February 1, 2018 / 1:31 PM / 10 months ago

Breakingviews - Shell is flush enough to afford mistakes

Filled oil drums are seen at Royal Dutch Shell Plc's lubricants blending plant in the town of Torzhok, north-west of Tver, November 7, 2014. REUTERS/Sergei Karpukhin

LONDON (Reuters Breakingviews) - Shell is entering a sweet spot. The Anglo-Dutch oil giant is starting to generate a large amount of cash after a couple of lean years. Just as well, given the crossroads at which the biggest energy companies stand.

Shell’s full-year results on Thursday showed operating cash flow of $36 billion comfortably exceeding $21 billion of capital expenditure and $11 billion in cash dividends. One driver is BG, which is now almost fully integrated and where synergies wound up totalling $4.5 billion, compared with initial estimates of $2.5 billion. Another is oil prices, which have risen from around $50 a barrel in August to nearly $70.

Shell has promised to invest $25 billion to $30 billion annually by 2020. If operating cash flow tops $55 billion by that date, as Jefferies analysts estimate, and oil prices stay around $60 a barrel, where oil futures contracts expect them to be, Chief Executive Ben van Beurden will be sitting on a mountain of cash. That should help the return on average capital employed to rise from 5.8 percent to Shell’s 2020 target of 10 percent, above the company’s cost of capital.

What van Beurden does with the cash pile matters. Plans for $25 billion of share buybacks by 2020 will please shareholders. But he has also to decide how much to invest in renewable and power, which will at some point displace the oil and gas core operations that currently generate the most cash.

On top of its self-imposed limit on investment, Shell has promised that no more than $2 billion will go into new energies. That offers some reassurance to investors who worry oil majors will make big bets on solar, wind or other new technologies that may have to be humiliatingly written down – as has happened before.

But Shell may be constraining itself unnecessarily. The company’s anticipated free cash flow per share in 2020 is more than 9 percent of its current share price, compared with peers’ free cash flow yield of less than 8 percent. Van Beurden would be forgiven for dipping deeper into his resources when investment in green energy could mean the difference between long-term success or failure.

Breakingviews

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