At the Ira Sohn Investment Conference, featuring some of the world's greatest investors, presenter Nick Tiller -- the founder of Precocity Capital -- thinks shares of integrated oil major Royal Dutch Shell (NYSE:RDS-A) are attractively priced. The Ira Sohn is an annual event that raises funds for children's cancer research by having great investors speak in front of a paying crowd.
Tiller believes that Shell's shares, if valued properly would trade for $100 -- more than twice the recent price. He also believes Shell's 7% dividend is sustainable, so that investors can get paid while waiting for that $100 price target to arrive.
After reading through another presentation on Shell from short-seller Jim Chanos, I'm not so sure.
A major acquisition with problems
In early 2015, Shell announced that it would be acquiring British Gas (BG) for a price that ended up being close to $50 billion. The two prized assets that BG brought to Shell were LNG export facilities in Australia and big oil reserves offshore from Brazil.
Both of these assets have had significant challenges arise after the deal was announced. First, the LNG business has been challenged on three fronts:
- Oil prices have collapsed (much LNG pricing is linked to oil).
- Demand for LNG has flattened.
- LNG supply is coming on strong.
The key to success in the LNG business is being able to produce natural gas cheaply in one location -- such as Australia, the United States, Qatar, and maybe someday Canada (if the country ever gets some LNG export terminals built) -- and then transport it to a market where prices are much higher. The high-priced market is China and Japan, where prices had been higher by multiples compared with the rest of the world -- though since oil prices have crashed, so, too, have LNG spot prices and that arbitrage has shrunk.
If Shell made its acquisition of BG expecting to be able to sell LNG at prices that are two to three times where they are today the commodity markets have so far not complied.
This is the commodity business, though, so there's a very good chance LNG prices can go back up. Most (65% per Shell's most recent investor presentation) of Shell's LNG pricing is tied to oil, so as oil goes, so, too, will go Shell's LNG revenue.
There are concerns, however, that even if oil prices do rebound, there could be complications. With huge amounts of LNG supply set to come on in the next few years and demand growth not meeting expectations, this market could get oversupplied. Throw in the fact that China is trying to unlock its vast shale gas resources and Japan could restart its nuclear plants, and the picture could get even worse.
If this market does get oversupplied, short seller Jim Chanos suggests that there are concerns that those oil-linked contracts could get broken by LNG consumers who will refuse to pay. Whether he is correct or not we will have to wait and see.
Brazil is a mess
Back when peak oil was a hot-button topic, the one great hope for oil supplies was offshore Brazil, where massive sub-salt discoveries were being made. There's a huge amount of oil there, but the economics of getting it out are thrown into question.
It doesn't help that the company primarily in charge of developing these properties is Petrobras (NYSE:PBR), which recently has been mired in a corruption scandal.
BG brought to Shell some big growth potential in Brazilian oil production. The problem is, it also brought with it a partner on virtually all of its assets. That partner is -- you guessed it -- Petrobras.
Since this deal with BG was announced in early 2015, Petrobras has had a few announcements of its own. Those announcements have revealed that Petrobras will be spending less than half over the next five years developing its oil fields than was originally expected. Along with that come huge reductions in production from what was expected -- reductions that will directly affect Shell.
These major operators have performed surprisingly poorly
With BG's key assets facing serious issues, it's hard to believe that Shell hasn't overpaid significantly for its acquisition. Remember that this purchase price was set when a much more bullish view of LNG existed and Petrobras wasn't such an obvious disaster.
Of course, one could argue that none of the oil and gas majors are great investment opportunities. This slide from Chanos paints a revealing picture of how these companies were unable to thrive at even much higher commodity prices.
All of these companies -- with the exception of BP, which was forced to reduce cash outlays (capex, dividends, buybacks) as the company prepared for the big dollar Macondo legal settlement -- had major cash outflows from 2009 through June 2015 despite robust commodity pricing over most of this period.
These companies funded many of their dividends and share repurchases by increasing the debt on their balance sheets. If these companies can't do better than that during the good times, how are they going to do if we don't get back to $100 oil?
Oil prices might turn around, and Shell could do very well. However, that outcome appears to be far from the slam-dunk opportunity that Tiller makes it out to be.
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