Crude oil prices are at a two-year high thanks to an improving demand outlook and a disciplined OPEC+. Furthermore, Iran’s long-awaited return is being delayed, while US shale companies resist by increasing their production. Meanwhile, the recovery has been muted for the integrated oil companies. Looking at Shell’s performance against that of oil, it appears that the linkage has been broken since the historic dividend cut:
The recent news flow is not helping either, with a Dutch court ordering Shell to reduce its emissions by 45% by 2030, including scope 3 emissions. Its size makes it indeed an easy target: Shell’s scope 3 emissions amounted to 1.3Gt of CO2 in 2019 (evenly split between Shell’s own production and the third-party products it sells), which is around 60% of the CO2 emissions of the European Union.
Two weeks after the ruling, the CEO posted that the company is most likely to appeal but also to accelerate its strategy. The ruling imposes dramatic changes on the business and we do not expect full compliance from the group. Meeting this order simply means shrinking the core business by the same amount. Green hydrogen and CCUS projects could only help in tackling scope 1 emissions, which is already a problem on its own at 70Mt.
The company has opened the data room for a disposal of its US shale assets, despite being considered as a core region, and profitable below $35/bbl. We view this potential sale as timely, as it would show Shell’s intentions to decarbonise while (more importantly) taking opportunity of the high oil prices. If equity markets cannot appreciate Shell’s assets, then is there more value in divesting them? The sector had time to deleverage and the mid-term outlook looks decent, enough to justify an acquisition for short-cycle assets.
Focus on cash flow again?
Despite the court order, it is worth remembering that shareholders have approved the company’s strategy. With this support, we expect the focus to finally shift back to Shell’s fundamentals and cash generation, under a $70-75 oil outlook. The shareholders distribution would go up too, in the form of a share buy-back programme, as deleveraging targets are met. Shell will start buying back shares once net debt is down to $65bn. At $71bn in Q1, this threshold will be reached in Q2 or Q3.
Brent averaged $68.5/bbl in Q2, vs $61/bbl in Q1, which implies a CFFO increase of c. $800m and above $13bn. Cash capex should be at $55bn. After interest ($1bn) and dividend ($1.3bn), that would bring net debt close to the $65bn mark. The needle-mover (Q2 or Q3 for the share buy-back announcement) might be the working capital, which increased by $4bn in Q1.
We have a positive view on the stock, as we see a robust cash generation ahead. At $70/bbl, we estimate a CFFO of around $45bn, meaning a distribution of $9-13.5bn (20-30% of CFFO). The yield to shareholders is therefore closer to 7% than the 3.5% from the dividend. The bull case for Shell is that of growing distribution on improving fundamentals, whereas TotalEnergies has less room to surprise positively but spares investors the effort in estimating its pay out.
ESG & Sustainability
On the ESG side RDS ranks 116th out of 463, with a 6.1/10 score vs 5/10 for the Oil&Gas sector. Its Governance sore at 8.8/10 ranks Shell 6th out of 463 companies. Social (5.6/10) and Environment (4.4/10) are below sector average. Read more