Morning Note: Market news and an update from Shell and BP.
Market News
Non-farm payrolls rose by 254,000 from the previous month in September, soaring past expectations of a 140,000 increase, and the unemployment rate unexpectedly fell to 4.1% (vs. 4.2% forecast). The data relaxed concerns of a weaker labour market that arose after softer reports in prior months, capping the Fed’s urgency to lower interest rates at an aggressive pace and limiting the magnitude of cuts that the central bank is expected to deliver in the current cycle. Treasuries sank in response – the 10-year now yields almost 4% – while the dollar climbed. Gold has drifted to $2,650 an ounce.
In Asia this morning, equity markets kicked off the week on a positive note on optimism about the health of the US economy and speculation that stimulus will finally kick-start growth in China: Nikkei 225 (+1.8%); Hang Seng (+1.3%); Shanghai Composite (holiday). Goldman upgraded Chinese stocks to overweight with a 15%-20% upside potential if authorities deliver on policy measures. Onshore markets reopen tomorrow after a week-long holiday, with MLIV seeing equities jumping at least 2%-3%.
The FTSE 100 is currently little changed at 8,305, while Sterling trades at $1.3108 and €1.1951.
After a very strong week, Brent Crude has settled at $78.40 a barrel as traders weigh Israel’s potential retaliation against Iran. Rio Tinto said it’s in talks to buy Arcadium in a deal Reuters said would value the lithium miner at up to $6bn.
German factory orders slumped by 5.8% month on month in August, well below the forecast for a 2.0% decline. The ECB will “quite probably” cut rates at its meeting this month, Francois Villeroy told La Repubblica.
Source: Bloomberg
Company News – The Oil Majors
Shell has this morning released a Q3 2024 update note and an overview of the group’s current expectations for the quarter. Full details will be published with the Q3 results on 31 October. Having declined for most of the year, the shares have recovered somewhat of late following the bounce in the oil price. In response to today’s update, they are little changed 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.
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.
In the period 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 $1bn was achieved in 2023. 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.
· 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 30 September 2024:
· In the Integrated gas division, trading and optimisation results are expected to be in line with the previous quarter. Integrated gas production is forecast to be 920-960kboe per day.
· Upstream production was 1740-1840kboe per day. Exploration well-write offs are expected to be around $0.1bn.
· Marketing results are expected to be in line with the previous quarter.
· Chemicals sub-segment earnings are expected to reflect a marginal loss. Trading and optimisation in the division is expected lower than the previous quarter. This is despite the fact that margins will be slightly higher ($164/tonne vs. $155/tonne). Refining margins ($5.5 a barrel ) are expected to come in well below the previous quarter ($7.7 a barrel).
· Renewables and Energy Solutions is expected to generate between a loss of $0.4bn and a profit of $0.2bn.
The balance sheet is strong and the company targets AA credit metrics through the cycle. At the end of the June quarter, net debt stood at $38.3bn, with gearing at a comfortable 17%. Further details on the group’s current gearing will be provided with the results on 31 October.
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 point is around $40 per barrel (vs. $78 currently) and the group is targetting 4% growth annually.
At $50 a barrel, share buybacks will be undertaken as a priority to debt reduction as management believe the shares are undervalued. The latest $3.5bn programme is expected to complete by the end of October and a new programme is likely to be announced with the Q3 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 shares remain on an undemanding valuation (PE 8x), both in absolute terms and relative to its US majors, 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
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We also note this morning a Reuters report that BP is planning to abandon its 2030 oil and gas output reduction target when the new CEO unveils his new strategy in February. The company is also set to scale back its energy transition strategy in a bid to regain investor confidence. When unveiled in 2020, BP’s strategy was the sector's most ambitious with a pledge to cut output by 40% while rapidly growing renewables by 2030. BP scaled back the target in February last year to a 25% reduction.
The company is now expected to target several new investments in the Middle East and the Gulf of Mexico to boost its oil and gas output. It is currently in talks to invest in three new projects in Iraq and is considering acquiring assets in the Permian shale basin to expand its existing US onshore business.
The move comes in response to the group’s poor share price relative to its industry peers as investors have questioned the company's ability to generate a return on investment under its current strategy. In recent months the company had already paused investment in new offshore wind and biofuel projects and cut the number of low-carbon hydrogen projects down to 10 from 30.
The group is scheduled to release its Q3 results on 29 October, although in the meantime there may be a trading update this week.