Shell: LNG Leadership Makes For An Attractive Risk/Reward

seekingalpha03-29

Following its Capital Markets Day 2023 and the appointment of new CEO Sawan, Shell has lowered the pace of its energy transition and now aims at stable production through 2030.Next to best-in-class ...

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pipeline.Due to its dominance in production and storage capacity, Shell's LNG trading is in a highly advantaged position to exploit global price arbitrage, alone contributing ~$2.4B in Q4 net profit.I am highly bullish on Shell's leverage to benefit from growing demand in LNG and realize higher natural gas prices in Asian and European markets. Initiate at Overweight (PT $90).   Carl Court Shell plc (NYSE:SHEL) has gotten its fair share of criticism over the past years, through its accelerated push into renewable energy generation in wind and solar power alongside the announcement to cut hydrocarbon production further every year. With the replacement of previous CEO van Beurden by Wael Sawan, previously the leader of Shell's Integrated Gas division, those plans have been significantly laxed with the new CEO aiming to keep liquids production stable through the decade and grow natural gas output. Helped by the new CEO's background, I estimate gas and LNG to be Shell's key value drivers in the future with the company already the global leader at ~17% of global supply in 2023. Through 2030 management aims to grow LNG sales by 25-30%, providing an attractive leverage on changes in the energy mix specifically in Asia and Europe. Alongside strong recent exploration efforts at peer-leading RRR, I view the company's leadership in LNG capacity and trading as a key competitive advantage and initiate my coverage of Shell at Overweight at a price target of $90 per US ADS (~34% upside). [Note: Peers generally refer to Exxon Mobil (XOM), Chevron (CVX), TotalEnergies (TTE), BP (BP), Eni (E) and Equinor (EQNR). All company targets from the 2023 Capital Markets Day and Shell's latest Annual Report. Shares are Shell's NYSE-listed ADS and financials in US$.] Company Overview Shell plc, previously known as Royal Dutch Shell is a London, UK headquartered global energy company operating in the Oil & Gas industry. Established in 1907 from the merger of Royal Dutch and Shell T&T, the company is the third largest of the Supermajors with a current market cap of ~$214B, placing it behind US peers ExxonMobil and Chevron and ahead of EU majors TotalEnergies and BP. As of 2024 Shell operates in over 70 countries on all continents except Antarctica and employs ~100k people. As an integrated major, the company's activities span the entire energy value chain including exploration, production, refining and marketing. Shell is also involved in renewable energy ventures, including wind and solar, although those investments have been scaled down significantly following the recent CEO change. Upstream (\"UP\") - Shell's Upstream division is responsible for the exploration, development, and exploitation of hydrocarbon resources globally, focusing on oil and liquids. Despite operations spanning across various regions and asset types, Shell has a clear skew towards offshore and deepwater assets with a strong footprint in the GoM, Brazil's Pre- and Post-Salt, the West African continental socket and the North Sea. Notably, Shell has zero exposure to shale since divesting its Permian assets to ConocoPhillips (COP) for a consideration of $9.5B in 2020. In 2023, the Upstream division achieved a total hydrocarbon production of ~1.8Mboed of which 1,325Kboed were comprised of liquids (mostly crude oil) for a 74% liquids share. Total production was down ~5% from 1.9Mboed in 2022 on asset divestments mainly in gas production (-16% YoY) while natural field decline was more than offset by new growth in liquids. Key recent developments in the segment include the January 2024 negotiated ~$2.4B sale of Shell's highly troubled operations in onshore Nigeria's Niger delta, where oil spills and other issues had created a series of PR problems for the company. Notably however, Shell will continue to operate its highly promising offshore developments with ~150Kboed worth of new liquids-rich production currently under evaluation. UP Global Operations (Shell IR) Integrated Gas (\"IG\") - The Integrated Gas division is a leading player in the global gas industry that is active in the exploration and production of natural gas as well the entire LNG supply chain through liquefaction, shipping and regasification. In 2023, IG averaged a daily hydrocarbon production of ~0.9Mboe of which 86% was comprised of natural gas for a volume of 4.7MMcfd. Further, the division achieved a total LNG production of ~28.3MTpa and sales of ~67MT, roughly 17% of global LNG supply (401MT). Next to production of gas and LNG, the segment also houses Shell's sizeable LNG and Natural Gas trading desks which continue to deliver industry-leading results and make the segment a vital asset to Shell's long-term LNG strategy. IG Global Operations (Shell IR) Marketing (\"MK\") - This segment is active in the global distribution of gasoline, middle distillates, lubricants and other petroleum-based products to retail and business customers. For FY23, total sales of petroleum-based products were ~2.5Mboed, up 2% from 2022 on higher global aviation demand