Royal Dutch Shell: Mismanagement Of Big Oil In 2013 Signals Declining Profitability

Feb.14.14 | About: Royal Dutch (RDS.A)

Recently, Royal Dutch Shell (NYSE:RDS.A), ExxonMobil (NYSE:XOM), and Chevron (NYSE:CVX) reported disappointing results for the fourth quarter and the whole year of 2013. The main reason for all their declines was lower production since oil prices remained high. Even more disappointing is that none of these huge corporations could forecast growth in production despite vast investments especially in the North American and Russian arctic, the Gulf of Mexico, and several other areas.

Shell's performance was particularly disappointing, and in my opinion it reflects a mixture of management decisions, which are in conflict as if the engineers and technical specialists of the company do not seem to agree with their own economists and/or accountants, which leads to huge losses in particular projects, huge underestimates of investment requirements and frequent announcement of changes in decisions for particularly important projects.

The most disappointing change is Shell's latest decision not to proceed with previous plans to build a major facility in Louisiana that would turn natural gas into synthetic diesel, as reported in my study "Expressway to US Energy- Independence GTL Diesel" of June 2012. Consumption of the middle distillates in the USA is about 4 million barrels per day (b/d) out of consumption of oil and liquids of 19 million b/d. The use of the abundance of low cost shale gas in the US for GTL diesel would not only be profitable, but it would reduce US oil imports by about 50% and save about $146 billion in foreign exchange for the US per year.[1]

Shell has built a GTL plant in Qatar called "Pearl" for about $19 billion and capacity of 140,000 barrels of products per day including Diesel based oil to lubricate vehicle engines, gear boxes and transmissions; GTL base oil for lubricating vehicle engines; blending with conventional diesel for cleaner burning and lower emission; GTL Kerosene for cooking, lighting, and dry-cleaning and potentially as jet fuel; GTL normal paraffin and GTL naphtha for plastics and many other products.

Shell's Pearl GTL began operations in mid-2011 and was expected to reach full production by mid-2012. Without attributing any cost for the gas in the input, a high official of Shell claimed that the Pearl GTL plant would be profitable as long as oil prices remain above $40/b. Another high official later claimed the same as long as oil prices remained above $70/b. Who can now claim such low oil-prices? Similarly, Shell expected its Qatar GTL to generate $4.5 billion of annual cash flow when fully up and running at $70/b oil price assumption.[2]

In its 2013 report, Shell reported "Pearl GTL in Qatar, contributed some 170 thousand BOE/D to production in 2013"[3]. In other words, the plant has already exceeded its proclaimed capacity by 21.4% with consequent lower capital costs. At an oil price of $70/b, diesel would sell between $1.67-$2.00 per gallon. In fact, at present the price of diesel in the US is almost $4.00 per gallon, or a difference of at least 100%. Therefore, the annual cash flow of the Pearl GTL plant should be double the $4.5 billion mentioned previously as estimated by Shell, $9-10B per year. A very profitable investment indeed! I estimate the total cost of $50 per barrel of diesel even if Shell pays $5 per 1,000 cubic feet of gas. Therefore, the plant's profit is at least one-third of the cash flow or $3 billion per year. Therefore, Shell's decision to cancel the construction of a similar plant in the US remains a mystery, and in the author's opinion, shareholders and the public deserve an explanation for such a consequential decision for the American economy.

Shell is certainly innovative and daring. The above example of the Pearl plant shows its ability for innovation. It's daring is perhaps best illustrated by spending as much as $5 billion in Alaska's Beaufort and Chukchi Seas off the state's North Slope before abandoning such a gigantic effort because of extremely frozen weather and no drilling at all.

The latest upset in Shell's decision making is the announcement that it had renewed an option to buy a site for a proposed $2 billion ethylene plant in western Pennsylvania. The proposed plant would turn ethane liquid produced alongside natural gas and oil into ethylene, used to make plastics.[4]

In this connection, it should be noted that the price of Marcellus shale gas is often quoted at about half the price of Henry Hub except for the recent weeks when extraordinary and record breaking cold weather briefly gave an uplift to the shale gas price of Pennsylvania.

Despite all of the above, Shell remains one of the biggest and most important oil and gas companies in the world with assets of $360.3 billion at the end of 2012 and earnings of $16.7 billion in 2013 as compared to $27.2 billion in 2012, a drop of 38.6%. The drop in earnings in the fourth quarter of 2013 was $5.2 billion from $7.4 billion in the same quarter in 2012, an amazing drop of 297.3%. Thus, the rate-of-return dropped from 13.6% in 2012 to only 7.9% in 2013.

1. Charles Cosntantinou "Expressway to U.S Energy Independence: GTL Diesel" June 2012 www.shaleintelligence.com

2. Wall Street Journal, July 29, 2011, pg. C8

3. Yahoo Finance "Royal Dutch Shell PLC. 4th Quarter and Full Year 2013 Unaudited Results" January 30th, 2013 page 5 Wall Street Journal "Shell Puts off Drilling in Alaska's Arctic" by Tom Fowler and Ben Lefebure" February 28th 2013 page B7.

4. Wall Street Journal "Shell is Renewing Option for Factory Site" By James R. Hagerty, December 27th, 2013, page B5.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.