Better sell Shell

Until 2020, the major oil and gas companies had long been considered reliable dividend payers – and Shell and BP (BP.) are responsible for a significant proportion of FTSE 100 payouts because of their size and historical long-term yields of around 6 per cent. Shell’s yield has now dropped to4 per cent after the dividend cut, even with its share price dropping 20 per cent since March and halving over the past year. BP’s yield has climbed to a lofty 10 per cent because it has held onto the payout despite seeing a similar drop in its valuation. 

The question for retail shareholders and managers of income-hungry pension funds is whether the income case is coming back. 

Shell itself has said the two-thirds cut to 16¢ was a “reset” rather than a brief measure to save cash in a poor year. Measures that are potentially more short-term are also in place: Shell announced a 20 per cent cut in capital expenditure and froze the share buyback scheme in April, while also increasing borrowing. 

Shell has now confirmed the balance sheet will take a significant hit this year. At the end of June, the company updated its estimates for the oil price in 2020, 2021 and 2022, which have come down from $60 to $35, $40 and $50 a barrel, respectively. Coupled with a separate refining write-down based on the company’s decarbonisation plans, the hit from these new forecasts will be $15bn-$22bn in the June quarter results. 

Shell has kept its long-term price forecast at $60 a barrel, $5 higher than BP’s estimate. It has also kept its long-term gas price at $3 per million British thermal units (mbtu), compared with BP’s $2.90/mbtu. There is a significant long-term impact in the downstream business, with the refining margin 30 per cent lower than previously anticipated. This is the spread between crude and fuel pricing. The downstream division provided 85 per cent of the company’s revenue in 2019. 

Despite some recovery hopes on the back of Opec cuts and demand improving, a spring back to business as usual is extremely unlikely. Rystad Energy’s base case for the coming 12 months sees limited scope for oil prices to recover, even without a second wave of Covid-19. “If anything, the whole new range of risk factors that still lie ahead in 2020 and 2021 would actually point to more volatility and downside risk before any ‘flip back into a true backwardation happens’,” the consultancy said.

At the same time as the downturn, Shell says it is changing its business with the aim of avoiding to become little more than the owner of a collection of uneconomic "stranded" assets in a decade. 

Chief executive Ben van Beurden’s plan is for Shell to be “asset-light” at the same time, compared with its current business style, based on owning hundreds of billions of dollars’ worth of producing assets, refineries and petrochemical facilities. Shell has said it wants its lower-carbon "new energies" division to have an 8-12 per cent return by 2030. Its return on invested capital for the whole business was 5.9 per cent in 2019, so this is a lofty goal.

The company has not split out results for new energies yet, so it's not clear how far along this path it already is. 

Shell is faced with a difficult few years, where capital expenditures will need to climb significantly for it to meet its transition goals, at the same time oil prices will stay relatively weak and investors are still receiving consistent dividends from its competitors.