On the Money

Royal Dutch Shell has the LNG as­sets to ben­e­fit from con­tin­ued strong de­mand for nat­u­ral gas

Alberta Venture - - Contents - By Jody Chud­ley

While Bay­tex is highly over­lever­aged, it will turn quickly with ris­ing oil prices

The Play

I’m con­cerned about where nat­u­ral gas prices are go­ing to go over the next five years, and I don’t mean them shoot­ing higher and push­ing up my heat­ing bill. If you have been pay­ing at­ten­tion, you will have no­ticed that the Mont­ney for­ma­tion, in north­east­ern B.C. and north­west­ern Al­berta, is one in­cred­i­ble shale gas play. What pure-play Mont­ney com­pa­nies like Painted Pony, Ad­van­tage Oil & Gas and Crew En­ergy are do­ing and are ca­pa­ble of do­ing in terms of pro­duc­tion growth is stag­ger­ing.

But if we don’t get our liq­ue­fied nat­u­ral gas (LNG) ex­port ducks in a row, Cana­dian nat­u­ral gas is go­ing to be sold at rock bot­tom prices for years to come.

It isn’t like there won’t be plenty of de­mand for LNG glob­ally. Exxon Mo­bil is fore­cast­ing that global con­sump­tion of liq­ue­fied nat­u­ral gas will triple to 100 bil­lion cu­bic feet per day by 2040. Asian coun­tries with big pop­u­la­tions and mod­est nat­u­ral gas pro­duc­tion will be re­ly­ing on LNG im­ports to pro­vide half of the nat­u­ral gas they con­sume.

And those pro­jec­tions are based on how the world is cur­rently viewed. I be­lieve there is a strong pos­si­bil­ity that China and even­tu­ally In­dia will sur­prise us in how quickly they aban­don coal to im­prove air qual­ity. That would mean even more de­mand for LNG.

But, with­out new pipe­lines and LNG fa­cil­i­ties on the B.C. coast, Cana­dian nat­u­ral gas may end up be­ing stuck. From an in­vestors point of view, that could work well for other, more global, play­ers in the mar­ket. The big­gest in that game by far is Royal Dutch Shell. Af­ter ac­quir­ing BG Group for a cool US$54 bil­lion, Shell has dou­ble the LNG ca­pac­ity of its near­est ri­val, Exxon Mo­bil. In short, Shell has bet its fu­ture on LNG.

The Pic k

Royal Dutch Shell (NYSE :RDS .A) I men­tioned the wave of Cana­dian Mont­ney pro­duc­ers that are gen­er­at­ing in­cred­i­ble pro­duc­tion growth even with low nat­u­ral gas prices. Ten years ago th­ese com­pa­nies didn’t even ex­ist. Royal Dutch Shell has been around a lit­tle longer. The com­pany was founded in 1833 by a man named Mar­cus Sa­muel. Orig­i­nally, Sa­muel used his com­pany to sell an­tiques be­fore ex­pand­ing into the im­por­ta­tion of shells from the ori­ent. It wasn’t un­til 50 years later that his two sons moved Shell into the oil and gas busi­ness.

It has grown into a blue chip com­pany that is widely owned and widely fol­lowed. It might sur­prise you, then, to learn that this mas­sive and durable com­pany cur­rently sports a div­i­dend yield of 7.5 per cent. That kind of yield is ex­tremely un­usual and ba­si­cally im­plies that the mar­ket be­lieves the cur­rent div­i­dend is un­sus­tain­able. Given the col­lapse in oil prices, that prob­a­bly doesn’t seem sur­pris­ing, but what we also need to con­sider is that Shell has not had a div­i­dend cut since 1945. Th­ese oil and gas ma­jors aren’t kid­ding when they say that they are com­mit­ted to their div­i­dends. Shell went through sub-$10 per bar­rel oil prices in both the 1980s and 1990s with­out cut­ting that div­i­dend.

When I take a look at what Shell is plan­ning to do in the com­ing few years, I have to say that it ap­pears they can keep this div­i­dend up. From gen­er­at­ing free cash flow of only $12 bil­lion per year from 2013-15 while oil was $90 per bar­rel, Shell is ex­pect­ing to in­crease that to $20 bil­lion to $30 bil­lion in 2019-21 with oil at only $60 per bar­rel.

The key to achiev­ing this is that an­nual cap­i­tal spend­ing, which peaked at $57 bil­lion in 2013, will be drop­ping un­der $30 bil­lion in the years go­ing for­ward. The com­pany will mas­sively re­duce spend­ing by cut­ting back on enor­mous long-lead-time mega-projects and by squeez­ing ev­ery penny out of the money it does spend. There is noth­ing like ne­ces­sity pro­vid­ing the in­cen­tive to cre­ate rad­i­cal im­prove­ments in cost ef­fi­ciency.

The POSTSCRIPT

A big fly in the oint­ment of Shell’s long-term plans could be LNG pric­ing. There will be de­mand growth, but the prob­lem could be how ef­fi­cient Shell and its com­peti­tors con­tinue to be­come at pro­duc­ing oil and nat­u­ral gas.

LNG prices, which are linked to oil pric­ing, have taken it on the chin in re­cent years. That means that not only does Shell need to worry about mas­sive amounts of nat­u­ral gas com­ing from shale flood­ing the mar­ket, it also needs OPEC to stop over­pro­duc­ing to get oil prices up.

Hav­ing to rely on OPEC to do any­thing is not a com­fort­ing po­si­tion to be in. At least for share­hold­ers of Shell, you know that you are in­vested in a com­pany that, hav­ing been around since 1833, has lived through a few chal­lenges.

“We’re more a gas com­pany than an oil com­pany. If you have to place bets, which we have to, I’d rather place them there.” – Ben van Beur­den, CEO, Royal Dutch Shell, to Bloomberg Busi­ness­week

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