and stronger volumes in European automotive fuels. Retail customers are served through a global network of ~47k Shell-branded gas stations of which around half are located in the Americas (mainly US, Brazil) and ~17% are in Europe. Chemicals and Products (\"CP\") - Shell's CP division includes the other half of its downstream operations being active in both refining and petrochemicals. It also houses the company's oil and petroleum products trading desks. The segment has interests in eight refineries worldwide, with capacity to process a total of ~1.6Mboe. FY23 utilization rate was 85%, lower than Supermajor and independent refining peers but in-line with Shell's previous years. Notably, Shell's refining footprint is significantly less US-heavy than that of peers including British bp with only ~15% of refining capacity located in the US while it continues to be a major player in continental Europe (~60% of capacity across Germany and the Netherlands). The segment is also one of the largest global producers of base petrochemicals with total sales volume of ~11.2MT in 2023, down significantly from 2022 on lower demand and oversupply. In Ethylen Shell is the second largest producer among the Supermajors only behind Exxon with total YE23 capacity of ~8.1MTpa. By far the company's largest asset in petrochemicals is the Shell Polymers Monaca project in Pennsylvania with a total capacity of 1.5MTpa in Ethylen alongside a further 1.6MTpa in Polyethylen. The project was finalized in November 2022 however due to major unplanned outages was not fully functional leading to significantly lower volumes. Currently, Shell expects the complex to return to full capacity and production by later H1 2024. Renewables and Energy Solutions (\"RES\") - This segment includes renewable power generation, marketing and trading of power and pipeline gas, as well as carbon credits. RES also includes hydrogen production and marketing, development of commercial CCS hubs and Shell Ventures, which invests in companies working to accelerate the energy and mobility transformation. Global electricity sales were up 15% YoY to 279TWh while pipeline gas sales dropped 12% to 738TWh on lower demand. While this segment used to be a significant corporate focus, under new CEO Sawan capex activity in the division was greatly reduced (-23% segment Capex YoY) with Shell also intending to scale down and eventually exit its retail electricity operations in most of Europe. FY23 Production and Reserves Shell's total Oil & Gas production averaged ~2.7Mboe per day with ~1.5Mboed contributed by liquids (including oil sands production) for a 55% share. Total gas output was ~7.5MMcfd. Compared to 2022, total hydrocarbon production fell by ~4% as gas volumes were ~5.3% lower YoY due to natural field decline and divestments. Liquids production actually grew by ~3% YoY as new developments in deepwater GoM and Brazil came online or reached peak production. Geographically, Shell maintains a comparably high exposure to the Middle East and Asia compared to specifically its US peers with ~35% of total production coming from the region and Oman alone contributing ~11%. With a focus on offshore developments in the Pre- and Post-Salt Campos and Santos basins, Brazil has emerged as Shell's single largest contributor with ~15% of total production, ahead of the US GoM and Australia (100% gas) at both ~13%. Other core producing regions are offshore Nigeria and, given Shell's legacy, the European North Sea where the company continues to redevelop older fields to stabilize production. FY23 Global Production Distribution (Company Filings) Looking at liquids as percentage of total production, Shell's deepwater assets in the US, Brazil and Nigeria continue to deliver highly oil-rich volumes significantly above the 55% company average while the European North Sea assets become increasingly gas heavy and Australian production consists entirely of gas.   Liquids Share by Region (Company Filings) Consistent with production split, Shell's ~9.8Bboe of proved reserves at YE23 are largely (~45%) located in Asia with North and South America making up the next largest shares. Further reserves are held in Australia (12%) while Europe and Africa together make up a similar amount.   FY23 Global Reserve Distribution (Company Filings) Key Investment Thesis Leadership in LNG provides attractive leverage to growing demand in APAC and Europe and regional pricing arbitrage. Through a significant investment spree in recent years Shell holds the clear global number one position in LNG, further supported by a promising and deep pipeline of projects extending well into the 2030s. As of YE23, the company had a total LNG production capacity of ~38MTpa, almost double that of Total and Exxon in the runners-up positions while Chevron and BP had significantly smaller footprints in the space. Major IOCs by LNG Capacity (Bloomberg Intelligence) With a total FY23 LNG sales volume of 67MT, Shell alone had contributed ~17% of global supply for the year which stood at ~404MT. Compared to next largest peer TotalEnergies, Shell's volumes were almost 1.5x with Total selling around 44MT for ~11% of global supply in 2023. Next to its pure scale advantage I also see Shell's LNG footprint as being highly geographically advantaged with ~56% in or with a favorable location towards East Asia which continues to be the worlds largest LNG importer. China alone is estimated to have imported over 71MT of LNG during 2023, up 11% vs 2022 and matching almost half of total EU, Turkey and UK imports at ~126MT. With the European gas crisis of 2022 a major catalyst, Shell has also scaled up production capacity in key Caribbean and North African LNG hubs to now has ~44% of capacity skewed towards European markets.   