Shell Shows Oil Majors The Way In Liquefied Natural Gas

| About: Royal Dutch (RDS.A)
This article is now exclusive for PRO subscribers.

Royal Dutch Shell Plc, (RDS.A,RDS.B) the ‘Koninklijke Nederlandse Shell Groep’, commonly known as Shell, is a global oil and gas company headquartered in the Netherlands, with its registered office in the UK. Shell is the fifth-largest company in the world, the second-largest energy company after ExxonMobil (NYSE:XOM) and one of the so-called oil and gas ‘supermajors.’

Shell outlined a 3-year strategic plan in 2010 to improve near-term competitive performance and to deliver a new wave of production growth. Shell’s decision to maintain investment in new projects in the 2009 downturn is driving growth in the company today, and this year’s ramp up of projects in Canada, and Qatar, is part of a series of over 20 new upstream start-ups planned for the 2011-2014 period.

Under the helm of current CEO Peter Voser Shell has made a strategic shift in recent years in order to achieve increased margins and profitability. In Canada oil sands, ASOP-1 recently reached its full production level of 100,000 b/d. In Qatar, the Qatargas 4 Liquefied Natural Gas (LNG) project reached production plateau earlier this year, and Train 1 of the Pearl Gas-to-Liquids project should see production stabilize at plateau rates shortly, with Train 2 on track for start-up before the end of this year, as planned.

These three projects, representing some $30 billion of investment, have contributed to Shell’s target to deliver 50%-80% growth in cash flow from operations from 2009 to 2012, driven by cost savings, operating performance and an 11% increase in oil & gas production from one of the most substantial portfolios of new oil & gas projects in the industry today. Excluding net working capital movements, cash flow from operating activities in the third quarter 2011 was $10.6 billion, compared with $8.1 billion in the same quarter last year, following the trend seen in the previous quarters.

Shell is also continuing to mature new investments for medium-term growth, taking final investment decision on the Clair Phase 2 development in the United Kingdom, and the Wheatstone LNG project in Australia. Shell also confirmed a new oil discovery in French Guiana and is building new acreage positions for exploration drilling in the future.

By now you may be wondering why Shell decided to invest so heavily in natural gas projects in recent years to become the world's leading LNG producer and exporter, as it’s fair to say that the natural gas business doesn’t tend to dominate the headlines in the same way as the oil sector does. Perhaps this is about to change as the development of the gas business in the past 30 years has been dramatic. Global demand has tripled and the International Energy Agency (IEA) is predicting a further doubling in the next 30 years. It is expected that gas will be supplying a quarter of our energy needs by 2030.

Within the gas sector, LNG is playing an ever increasing role. Cooling natural gas to-162 Celsius (–260° F) to create a liquid means it becomes easy to transport at 1/600 the volume of its gaseous state and without the need to be pressurized. LNG is cleaner than coal or oil and it offers an opportunity to diversify energy supplies. The decreasing cost of LNG is making it more competitive in more markets and provides an attractive option compared with international pipelines that cross multiple borders. As a result, LNG demand is forecast to grow more quickly than for gas in general, at about 10% a year over the next 10 years.

Clearly, access to significant gas reserves is critical, ideally large deposits that can underpin major LNG plants that can be expanded over and over as demand grows, and major natural gas resource holders such as Nigeria, Russia, and Qatar, have a lot to gain. New LNG projects continue to move forward underpinned by a high proportion of their capacity already committed by 15-25 year sales contracts to firm customers.

The most recent example of this quest for reserves is the green light on Shell's Prelude FLNG Project (F stands for Floating), which includes building a vessel to harvest offshore natural gas reserves in the Prelude and Concerto natural gas fields, discovered in 2007 and 2009 off the northwest coast of Australia, processing up to 110,000 barrels of oil equivalent per day. The proposed vessel will be a juggernaut as it will displace 600,000 metric tons of water, about 6 times the water displaced by the biggest super carrier, and will be about 1,500 meters long. Price tag of the vessel: $11 billion!

Winners will be the supermajors who are not only able to develop the upstream gas and liquefaction capacity, but can also connect gas supplies to emerging and premium markets. Asian markets continue to see strong and ever growing demand for LNG. Demand has historically been particularly strong in Japan, but China has also become a major consumer in recent years as it looks to replace its heavy dependence of oil based commodities with LNG.

Although Shell clearly has a lead in the LNG and GTL arena due to decades of R&D, extensive experience, massive investment and very good relationships with partners and governments around the world, the other oil and gas majors aren’t sitting back either. ExxonMobil is also increasing focus on natural gas following its XTO Energy (XTO) acquisition, which was completed mid-2010.

