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Royal Dutch Shell is the biggest player in LNG game

Royal Dutch Shell has the LNG assets to benefit from continued strong demand for natural gas

Jody Chudley is is a contributor to Agora Financial’s Outstanding Investments and Real Wealth Trader.

Jan 30, 2017

by Jody Chudley

The Play
“We’re more a gas company than an oil company. If you have to place bets, which we have to, I’d rather place them there.” – Ben van Beurden, CEO, Royal Dutch Shell, to Bloomberg Businessweek

I’m concerned about where natural gas prices are going to go over the next five years, and I don’t mean them shooting higher and pushing up my heating bill. If you have been paying attention, you will have noticed that the Montney formation, in northeastern B.C. and northwestern Alberta, is one incredible shale gas play. What pure-play Montney companies like Painted Pony, Advantage Oil & Gas and Crew Energy are doing and are capable of doing in terms of production growth is staggering.

But if we don’t get our liquefied natural gas (LNG) export ducks in a row, Canadian natural gas is going to be sold at rock bottom prices for years to come.

It isn’t like there won’t be plenty of demand for LNG globally. Exxon Mobil is forecasting that global consumption of liquefied natural gas will triple to 100 billion cubic feet per day by 2040. Asian countries with big populations and modest natural gas production will be relying on LNG imports to provide half of the natural gas they consume.

And those projections are based on how the world is currently viewed. I believe there is a strong possibility that China and eventually India will surprise us in how quickly they abandon coal to improve air quality. That would mean even more demand for LNG.

But, without new pipelines and LNG facilities on the B.C. coast, Canadian natural gas may end up being stuck. From an investors point of view, that could work well for other, more global, players in the market. The biggest in that game by far is Royal Dutch Shell. After acquiring BG Group for a cool US$54 billion, Shell has double the LNG capacity of its nearest rival, Exxon Mobil. In short, Shell has bet its future on LNG.

The Pick

Royal Dutch Shell (NYSE:RDS.A)

I mentioned the wave of Canadian Montney producers that are generating incredible production growth even with low natural gas prices. Ten years ago these companies didn’t even exist. Royal Dutch Shell has been around a little longer. The company was founded in 1833 by a man named Marcus Samuel. Originally, Samuel used his company to sell antiques before expanding into the importation of shells from the orient. It wasn’t until 50 years later that his two sons moved Shell into the oil and gas business.

It has grown into a blue chip company that is widely owned and widely followed. It might surprise you, then, to learn that this massive and durable company currently sports a dividend yield of 7.5 per cent. That kind of yield is extremely unusual and basically implies that the market believes the current dividend is unsustainable. Given the collapse in oil prices, that probably doesn’t seem surprising, but what we also need to consider is that Shell has not had a dividend cut since 1945. These oil and gas majors aren’t kidding when they say that they are committed to their dividends. Shell went through sub-$10 per barrel oil prices in both the 1980s and 1990s without cutting that dividend.

When I take a look at what Shell is planning to do in the coming few years, I have to say that it appears they can keep this dividend up. From generating free cash flow of only $12 billion per year from 2013-15 while oil was $90 per barrel, Shell is expecting to increase that to $20 billion to $30 billion in 2019-21 with oil at only $60 per barrel.

The key to achieving this is that annual capital spending, which peaked at $57 billion in 2013, will be dropping under $30 billion in the years going forward. The company will massively reduce spending by cutting back on enormous long-lead-time mega-projects and by squeezing every penny out of the money it does spend. There is nothing like necessity providing the incentive to create radical improvements in cost efficiency.

The Postscript

A big fly in the ointment of Shell’s long-term plans could be LNG pricing. There will be demand growth, but the problem could be how efficient Shell and its competitors continue to become at producing oil and natural gas.

LNG prices, which are linked to oil pricing, have taken it on the chin in recent years. That means that not only does Shell need to worry about massive amounts of natural gas coming from shale flooding the market, it also needs OPEC to stop overproducing to get oil prices up.

Having to rely on OPEC to do anything is not a comforting position to be in. At least for shareholders of Shell, you know that you are invested in a company that, having been around since 1833, has lived through a few challenges.

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