainly in the Gulf of Mexico, Texas' Permian Basin, and Canada's oil sands.
Shell's not the only oil major to restructure its U.S. shale business because of disappointing results. Peer BP (NYSE:BP) also recently decided to separate its U.S. onshore oil and gas unit into a separate entity, a move the British oil major hopes will improve the unit's competitiveness.
A good move for Shell?
Given Shell's lack of competitiveness in U.S. shale, the company's decision to cut spending on its upstream Americas business and sell shale assets is an encouraging first step. It should allow the company to focus on its highest-value opportunities, which, combined with spending cuts, should boost earnings and cash flow.
This year, Shell plans to slash its capital spending to roughly $37 billion, down sharply from a record level of $46 billion last year. It also plans to divest some $15 billion worth of assets over the period 2014-2015. So far this year, it has already announced several asset sales, including the recent sale of its Australian downstream business to commodity trader Vitol Group for $2.6 billion and the sale of a 6.4% stake in an Australian LNG project to a Kuwaiti company for $1.135 billion.
Overall, drastically reduced spending and asset sales, combined with stronger cash flow thanks to major high-margin oil project start-ups this year, including Mars B and Cardamom in the Gulf of Mexico, should help drive stronger financial performance for Shell over the next few years. This should allow the company to continue growing its dividend at a modest pace.