Shell: Saving The Planet Costs Money; Investors Money
Wind Farms Don't Make Money
Note-this article was published in late December, 2021
Shell's stock has bounced from its 2020 lows, but lacks a catalyst to go much higher. A number of market forces are putting a lid on the stock in the low $40's, as government climate mandates, activist investors, renewed pandemic fears, and a lack of focus on their core petroleum business are forcing the company in directions that have no sure outcome. Recent trading has taken it back toward the middle $40’s, offering a yield of ~4.5%.
I am bearish on Shell at the current prices. It's easy to throw money at wind farms and hydrogen and that is just what the company is doing. It's another thing to reap profits from these investments, something for which they have no track record, and shield the relevant financials from investors. In this article I will point out some problem areas I see and suggest a couple of investment alternatives.
Shell and the energy transition
Shell (RDS.A), (RDS.B) is making a lot of changes in their approach to their general business plan-providing energy to retail customers. Some of these changes are to remain aligned with their previously announced carbon and climate goals, that hew closely to those put forward in the Paris 1.5 Accord. Others are being forced on them by the courts, governmental agencies, and internally by Activist Investors. The company has a stated goal of being net-carbon neutral by 2050 across its product lines. We will avoid a pro/con discussion of climate change initiatives here. You can find plenty of that in other forums. We are here to make money.
The company has doubled in share price since last October when it hit $25 per, but has since pulled back to the low $40's. About the same proportionately as its Super Major Peers, ExxonMobil (XOM), and Chevron (CVX). Both of which have their own "interference loads" to bear while delivering returns to investors.
Shell wants to be your electric company
Shell has made a huge bet about the future of energy and the role it wants to play in the distribution scenario they see evolving. As noted this isn't something that the company just "woke" up one day and decided to do. They were moving in this direction for a number of years, but events in 2021 added a flair of urgency and need for demonstrable progress that had not been present in prior years. It's fair to say that Shell got that good old-fashioned climate "religion" in 2021, and did what companies do when they are looking to make a splash. They reorganized.
The first step was renaming Shell New Energies to Renewables and Energy Solutions-R&ES. Despite a big splash on their website, R&ES is an economic "Black Hole" at present. It's costs and revenues are absorbed in other of their 5 reporting segments (Integrated Gas, Upstream, Oil Products, Chemicals, Corporate according to a formula only they know. It suggests to me these efforts are so nascent that no significant revenues are accruing at present. So what is Shell putting investor’s cash these days?
A pre-Dutch Court article in Reuters notes their planned shift to power trading and green hydrogen, with annual capex allocation approaching $8.0 bn by 2025. Some recent moves they've made in that direction include:
Doggerbank Wind Farm, U.K. Shell has signed an 15-year agreement from this world's biggest offshore wind farm, expected to come online in 2026, for 20% of Phase III's 1.3 GW output. Terms were not disclosed, but perhaps we can take instruction from the escalating costs at a U.S. offshore project. At $10 bn for 180 turbines, roughly 1.0 GW output you can bet on a multi-billion dollar future commitment.
A 51% stake in the Western Star offshore wind farm in Ireland. They don't disclose the terms, but a 2018 Fortune article notes that a 1-GW offshore wind farm costs about $4.0 bn in upfront costs. Things cost more today than in 2018, so let's add $3.0 bn to Shell's investment tally here. It should be noted that Shell likes the idea of selling electricity in Ireland as this is their second deal with co-developer Simply Blue Group a privately held clean energy developer, headquartered in Cork, Ireland. The first was the Emerald Wind Farm, another 1.3 GW project in the Southern Irish sea. So we will keep things consistent and add another $3.0 bn to Shell's electricity capex outlay.
Powershop, Australia will now be part of Shell for a cool $573 mm. Selling power to 185K consumers from wind farms, solar and hydro sources. Not everyone is excited about Shell's arrival. It should be noted these "big money" displays don't always go well. BP tried to buy Woolworth's gas retailing operation and was blocked by Aussie regulators.
Then Shell has signed agreements with Norsk Hydro to explore for green hydrogen opportunities in Europe. Shift a German refinery away from fossil fuels to green hydrogen, biodiesel and jet fuel by 2025. Spend $535 mm in Brazil on renewables-solar in this case. Then it has entered deal to develop a 900 MW solar farm in South Eastern England.
The one legacy fossil fuel project that's been sanctioned recently is the 2.7 TCFe Manatee shallow water gas field in Trinidad. No financial terms are mentioned but there is a lot of existing infrastructure in this area, so we aren't looking at much capex other than placing a jacket for the wells and drilling costs.
