Royal Dutch Shell (NYSE:RDS.A), the largest company in the FTSE 100 and one of the world's "supermajor" oil companies, reported its third-quarter results earlier this week.
BP (NYSE:BP), whose third-quarter results I reported on earlier this week, and Royal Dutch Shell are integrated oil companies, which means that in addition to extracting oil and gas and selling it on the open market, they sell their own refined products like petrol and diesel to consumers and chemical products to the petrochemical industry.
Q3 2012 Results -- Profits Fall 15%
With group revenues declining by 8.4% to $115.43 billion, Shell reported a 15% drop in third-quarter net profits, to $6.1 billion, compared with $7.2 billion in the equivalent period last year. Profits were hit by lower oil and gas prices and a net $432 million charge from one-off items, compared with a net gain of $245 million in the third quarter of 2011. Shell's pre-tax profits rose 1% to $12.6 billion, while the quarterly dividend was increased by a miniscule US$0.01 to US$0.43, unchanged from the second quarter and payable on Dec. 20.
The group reported a writedown of $354 million of its U.S. shale gas assets and a net charge of $134 million in its downstream division, reflecting "legal and environmental provisions" without disclosing what these were. Shell's quarterly numbers are reported on a "current cost of supply" basis that removes changes to the value of the inventory that would otherwise skew the results to track movements in the oil price.
Like BP, Shell benefited from higher refining margins -- something that Shell admits is not sustainable going forward. That margin strength was the result of supply shortages due to unexpected shutdowns at other refineries, rather than increasing demand. The group reported an 8% rise in "downstream" refining and marketing profits, while at the same time showing a 25% slump in earnings in the company's "upstream" exploration and production division -- the latter seen as the drivers of profits in the long term.
Shell's Chief Executive Peter Voser worded it in the earnings release as follows:
Shell is driving a long-term and consistent strategy, against a backdrop of volatile energy markets.
Our earnings were driven by lower oil and gas prices, and lower chemicals margins, which offset the benefits of our operating performance, underlying growth in oil and gas production, and higher results in integrated gas and oil products.
Our profits pay for substantial investments in new energy supplies, and they pay dividends for our shareholders.
U.S. Gas Writedowns
With U.S. natural gas prices down 29% on a year-on-year basis, just as BHP Billiton (NYSE:BHP) and others in the U.S. Shell has adjusted its onshore gas strategy from shale gas to focus more on so-called "tight oil" -- oil found in porous rock formations that is extracted in a similar process to shale gas, by hydraulic fracturing. As a result, the group wrote down $354 million (£219 million) of its U.S. shale gas assets due to the low gas prices resulting from the gas glut in America following development of these reserves. Actually, this is rather small beer when compared to BHP Billiton ($2.84 billion charging its gas assets) -- BG Group charging $1.3 billion -- while the BP writedown amounted to $2.1 billion.
Given Shell's position in onshore gas in the U.S., and given some of its competitors' massive write downs, it is somewhat surprising that its gas writedown was this low. Is there more to come, if and when natural gas prices remain at these levels or drop even lower with prospects for a recovery in gas prices only once the recovery in the U.S. gathers pace and becomes a net exporter in five years' time (perhaps)?
Shell's Nigerian Troubles Are Not Going Away Anytime Soon
In late October, Shell's Nigerian subsidiary declared force majeure on oil exports, citing damage caused by thieves who break open its pipelines to steal crude and flooding surrounding areas.
As per Ian Craig, Shell's vice president of production and exploration in sub-Saharan Africa:
The problem that we're having is these repeated incidents. So you fix one, you go for a period and then you have another one. I'm pretty sure we'll get out of this one quickly, the difficulty is how long before the next incident.
Production shut-ins in Nigeria due to security breaches contributed to a fall in overall oil and gas production to 2.982 million barrels of oil equivalent a day from 3.012 million a year ago. And this is not likely to be reversed anytime soon, with the company expecting that fourth-quarter output from Nigeria would be down by another 20,000 barrels a day due to flooding in the Niger delta.
Even leaving out the impact of its Nigerian troubles, divestments, temporary shutdowns in the North Sea and Gulf of Mexico and other one-offs, Shell's oil and gas third-quarter output grew only 1%. That's something it has in common with several of the other top oil companies reporting recently.
Despite the 1% fall in production in the third quarter, Shell has ambitious plans to increase reserves and grow future production over the next few years with an increasing bias towards gas. Indeed, in the past three months, gas production rose 4% while liquid output was down 4%.
Strong Cash Generation Feeding Into Higher Dividends?
One of the most important things for investors to consider about Shell is its cash generation. The group's stated strategy is to improve cash flow by a massive 50% to $200 billion over the 2012-15 period.
During the quarter Shell generated operating cash flow of $9.5 billion, financing net capital investment of $8.0 billion, generating a return on capital employed of almost 13% and gearing is standing at just 8.6%, down from 10.8% a year ago. However, the fourth quarter of the year may well be much tougher, with refining margins easing and with the oil price remaining at around US$100 levels. Longer term, the successful delivery of the group's new projects should lead to capital appreciation over the next few years, but really only once the global economic recovery take hold.
From a dividend perspective, clearly, Shell has scope to increase its dividend payments quite a bit, despite its ambitious capital expenditure plans. But thus far above-inflation payout increases remain elusive.
Disclosure: I am long BHP. 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.