Current LNG Assets (Shell IR) As the majority of Shell's natural gas production is not being sold directly but being liquefied into LNG, I see a significant realization advantage versus specifically US peers as it holds almost zero exposure to weak Henry-Hub based pricing and full capture of favorable EU TTF and APAC Japan-Korea-Marker price environments. With cheap Russian gas removed from the European energy supply and rapid demand growth in Emerging Asia alongside coal-to-gas switching in China and other developed Asian economies, Shell predicts the current demand-supply imbalance to continue, making LNG a highly in-demand fuel and supporting prices well into the mid-century. Asia LNG Demand Forecast (Shell IR) Building on this outlook, Shell has a deep and promising pipeline currently under construction or evaluation. In total the company aims to add around 11MTpa of equity capacity through the end of the decade, including a 40% stake in the massive LNG Canada projects which aims to provide highly profitable exports of liquefied, cheap Canadian gas to East Asia. I expect Shell will increase its total LNG capacity by ~29% to 2030, implying almost 50MT of annual equity production capacity. Considering also projects currently under evaluation and in a pre-FID stage, Shell has the option to add a further 9.4MTpa of additional supply with a planned expansion to the Canada LNG project and a potential large-scale LNG hub in Tanzania to serve Indian and APAC markets.   LNG Project Pipeline (Shell IR) With the largest footprint in the space, Shell also has a highly effective and profitable LNG trading operation which I see as a further competitive advantage. Similar to (physical) oil or gas trading, LNG trading requires immense amounts of both storage and transport capacity in order to profit from price imbalances between major global markets. During Q4 2023 alone, Shell's LNG trading teams made ~$2.4B in net profit, or more than a quarter of the $7.2B in total group profit as it captured strong winter demand in Europe and exploited historically high East-West arbitrage. Management believes those trading teams, which rival the likes of Vitol, Gunvor and Trafigura (major independent energy trading houses) can continue their industry-leading performance on the back of Shell's competitive advantage in LNG capacity and infrastructure to provide a ~2-4% uplift to group ROCE in the long run. Derisking and upgrading of existing upstream portfolio focusing on core producing areas  Under new CEO Sawan, Shell has repeatedly stated its new commitment to keep liquids production stable through the end of the decade with gas production likely rising by low single-digits annually to support targeted growth in LNG. Coupling this with targeted divestments of lower-return assets, I estimate this will significantly upgrade the portfolio with the company aiming to focus all future development in existing key producing regions including Brazil, GoM and South East Asia.   Shell IR With 8 projects currently under development and scheduled for start-up (of which 5 to be operational through 2025), I see up to ~350Kboed of new liquids-rich production coming online at highly advantaged cash margins of ~$30/bbl breakeven to replace divested assets. Also including planned but pre-FID stage projects, I estimate a further ~260Kboed of production to come online later in the decade and the 2030s. Overall added production will amount to ~0.6Mboed or around 21% of current total output, effectively replacing divested assets and base decline beyond 2030.   Upstream Pipeline (Shell IR) With renewed O&G focus, R/P is likely to improve with Shell notably the only EU major to add reserves relative to YE21 The company has shown a strong recent performance in its reserve replacement, achieving an 120% RRR over the last 3 years, significantly above its EU peers which averaged ~67% over the period with only TotalEnergies exceeding Shell in FY23 at 141%.   Reserve Replacement Ratio (Company Filings) Building on its peer-leading exploration and development efforts, Shell was notably the only European major to have actually grown its total reserves from YE21 to YE23, improving portfolio depth by 4.1% from 9.4Bboe to 9.8Bboe. Including the impact of BP's Rosneft exit in 2022, total proved reserves have on average fallen by ~5.8% across the European majors with BP's reserves shrinking the most at -10.2% compared to YE21.   European Majors Reserves (Company Filings) However, despite the rise in R/P from 9.4 in 2021 to 9.9 years by 2023, Shell still remains below most of its peers with only depth-strained BP and Equinor having a lower reserve life. Specifically in liquids, Shell continues to lag behind all but gas-focused Equinor with just 8.6 years of current production covered by ~4.7Bboe in proved reserves while gas R/P is relatively on par with peers at 11.1 years. As liquids production was targeted to decline at mid single-digits through the decade prior to the company's strategy change in mid-2023 which now called for stable production to 2030, Shell's execution in the addition of new oil reserves will be a crucial item to monitor going forward. With the company delivering a peer-leading 120% RRR for the past 3 years however, I am confident that management can realign its reserve depth with the new business outlook and improve coverage in the near and mid term.   