The acquisition, which was ExxonMobil's biggest in a decade, showed the continuing trend of consolidation in the energy sector as the supermajors increasingly target smaller independent players. Following completion of the acquisition, ExxonMobil created a new organization to focus on the production of unconventional natural gas and oil resources.

PetroChina (NYSE:PTR), China's biggest oil producer and the listed arm of state-owned CNPC, is also looking at ways to ensure that China has a steady supply of LNG for the next few decades. In 2009 joint venture participants Chevron (NYSE:CVX), Shell and ExxonMobil signed a $50 billion deal with PetroChina to supply LNG from the Gorgon field in Western Australia, which was considered the largest contract ever signed between China and Australia.

In 2010 a joint venture was created between Shell and PetroChina for the takeover of Arrow Energy of Australia. The joint venture is integrating Arrow's Australian assets with Shell's existing assets and Shell's LNG plant in Queensland. Shell and PetroChina will each own 50 percent of the gas produced by the LNG plant and Shell has indicated that it will likely sell its gas to China. Shell and PetroChina subsequently also made a successful bid for Australian Bow Energy through Arrow Energy, which was concluded in September of this year.

ConocoPhillips (NYSE:COP) recently announced that it will be investing in a joint venture with Australian Origin Energy (OTCPK:OGFGF) and Sinopec (NYSE:SNP) by purchasing a 42.5% stake in the Australia Pacific LNG project. Australia Pacific LNG, which is expected to start production in 2015, already has binding purchase agreements with Sinopec, and ConocoPhilips has indicated it aims to triple its Australia-assets over the next 10 years.

Natural gas is also a growing segment of Chevron's energy portfolio, with natural gas resources now spanning 6 continents. Chevron is the project operator of the previously mentioned Gorgon Project, which is a joint venture of the Australian subsidiaries of Chevron (47,33%), Shell (25%), ExxonMobil (25%), Osaka Gas (OTCPK:OSGSF) (1.25%), Tokyo Gas (OTCPK:TKGSY) (1%) and Chubu Electric Power Company (OTC:CHUEF) (0.417%). Gorgon is Australia’s single biggest project with estimated gas reserves of 35.3 trillion cubic feet and a lifespan of around 60 years. The project’s LNG production facility will be located on Barrow Island, 70km off the coast of Western Australia.

In early 2011 France's Total (NYSE:TOT) created a strategic alliance with Novatek, the largest independent gas producer in Russia, and the two companies signed final agreements last month to jointly develop the Yamal LNG project. The Yamal LNG project will develop the South Tambey field located in the arctic area of the Yamal peninsula, a strategic oil- and gas bearing region of Russia. In another joint venture, Shell and Total announced last week that they plan to expand capacity of their LNG terminal in western India by more than a third, buoyed by strong demand for the fuel in the country, which will come online in Q2 2012 according to a senior Shell executive. Total (24.5%), Statoil (NYSE:STO) (24,5%) and Gazprom (OTCPK:OGZPY) (51%) are also part of a consortium, Shtokman Development AG, established to develop the Shtokman field, one of the world's largest natural gas fields, in the central part of Russian sector of the Barents Sea.

UK’s BP Plc (NYSE:BP) is currently in the final phase of planning for a 3rd LNG train at the Tangguh gas field in Papua New Guinea, where it operates an LNG plant. Tangguh is a massive gas project located in the Bintuni Bay area in West Papua with total proven gas reserves of 14.4 trillion cubic feet. The plant currently consists of two production units, each with capacity of 3.8 million tons of LNG per year. The project, which shipped its first LNG cargoes in 2009, has multi-year contracts to supply 2.6 million tons a year to China, 1.15 million tons a year to South Korea and an agreement to supply as much as 3.7 million tons a year to San Diego-based Sempra Energy (NYSE:SRE).

BP plans to invest around $10 billion over the next 10 years to crank up production at the Tangguh LNG plant and explore Indonesia’s coal-bed methane (CBM) potential, a form of natural gas extracted from coal beds. Indonesia is currently the 3rd largest LNG exporter after Qatar and Malaysia.

Clearly the view on natural gas has changed over the last few decades as advances in technology have reduced the costs associated with the extraction and transportation of gas. Proven reserves have shown dramatic increases in the past 20 years and global demand has grown in unison. As natural gas produces less carbon dioxide compared with either coal or oil, there’s also the potential benefit to the environment to the degree that gas replaces either of those.

Investing in new technologies and massive projects is always a risk, but Shell is known for bringing some of the biggest, most challenging and capital-intensive projects to successful fruition, and remaining at the forefront of development in the energy sector. In June of this year CEO Vosser stated that Shell aims to grow its dividend as its cash flow increases, and it seems that Royal Dutch Shell is well on its way in achieving all targets as outlined in its 3-year strategic plan, to create value for its shareholders, not just today, but also in the future.

Disclosure: I am long RDS.A, BP.