Morning Note: Market news and an update from Shell.
Market News
US equities reversed gains from the previous session last night – S&P 500 (-1.1%); Nasdaq (-1.9%) – as growing concern about inflation led to a selloff in Treasuries. A report on US service providers showed inflation hitting the highest since early 2023, fuelling speculation the Federal Reserve won’t cut rates before July. The 10-year Treasury currently yields 4.67%, while an auction of 10-year notes drew the highest yield since 2007. Gold trades at $2,650 an ounce.
Geopolitics remain elevated – Trump escalated threats over absorbing Canada and declined to rule out using military or economic coercion to seize Greenland and the Panama Canal, erasing any doubt he plans to take foreign policy to precedent-shattering levels. The president-elect also said NATO nations should spend the equivalent of 5% of their economic output on defence, more than double the current target.
In Asia this morning, equities were generally lower with investors fearful of an anticipated hike in US tariffs: Nikkei 225 (-0.3%); Hang Seng (-0.9%); Shanghai Composite (flat). The PBOC set its yuan reference rate at the strongest compared to estimates since April.
The FTSE 100 is currently little changed at 8,245, while Sterling trades at $1.2441 and €1.2056. Brent Crude rose to $77.40 a barrel.
The German economy remains subdued – November industrial orders fell 5.4% versus a flat estimate, while retail sales fell by 0.6%, versus a 0.5% rise expected.
Source: Bloomberg
Company News
Shell has this morning released a Q4 2024 update note and an overview of the group’s current expectations for the quarter. Full details will be published with the full-year results on 30 January. The company highlights that trading in some parts of the business is slightly below previous guidance. Having declined for most of the last year, the shares have recovered somewhat of late following the bounce in the oil price. In response to today’s update, they are down 1% in early trading.
Shell is a global integrated energy company with expertise in the exploration, production, refining, and marketing of oil and natural gas, and the manufacturing and marketing of chemicals. The group is also allocating capital to low and zero carbon products and services including wind, solar, advanced biofuels, EV charging, hydrogen, and carbon capture & storage. According to Brand Finance Global 500, Shell is the most valuable brand in the industry, valued at around $50bn.
The business is divided into five segments:
· Upstream (i.e. E&P) explores for and extracts crude oil, natural gas and natural gas liquids. Shell has best-in-class deepwater assets complemented by resilient conventional assets in the Gulf of Mexico, Brazil, Nigeria, UK, Kazakhstan, Oman, Brunei, and Malaysia.
· Integrated Gas includes liquefied natural gas (LNG), conversion of natural gas into gas-to-liquids (GTL) fuels, and other products. Shell is the global leader in LNG (achieved through the 2016 acquisition of BG), a critical fuel for the energy transition, with a business that spans upstream, liquefaction, shipping, marketing, optimising, and trading.
· Chemicals & Products is made up of a focused set of assets – there are currently five energy and chemicals parks (i.e. integrated refining and chemicals sites) and seven chemicals-only sites.
· Marketing includes mobility, lubricants, and decarbonisation. In addition to the service stations with their EV charging footprint, Shell is the global number one lubricants supplier and operator of assets is renewable natural gas, sugar cane ethanol, and biofuels.
· Renewables & Energy Solutions includes Shell’s production and marketing of hydrogen, integrated power activities (solar and wind), carbon capture & storage, and nature-based projects. The assets are helping to reduce the carbon intensity of the group’s hydrocarbon product sites. Last month, the group said it was stepping back from new offshore wind investments and is splitting its power division following an extensive review of the business.
The group’s strategy (Powering Progress) is to invest in providing secure supplies of energy, while actively working to reduce carbon emissions at a time of macroeconomic and geopolitical uncertainty. The focus is on ‘value over volume’ – the group will take advantage of opportunities where it has competitive strengths, existing adjacencies, a track record, strong customer demand, and clear regulatory support from governments. Where the company is not ‘advantaged’, it won’t invest.
In the two years to the end of 2025 (known as the First Sprint), the company is seeking to:
· Improve performance and increase efficiency, with annual operating costs reducing by $2bn-$3bn by the end 2025, of which $1.7bn was achieved by H1 2024. We believe this could prove to be prudent.
· Increase investment discipline – capital investment (organic spend and M&A) will reduce to $22bn-$25bn p.a. over 2024 and 2025, with around a quarter for low carbon solutions. Every investment is benchmarked against the value of share buybacks.
· Simplify the portfolio through the sale of high-cost and lower-return businesses.
· Generate free cash flow per share growth of 10% p.a. through to 2025 and free cash flow growth on an absolute basis more than 6% p.a. between now and 2030.
Today’s statement highlights that in the three months to 31 December 2024:
· In the Integrated gas division, trading and optimisation results are expected to be significantly lower than the previous quarter driven by the (non-cash) impact of expiring hedging contracts. The forecast for integrated gas production has been trimmed to 880-920kboe per day due to scheduled maintenance at Pearl GTL in Qatar.
· Upstream production was 1790-1890kboe per day. Exploration well-write offs are expected to be around $0.4bn.
· Marketing results are expected to be lower than the previous quarter, reflecting seasonality.
· Chemicals sub-segment earnings are expected to reflect a loss in Q4, driven by a decline in chemicals margin from $164/tonne to $138/tonne. Trading and optimisation in the division is expected to be significantly lower than the previous quarter, reflecting seasonality. Refining margins ($5.5 a barrel) are expected to be in line with the previous quarter.
· Renewables and Energy Solutions is expected to generate a loss of between $0.6bn and $0.1bn.
· The company will take $1.5bn-$3bn of non-cash, post-tax impairments including $0.8bn-$1.2bn in its renewables division.
The balance sheet is strong, both in absolute terms and relative to the peer group, and the company targets AA credit metrics through the cycle. This provides resilience regardless of the industry or operational backdrop. At the end of the September quarter, net debt stood at $35.2bn (down from $40.5bn last year and half the level of 2019), with gearing at a comfortable 15.7%. Year-end net debt is expected to include $4bn-6bn of new lease liabilities recognised in Q4, including the recognition of the LNG Canada pipeline liability. Further details on the group’s year-end gearing will be provided with the results on 30 January.
Shell’s current policy is to return 30%-40% of cash flow from operations (CFFO) to shareholders through the cycle through a combination of dividends and share buybacks. The group’s dividend breakeven is around $40 per barrel (vs. $77 currently) and the group is targetting 4% growth annually.
At $50 a barrel, share buybacks will be undertaken as a priority to debt reduction and capital investment as management believe the shares are undervalued. The latest $3.5bn programme is expected to complete by the end of January and a new programme is likely to be announced with the Q4 results. Total shareholder returns are expected to amount to more than 10% of the current market cap.
We believe decarbonisation can’t happen at the flick of a switch – oil and gas will remain part of the global energy mix for decades, with demand driven by population growth and higher incomes, particularly in developing countries where the desire for energy intensive goods and services like cars, international travel, and air conditioning is rising. We also believe the production of the materials needed to transition to net zero can’t happen without using hydrocarbons. At the same time, reduced investment in new production, partly because of environmental concerns, and natural decline rates, are increasingly leading to constrained supply.
In common with all the oil majors, Shell is looking to reduce emissions in a way that delivers attractive returns for shareholders at a time of macroeconomic and geopolitical uncertainty. The company does this from a position immense financial strength. The shares remain on an undemanding valuation (PE 8x), both in absolute terms and relative to its US peers, which fails to discount the potential for free cash flow generation and shareholder returns. We believe they also provide something of a hedge against inflation.
Source: Bloomberg