IOCs by Proved Reserves (Company Filings)  IOCs Production Coverage (Company Filings) N5Y Production Forecast Following the shift in strategy, I now estimate Shell's overall production to slightly grow at ~1.1% CAGR through 2028 which is higher than what I expect for BP (-1%) but lower than its EU peer TotalEnergies (~1.7%) and the US Supermajors (5%+). I expect this growth to mainly come through additions to natural gas production in line with CEO Sawan's remarks on keeping a stable liquids production through at least the end of the decade. I see gas volumes rising at ~3% p.a. on a deep pipeline of production expansion and infill projects as well as the need to fuel expanding LNG production with Shell's global sales volumes estimated to grow at ~3.7% CAGR through the period. Shell Production Forecast (Company Filings, WSR Estimates) Valuation On the back of its vertically integrated business model, I value Shell on a Sum-of-the-Parts (\"SOTP\") basis with separate valuations for its upstream (not equal to the UP division), downstream and renewable power operations adjusted for non-allocated corporate expenses. Upstream To value Shell's upstream business, I use a NAV model which I recently introduced in my initiation of Chevron (see here) and which I aim to implement further across my entire Oil & Gas coverage. Refer to this note for more in-depth and fundamental description of the methodologies and assumptions used. Key differentiators are a lower assumed decline rate at 7% for liquids and 5% for gas due to Shell's 100% exposure to conventional and heavy oils as well as the removal of NGLs as a separate category since European firms do regularly report on those and incorporate them in their liquids category. Since Shell does still produce some amount of NGLs (~5-10%) I apply a 5% haircut to realized liquids revenues to account for lower selling prices on NGLs. Shell realized a gas price of ~$8/Kcf during FY23 which is significantly higher than its US and EU peers due to the strength of its LNG business and the higher price capture associated with it. I assume a gradual rise through 2028 towards a long term $10/Kcf, aiming to represent my expectations for Shell's continued dominance in LNG and thus higher exposure to European TTF and Asian JKM pricing as opposed to US Henry Hub. Discounting all cash flows at a standard 10% cost of capital and applying a 35% tax rate as opposed to the 25% for US O&G, I calculate a total NAV of $205B for Shell's hydrocarbon producing operations. Shell NAV Model (Company Filings, WSR Estimates) Adding current undeveloped acreage which I estimate at a very conservative $2,000/acre in the US (mostly offshore GoM) and $1,000/$5000 per acre in other Americas and RoW locations, I obtain a total EV for Shell's upstream business of $259B, implying every FY23 flowing barrel to be worth ~$94 and every boe of YE23 reserves to contribute ~$15 in value.   Shell Upstream EV and Implied Multiples (Company Filings, WSR Estimates) Downstream and Renewable Power  For my valuation of Shell's downstream business I use multiples on FY23 generated EBITDA with my assumption of downstream being the MK and CP segments as well as 70% of IG to account for the division's significant and growing exposure to LNG production and trading. Valuing the resulting $30.4B in FY23 EBITDA at 4.5x which is below what I use for peers given Shell's ongoing lower downstream profitability (1.9% net margin vs IOC average ~3%), I see the downstream business worth as much as $137B. Valuation the RES segment, which generated ~$1.4B in FY23 EBITDA, I use a peer average multiple across EU gas and renewable utilities (OTCPK:IBDSF, OTCPK:DNNGY, OTCPK:ENGGF and OTCPK:SNMRF). At 11.0x FY23 EBITDA I see the segment worth as much as $16B although this valuation is heavily dependent upon Shell's future commitment to the segment with FY23 capex figures and management remarks indicating a smaller focus in coming years.   EU Gas and Renewable Utilities Multiples (S&P Market Intelligence) I further value the corporate segment, which in FY23 had ~$1B in negative EBITDA, at Shell's current 5.6x EV/EBITDA for a total negative $6B. SOTP Combining all segments gives a total $405B in SOTP Enterprise Value which, adjusted for net debt and minority interests, yields an Equity Value of $361B. Given the regulatory and political risks associated with European oil companies as well as the general lower scope of Oil & Gas institutional investment in Europe, I assign a 20% fair value discount for an adjusted Equity Value of $289B or $90 per US ADS (~34% current upside).  Shell SOTP (Company Filings, WSR Estimates)","kind":null,"is_publish_news":null,"is_publish_highlight":null,"is_publish_live":null,"is_publish_wemedia":null,"editions":null,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.22.4","shortVersion":"4.22.4","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2423441961"}