The warning came as the group posted a 15 per cent dip in CCS (current costs of supply) earnings to $4.8bn. Shell’s upstream earnings caved in due to lower realised oil, liquefied natural gas (LNG) and gas prices compared with the third quarter of 2018, with the average price for a barrel of crude at $55.99, down from $61.26 in the corresponding period. Even so, the return was still ahead of analyst expectations and – perhaps more tellingly – free cash flow was up by a quarter to $10.1bn, prompting some talk of an over reaction on the part of the market.
Some analysts expressed surprise that Shell’s chief executive, Ben van Beurden, felt the need to warn that the timeframe for completion of the share buyback programme could slip beyond 2020. But management has committed to enhanced corporate disclosure, hence the greater quarterly detail afforded investors. It deserves credit on this basis, although no good deed ever goes unpunished.
The group’s share price generally trades in a relatively narrow band – and there’s a reason for this. You would imagine that global energy markets would have to be in the doldrums for an unprecedented length of time before Shell lets its shareholders down. The group has explicitly prioritised the maintenance of shareholder returns down through the decades, even if that has meant expanding borrowings or hiving off productive assets. Even when Brent crude slumped to $27.67 a barrel at the time of the oil price collapse of 2014-15, management held its nerve and shareholders reaped the benefits.
It does seem curious that the market has now reacted as negatively as it has, although we should add that trading volumes hardly went through the roof. It’s not as though the “prevailing weak macroeconomic conditions and challenging outlook” hadn’t already been factored into the share price, evidenced by a forward dividend yield running at 5.8 per cent prior to Ben van Beurden’s comments.
So, why are income seekers apparently so apprehensive? Although free cash flow was up on a relative quarterly basis, it’s down by 7.6 per cent through to the end of the third quarter. The group generated $5.96bn from acquisitions in 2018, broadly equivalent to the increase in cash/cash equivalents, and just under $11bn in the prior year. The trouble is that Shell has already hived off some of its most carbon-intensive assets, so the sales spree can’t go on forever. There are only so many ‘non-core’ assets on the books.
But it’s not as though the group will inadvertently diminish in scale through its determination to underpin distributions. Norwegian consultancy Rystad Energy believes that Shell could still grow production appreciably over the next decade with the emphasis on deep-water, shale gas and tight oil, but this will necessitate further large-scale capex commitments. Shell allocated $20bn in capex last year, while another $20.2bn was given over to distributions and buybacks, but all this was achieved when energy prices were more favourable. You would need a mystic to predict the likely trajectory of energy prices, but either way you’re left wondering how the group will be able to make good on its commitments without expanding the balance sheet.
Shell’s increased caution in this area can be seen in a wider context. You could make the case that one of the key drivers of the unprecedented bull run has been the proliferation of share buybacks. This practice can serve to mask underlying earnings by reducing the total shares outstanding. So you can get a situation where a company’s net earnings have fallen, yet its price-to-earnings ratio may have also reduced, thereby making the stock seem cheaper on a per share basis without reference to underlying performance.
The signs are that market support from this avenue is dwindling. Goldman Sachs recently noted that S&P 500 share buybacks fell by close to a fifth (in aggregate terms) from the first through to the second quarters of 2019, while the investment house predicts that the total amount spent on buybacks through the year, though impressive within an historical context, will fall by around 15 per cent. The analysis squares with Ben van Beurden’s comments, but index values will come under pressure if it accurately describes a developing trend.
