Royal Dutch Shell plc (NYSE:RDS-A) said Tuesday that it will bow out of the Kidan natural gas project in Saudi Arabia -- a move that suggests the Anglo-Dutch oil major is serious about focusing only on its most profitable opportunities. Let's take a closer look at why the company decided to exit the project and why its new strategy could pay off in the long run.
Shells exits Kidan gas project
Kidan, located in the Rub al-Khali desert that spans much of the southern Arabian Peninsula, was to be developed by Shell alongside Saudi Aramco, the Kingdom's national oil company, as part of the South Rub al-Khali, or SRAK, field development joint venture. But likely due to overwhelming economic, logistical and technical challenges, Shell decided to back out.
In an emailed statement to the Oil & Gas Journal, a Shell spokesman said the company "has decided to end further investment in the Kidan development." It's not the only one. According to Reuters, at least three Western firms including Italy's ENI (NYSE:E), Spain's Repsol and France's Total (NYSE:TOT) have also scrapped plans to search for gas in the Rub al-Khali.
Shells exits Kidan gas project
One of the biggest challenges these companies faced in developing the Rub al-Khali, which means "the empty quarter" in Arabic, is the presence of what's known as "sour gas," which contains large quantities of hydrogen sulfide, a highly toxic and corrosive compound.
Because all that hydrogen sulfide has to be removed from the raw gas and associated liquids to make a usable end product, it makes the Rub al-Khali reserves more complicated and expensive to develop than conventional gas reserves.
Not only does the removal of hydrogen sulfide add an extra step and additional costs to gas processing, but it also produces elemental sulfur as a byproduct. While sulfur can be used to make fertilizers, sulfuric acid, and sulfurized rubber, exporting it to international markets poses a serious logistical challenge.
Due to the remote location of the Rub a-Khali desert, shipping sulfur abroad would require constructing an extremely lengthy pipeline or rail link to the Kingdom's east coast. On top of that, add in the fact that Saudi Arabia keeps gas sales prices fixed at a fraction of production costs and the economics of developing the SRAK joint venture become even more unappealing.
Shell's new strategy
Shell's exit from the SRAK joint venture, a widely expected and long overdue move, highlights the company's renewed emphasis on scrapping risky or uneconomic projects and focusing on higher-return projects that will boost cash flow and improve its financial performance.
As part of this new strategy, the company has embarked on a major restructuring of its two worst-performing businesses -- upstream Americas, which includes its various North American shale ventures, and its downstream segment -- that will see the sale of some $15 billion worth of assets through the end of next year.
Most recently, it announced that it will sell its 19% stake Australian independent oil and gas company Woodside Petroleum (ASX:WPL) for an estimated $5 billion. It has also sold various downstream assets in Australia and shale properties in North America over the past year or so, as well as scrapped plans to build an expensive gas-to-liquids plant in Louisiana.
Meanwhile, Shell plans to slash its capital spending from more than $44 billion last year to roughly $37 billion this year. At the same time, it expects to generate sharply higher cash flows thanks to the start up of major high-margin oil projects in the Gulf of Mexico and elsewhere. This combination of asset sales, reduced spending, and growing cash flow should allow stronger dividend growth in the years ahead.
Shell's decision to back out of the Kidan development in Saudi Arabia suggests the company is serious about scrapping risky or uneconomic ventures. If Shell can deliver on its promises to divest unprofitable assets, reduce spending, and boost cash flows, it should be able to significantly improve its financial performance over time and return more cash to shareholders.