Shell’s Focus on Natural Gas Will Pay in the Long Run

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The European oil major Royal Dutch Shell (NYSE: RDS-A) posted a surprise slump in profits recently, but that hasn’t deterred the company from investing heavily in liquefied natural gas and unconventional fuel sources. Shell is putting its bet on increasing energy demands from emerging economies in the future--in my mind, a good bet. The company’s annual income dropped by 6% to $27 billion as it missed analysts’ estimate for the fourth quarter. Shell posted a profit of $5.6 billion in the fourth quarter, a 15% increase, but considerably below analysts’ estimate of $6.3 billion.

Reuters has reported, citing local sources, that Spain’s leading oil explorer Repsol S.A (NASDAQOTH:REPYY) is prepared to sell its LNG assets in Canada, Trinidad and Tobago and Peru to Shell. China’s Sinopec, Russia’s Gazprom, France’s GDF Suez and India’s state owned GAIL were some of the firms reportedly interested in purchasing Repsol’s assets. Repsol has been trying to sell its $2.7 billion LNG business as part of its plan to sell $6 billion of its assets to avoid a downward revision in its rating to ‘junk.’ If that happens, then Repsol will become the only oil company in the world, out of the 30 leading oil and gas firms, with a rating below investment grade.

Meanwhile in India, Shell is also planning to invest up to $1 billion in the energy starved nation to develop a floating LNG terminal off the coast of Kakinada, Andhra Pradesh by 2014. The business is partnering with India’s energy giant Reliance Power. Shell currently has a 3.4 million ton LNG import terminal at Hazira, Gujarat which will be upgraded to 5 million tons by the end of the current quarter and 10 million tons over the next three to four years.

India has enormous energy needs--it currently imports 80% of its oil equivalent consumption annually--and its gas market is expected to grow rapidly from 58 billion cubic meters last year to 220 billion cubic meters by 2020. While Shell is more optimistic about its upstream Indian operations, the business, like other multinational organizations operating in the country, wants the government to do away with subsidies and let the market determine the price of fuel.  

The first steps of this have been taken. As with many things in India, there are very few things that change rapidly, so the draw down on the diesel as well as natural gas – mainly cooking gas – subsidy will take time to fully implement, if ever.  But in order to get the overhaul of the diesel subsidy through parliament an expansion of the cooking gas subsidy had to be accepted. 

In the meantime, in Ukraine, the government is preparing to sign a massive agreement of “at least $10 billion” with Shell for natural gas production and exploration, particularly shale gas, in what is going to be the biggest unconventional fuel deal ever. Ukraine wants to reduce its exposure to natural gas imports from Russia’s Gazprom. According to the U.S Energy Information Administration’s (EIA) data, Ukraine requires 44.17 billion cubic meters of gas but it produces only 20.38 billion cubic meters and ends up importing more than half of its consumption, mainly from Russia. Ukraine has around 1.19 trillion cubic meters of technically recoverable shale gas reserves, more than twice as much as the U.K; it would be absurd if it doesn’t use these to its advantage.

This would be the second time that Shell has come forward to tap into undeveloped shale gas reserves of an energy starved economy. Last year, the company revealed an enormous plan to invest $1 billion each year in China’s growing shale gas sector. Like China, Ukraine also wants a part of the natural gas boom that occurred in the U.S. The current Ukraine deal is going to be the next step following the shale gas exploration rights for Yuzivska field, which were awarded to Shell in May 2012. The company is expected to start actual exploration in 2013 after investing $400 million. Besides Shell, Chevron (NYSE: CVX) was also awarded a shale gas exploration tender and a consortium of investors led by Exxon Mobil (NYSE: XOM), which also includes Shell, are to explore the Black Sea off the nation’s coast.

The foreign firms, particularly Chevron, are facing stiff opposition due to environmental concerns related to fracking. But Eduard Stavytsky, Ukraine’s energy minister, wants to renegotiate their 2009 10-year natural gas supply agreement with Gazprom. The current developments are not going to have any impact on Ukraine’s gas imports in the short term, but in the long run they can completely change the country’s energy landscape.  Gazprom’s dominance over the European natural gas market is under attack from a variety of avenues, most notably the much cheaper gas now coming from Finnish state oil company Statoil which is giving leverage to countries like Ukraine in their re-negotiations. 

<table> <tbody> <tr> <td> <p> </p> </td> <td> <p>CVX</p> </td> <td> <p>RDS.A</p> </td> <td> <p>XOM</p> </td> </tr> <tr> <td> <p>Stock 6M</p> </td> <td> <p>+2.04%</p> </td> <td> <p>-7.20%</p> </td> <td> <p>-0.05%</p> </td> </tr> <tr> <td> <p>P/E</p> </td> <td> <p>8.6</p> </td> <td> <p>7.7</p> </td> <td> <p>9.1</p> </td> </tr> <tr> <td> <p>EPS</p> </td> <td> <p>$13.32</p> </td> <td> <p>$8.48</p> </td> <td> <p>$9.7</p> </td> </tr> <tr> <td> <p>Yield</p> </td> <td> <p>3.1%</p> </td> <td> <p>4.7%</p> </td> <td> <p>2.6%</p> </td> </tr> <tr> <td> <p>ROE</p> </td> <td> <p>20.5%</p> </td> <td> <p>14.9%</p> </td> <td> <p>28.6%</p> </td> </tr> </tbody> </table>

Of the oil majors, Shell’s high yield, willingness to get its hands dirty around the world in unconventional gas – especially working with China and its involvement in the LNG export terminals in British Columbia – and low multiple make it a valuable addition to the commodity portion of your portfolio. 

PeterPham8 has no position in any stocks mentioned. The Motley Fool recommends Chevron and Statoil (ADR). Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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