Shell Makes Cuts to Boost Returns

Shell is making cuts - reducing headcount and improving its supply chain. But will it be enough to improve earnings in a low oil price world?

Allen Good 7 December, 2016 | 1:11PM

With the BG acquisition in the books, Shell (RDSB) is embarking on the necessary steps to compete in a world of $60 a barrel oil. Like the rest of the integrated group, Shell is working to reduce its cost base, which has become bloated during the past five years, by reducing headcount and improving its supply chain. The integration of BG is integral to Shell’s efforts, as it holds the potential for $4.5 billion of cost-reduction synergies. Furthermore, the addition of BG’s low-cost production reduces Shell’s per-barrel operating cost, which ranked among the highest in its peer group. In total, Shell aims to reduce operating cost by 20% from 2014 levels by the end of 2016, with further reductions possible in later years.

At the same time, Shell plans to dramatically reduce investment levels as new projects are completed by capping yearly capital spending at $30 billion through 2020, versus the nearly $50 billion it spent in 2014. The sharp decrease should improve capital efficiency, but should not completely sacrifice growth. While the reduction in spending is in part a function of canceled marginal projects that are no longer economical, it also results from cost deflation, improved performance, and design standardization, which have meaningfully improved potential returns and reduced total project spend.

The impact is most notable in Shell’s future deep-water projects in the Gulf of Mexico and Brazil, where break-even levels have fallen to $45 a barrel. The improved economics of deep-water projects, combined with projects nearing completion, high-return conventional reinvestment opportunities, and a large LNG portfolio, which does not decline, mean it can deliver modest growth at a reduced level of spending.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
Rating
Royal Dutch Shell PLC B1,252.80 GBX4.68

About Author

Allen Good  Allen Good is a senior stock analyst covering the oil and gas industries.

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