Keeping it classy

Shell puts post-merger momentum to good use

Royal Dutch Shell is putting post-merger momentum to good use. As part of a strategy presentation on June 7, the Anglo-Dutch energy major added $1 billion to its targeted synergies from merging with gas group BG and pledged to create a "world class investment case". That sounds ambitious, but Shell has laid out a credible path to reduce its debt pile and boost returns.

Low oil prices are holding energy companies' feet to the fire. Shell is feeling the heat more than most after splurging $53 billion in cash and shares on its smaller rival. That has left the group run by Ben van Beurden with much higher net debt. Yet the BG deal seems to have become a spur for making cuts above and beyond those coming just from the takeover.

There are essentially five levers. The sagging oil price is the main one and is out of its control. Shell's ambitious $30-billion divestment plan, which includes exiting up to 10 countries, will also be tricky to achieve.

Shell is making good progress on three other fronts: capital expenditure, costs and production. Operating costs will be 20 per cent below the companies' combined spend in 2014. Capital expenditure will fall to $29 billion this year, and Shell has set a $30-billion ceiling in the next few years.

Add this all up, and Shell says it could make a return on capital employed of 10 per cent by 2020, assuming $60 oil. That compares to an average of eight per cent between 2013 and 2015 when oil prices averaged $90 a barrel. It is equivalent to some $20 billion to $25 billion in organic free cashflow a year, which suggests Shell can break even at an oil price of between $40 and $50 a barrel, estimate analysts at Barclays. The much coveted idea of a deal for a low-oil-price world may not be so far-fetched.