Shell needs to repay investors who backed biggest ever wager

Royal Dutch Shell Plc is under pressure to reward the faith of the more than 80 percent of shareholders who shrugged off the risks from slumping oil prices to back its record acquisition of BG Group Plc.

That won't be easy: the rout in crude has cut the value of Europe's biggest oil company to the lowest in more than 10 years and raised investor concerns that its dividend is unsustainable. Chief Executive Officer Ben Van Beurden, who expended a lot of political capital convincing investors that BG will help Shell ride the downturn, has to deliver promised benefits from liquefied natural gas to deepwater oil production as billions of dollars of cash flow is choked off.

"The acquisition of BG must be a springboard for change within the company," said Chris Wheaton, an analyst at Allianz Global Investors, which backed the deal. "The group needs to become quicker to react, simpler, more efficient, and more focused on cash generation for shareholders to cope with the brutal reality of a more volatile and lower oil price than the world has seen over the last decade." While the acquisition will see the combined entity leapfrog Chevron Corp. to become the largest non-state oil company after Exxon Mobil Corp., its market value may be below that of Shell before the collapse in crude prices.

Shell's B shares, the class of stock used in the transaction, rose as much as 2.6 percent in London trading and BG gained as much as 1.8 percent. Shell's Chief Financial Officer Simon Henry said the purchase is positive for cash flow at any crude price, although the decline from $50 a barrel to $30 cuts $8 billion a year from the flows generated by the enlarged company.

"The BG deal will add to our cash flow at any oil-price environment," Henry told shareholders in The Hague before they voted for the deal on Wednesday. Some of the economics of the transaction "may indeed be stretched in a low oil-price environment" over the next two years, he said.

The slump has been brutal for Shell and other oil producers. The company's returns from its assets went below one last year for the first time since 1987, according to a report this week from Sanford C. Bernstein & Co.

Oil's more than 70 percent decline since June 2014 has forced companies to write off the value of assets worth billions of dollars. Shell booked a $7.9 billion writedown in the third quarter of last year after abandoning projects in Alaska and Canada.

Another metric CEO Van Beurden and CFO Henry will be looking to improve is the return on invested capital, which has dropped to the lowest in more than 15 years. The ratio, showing the profitability of funds invested, turned negative in the quarter through September, even as Shell's returns exceeded those of European rival BP Plc.

Inevitably, those deteriorating metrics are flowing through to the bottom line. Shell last week said it expects fourth-quarter profit to decline by at least 42 percent from a year earlier, after net income dropped to the lowest in more than six years in the preceding three months.

While these problems persist, investors have voted through Shell's acquisition of BG because it adds to production and reserves and makes the company the largest LNG trader.

Shell says the deal will also enhance its ability to pay dividends. The oil slump has sent Shell's dividend yield to the highest level in 20 years, above 8 percent -- a sign that some investors see the payout at risk.

"The oil sector's financial metrics have been hurt by oil prices," said Jason Gammel, a London-based analyst with Jefferies International Ltd. "Shell will need to demonstrate over the next six months what action they can take to underpin the dividend. They will also have to push ahead with the divestitures to protect the balance sheet."

Other shareholders will be harder to convince in an era of lower-for-longer prices. "We feel that the downside risks have not been fully reflected," Paul Koster, head of Dutch investor group VEB, said before the vote in The Hague. "We would like a better understanding on the importance of cash flow. We are concerned, we can't find enough data on what will happen if oil prices stay low for five years, as low as they are now."