And all of that's just since late September! To reemphasize my central point. Shell is taking money generated today from producing and selling fossil fuels and investing it in these low carbon ventures that will not generate a return for years.
When you combine this trend with the trend toward declining oil and gas revenues you can understand why investors might be concerned about the long-term economic viability of the company. In reply Shell CEO, Ben Van Beurden commented-
The needs of Shell customers and the company's efforts to pivot away from fossil fuels would be best achieved by keeping its full range of assets and businesses, noting Shell's legacy oil and gas assets are needed to fund its investments in lower-carbon energy.
Shell filings
Prelude…to what?
Shell gets a lot of credit for being an able and experienced project manager, and when it's their core business, they are. By comparison, Prelude, an FLNG project, has to be considered a financial and technical disaster by any measure, and a lot of that involves mistakes by Shell. An article from last year notes-
While the Prelude did export LNG at about half its capacity for the second half of 2019, it is now idle.
Moored far off the Kimberley coast it is plagued with technical problems, dwindling gas reserves and safety processes condemned by the regulator despite Shell and its partners spending about $US19.3 billion ($A30.0 billion) to the end of 2019. Shell has escaped scrutiny over Prelude's cost by not issuing an estimate when the project was sanctioned or supplying updates during construction.
Shell chief executive Ben van Beurden was asked about the cost of Prelude in 2018.
"We don't disclose cost on projects, so I'm also not in a position to disclose whether it is any different to what we have previously not disclosed and I don't want to make an exception in this case," van Beurden said.
Well that is certainly opaque, but consistent with the way they are reporting renewables.
Prelude now sits idle after a fire suspended operations in early December. Not a great deal of damage was done, but there is an Australian agency investigation underway that will delay things while it is ongoing.
Bad news just gets worse for Shell investors, down nearly $20 bn on this investment by the figure cited above. The Australian offshore petroleum regulator, NOPSEMA, just delivered a major ouchie.
Inspectors from Nopsema visited the Prelude facility from 8-10 December and "concluded that the operator did not have a sufficient understanding of the risks of the power system on the facility, including failure mechanisms, interdependencies and recovery," the regulator said
I bring this up at this point in the article to point out, Shell puts out some pretty blithe assumptions about the new horizons they have laid out for their future energy mix. As Prelude has shown, horizons can recede and be very costly to attain. When national regulators issue notices like the one above, they can extend to infinity.
Ok, Let’s Wrap it up
As we have discussed, Shell has been favoring renewables energy investing over its traditional forte, oil and gas. Recent actions like selling its Permian acreage to ConocoPhillips, and walking away from the Cambo field in the North Sea for “climate differences,” will only exacerabate the decline trend in the graph below (compiled from Shell filings).
Right now Shell is trading at 7X forward EV/EBITDA, which is certainly in bounds for capital intensive businesses. Professional analysts almost universally rate Shell a buy, with estimate ranging from $53 on the low side to $66 on the high side. Either scenario would mark significant appreciation for investors. But it’s not happening.
Why won’t the stock budge? I think investors, like you and me have concerns about the direction the company is taking and it’s impact on the stock’s valuation. We didn’t discuss it in detail in this article but a strong push has been made by an activist investor to split the company into two operating entities for just the reasons I propose. Fear stalks Shell.
Yesterday, on a pretty good day for oil equities in the market, Shell ADRs rose a paltry $0.49 by the close of trading, and appears ready to give some of this back today. By comparison Devon Energy, (DVN) rose by 6%, or $2.52 in the market yesterday. Another domestic energy play, Pioneer Natural Resources, (PXD), added $5.74 per share to its capital base. Both companies are showing gains in pre-trading today.
In the next post tomorrow we will discuss a shale driller powerhouse that belongs in every energy investor’s portfolio.
Cheers, Dave
Disclosure: The author has long positions in PXD, DVN. Has not owned Shell for 2-years.
Disclaimer. Nothing I say in this article should be construed as investment advice. It may look or sound like it, but it is not. I am not a CPA/CFA and have no formal training/certifications/licences in either discipline. In these articles I present analysis and relevant information that an interested investors may find instructive. I may be bullish, bearish, or neutral and will discuss why, but I am definitely not recommending you buy or sell any security I discuss. Investors should always do their own due diligence before plunking down their hard-earned cash. They alone are responsible for their investing decisions.