Shell set out a striking scenario as it gave a vision of its long-term future this week: over the next five years, the UK energy major may end up buying back as much as 40 per cent of its shares.
In an effort to boost its valuation to the level of its US rivals ExxonMobil and Chevron, the company is already spending more on its shareholders than on its future growth. Last year it allocated $23bn on dividends and buybacks and $21bn on capital expenditure.
The pivot from growth to value is a far cry from the grandiose but now abandoned plans that Shell had to become a top player in electricity and diversify from oil and gas to be at the forefront of the world’s shift to clean energy.
Now it plans to tilt the balance further, offering to return up to half of its operating cash flow to shareholders. Sinead Gorman, Shell’s chief financial officer, told an audience at the New York Stock Exchange on Tuesday that the company had heard what investors wanted: “Everyone is clear: keep giving more,” she said.
Investors, in turn, have rewarded Shell. The company’s shares are up more than 20 per cent since Wael Sawan became chief executive at the start of 2023.
But there are questions about where Shell’s long-term growth will come from, and how it will be positioned beyond the next five years, as its oilfields in the Gulf of Mexico and Brazil begin to decline.
Asked if Shell was in danger of self-liquidation if it kept cancelling so many shares, Sawan simply said he was comfortable with a much smaller number of investors sharing the company’s future “glory”. “They will be much richer than they are today.”
He has slimmed down the company, refocused it on oil and gas, slashed spending on clean energy and promised consistency. He has cut a swath through the company’s bureaucracy and seized control of all major spending decisions from its powerful division heads.
“We need to be able to look unemotionally across our businesses and make sure that capital is allocated to the opportunities with the most running room,” he explained to the Financial Times. “That’s best done around the CEO and the CFO table.”
As a result of its new discipline, Shell has now bought back more than $3bn of shares per quarter for 13 quarters in a row. This week, Sawan insisted that he could maintain this consistency with a higher rate of distributions even if the oil price starts to wane from its current level of about $70 a barrel, saying the “divvy break-even” was $40 a barrel.
But despite all his efforts, investors looking at the oil and gas sector still prefer American companies. Shell’s market value is five times its debt-adjusted cash flow, while ExxonMobil’s is 9.2 times and Chevron’s is 9.6 times.
The problem is not specific to Shell, it applies to all European energy companies. Despite consistently generating more free cash flow per share than their US counterparts for the past five years, investors do not trust them to spend the money wisely.
Explanations for the valuation discount include the fear that companies will burn cash on unsuccessful clean energy projects, their lack of access to high-margin US oilfields, and the generally lower flows of money into European markets.
In addition, US companies are also returning even more cash to shareholders than Shell. Last year Exxon spent 65 per cent of its operating cash flow on buybacks and dividends.
Exxon can return more money partly because it has a lower break-even oil price than Shell. Exxon is aiming for a break-even price — the minimum amount of revenue needed to cover spending — of $30 a barrel by 2030 compared with Shell’s $35 a barrel, according to the companies.
Asked if he could reach a similar level of shareholder distributions to Exxon, Sawan said he was “not looking at dialling up one part of the financial framework” and that he wanted to balance shareholder returns against investing for growth and keeping “a pristine balance sheet”.
Instead, Sawan is trying to answer two key questions from investors: What makes Shell different from its US rivals, and what does the company look like in the long term, after the world’s demand for oil peaks and starts to wane?
“The longevity question has been a big question,” he said to analysts on Tuesday. “When you walk out of the room today, you will have line of sight not to 2028 only but to 2040. We are playing this game for the long run, not trying to get a sugar rush for our share price in the short term.”
His answer, which also differentiates Shell from its oil-heavy US rivals, is that the company believes gas is a better long-term bet. Shell is forecasting a 60 per cent rise in demand for gas by 2040, as fast-growing Asian economies start to increase their consumption.
Already the world’s biggest trader of liquefied natural gas, Shell said it would increase its sales by 4-5 per cent a year through to 2030. “The number one pillar of our vision is to be the world’s leading integrated gas and LNG player,” he said. “We have a real competitive advantage that is going to be incredibly difficult for anyone to replicate.”
Another point of difference from its US peers is Shell’s trading operation, a business that the company has traditionally kept under tight wraps. Sawan revealed this week that his traders have not lost money in any single quarter over the past decade, and that they delivered an average return on capital employed of 2 per cent in that time, and may contribute up to a 4 per cent return going forward.
Martijn Rats, an analyst at Morgan Stanley, said on a back of an envelope calculation, the numbers suggested that trading represented “more than a quarter, less than a third” of future earnings, making it “one of the very largest businesses in all of Shell”.
Even though it was cutting its capital spending to pay for more buybacks, Sawan also said Shell could bring a million barrels a day of new oil and gas online in the next five years at the break-even price of $35 a barrel, allowing it to slightly increase its overall production after accounting for the retirement of old fields.
And he promised further consistency: “You will see us working our backsides to make sure we deliver what we have said we will do. We want to make this an exciting story for you.”
But while analysts were positive about the strategy, few thought that Shell would fully close the gap with its US rivals.
“I don’t think Shell should trade in line with Exxon. Fundamentally, Exxon has proven to be a better steward of capital over a longer period of time,” said Biraj Borkhataria at RBC Capital Markets. “The discount has moved from 45 per cent to 35 per cent under Wael Sawan. Could that discount be 20 per cent? I think so.”
The prospect of moving the listing to New York, an option that Sawan said was on the table a year ago to boost the valuation, was no longer a “live discussion”, with most observers concluding that US investors already had easy access to Shell stock, if they wanted it.
“The stock will clearly re-rate,” added Irene Himona, head of European oil & gas at Bernstein. “But not overnight.”
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