Weak Energy Prices Drag Down Shell

Europe’s largest oil company Royal Dutch Shell plc ( RDS.A - Analyst Report ) reported disappointing second quarter 2012 results, as depressed crude and North American gas prices more than offset higher upstream volumes and refining margins.

Earnings per ADR (on a current cost of supplies basis), excluding one-time items and gains or losses from inventories, came in at $1.82, below the Zacks Consensus Estimate of $2.13 and the year-ago result of $2.10. Revenues were down 3.5% to $117.1 billion.

Segmental Performance

Upstream: Upstream segment earnings during the quarter (excluding items) were $4.5 billion, down 16.9% from $5.4 billion (adjusted) earned in the year-ago period.

This primarily reflects the impact of lower liquids realizations, depressed natural gas prices in North America, higher depreciation and exploration expenses, muted trading contributions, together with planned maintenance activities that adversely impacted production. These factors were partly offset by higher output and better liquefied natural gas (LNG) realizations.

Upstream volumes averaged 3.1 million oil-equivalent barrels per day (MMBOE/d), up 1.9% from the year-ago period. Natural gas volumes rose 8.1%, while crude oil output dipped 3.4% from the corresponding period last year.

Crude oil contributed approximately 52% of total volumes, while natural gas accounted for the rest. Excluding the effects of lost production on account of divestments and other reasons, Shell’s output was 4% higher than the year-earlier level.

Production during the quarter compared with the year-ago quarter included volumes from new field start-ups and the continued ramp-up of existing fields, which boosted output by roughly 205 MBOE/d.

Shell’s worldwide realized liquids prices were 4% below the year-earlier level, while natural gas realizations decreased by 7%. In particular, natural gas prices in North America plummeted 52% from the year-earlier levels.

LNG equity sales volumes of 4.57 million tons were 5% lower than the year-ago quarter, mainly due to planned repair work (mainly in Nigeria and Australia), somewhat made up by enhanced output from the Qatargas 4 project and startup of the Pluto LNG development in Australia.

Downstream: In the Downstream segment, Shell recorded a profit (excluding items) of $1.3 billion as against adjusted earnings of $1.1 billion in the year-ago period. The uptrend reflects the impacts of lower operating expenses and increased refining realizations.

A rise in oil products sales volumes also helped the results of the Anglo-Dutch super-major. To some extent, these factors were offset by lower trading contributions and a reduction in Chemicals earnings.

Cash Flow

During the quarter, the group generated cash flow from operations of $13.3 billion, returned $3.7 billion to shareholders through dividends/share buybacks and spent $8.1 billion on capital projects.

Balance Sheet

As of June 30, 2012, the group had $17.3 billion in cash and $33.0 billion in debt (including short-term debt). Net debt-to-capitalization ratio stood at approximately 8.1%.

Outlook, Rating & Recommendation

Royal Dutch Shell – Europe's most valued oil company, ahead of BP plc ( BP - Analyst Report ) and Total SA ( TOT - Analyst Report ) – owns one of the largest integrated oil and gas businesses in the world. The group has operations all over the world and is involved in various activities related to oil and natural gas, chemicals, power generation, renewable energy resources and other energy-related businesses.

The Hague-based group continues to make solid progress with its long-term strategic plan that aims to cope with significant energy price fluctuations stemming from economic and political developments. With a capital expenditure war chest of $32 billion in 2012, the company’s financial and production growth plans are well on track.

Shell has been looking to boost returns and remain competitive by embarking on aggressive cost reduction initiatives, exiting unprofitable markets, refocusing its efforts on emerging economies and streamlining the organization.

In particular, the vertically-integrated energy entity said that its substantial investment in more than 20 key upstream projects under construction is expected to drive output during the coming years.

The company continues to strengthen its potential exploration acreage (including new liquids rich shale and deepwater plays), in addition to reviewing new integrated gas options in North America.

However, Shell is particularly susceptible to its high exposure to the downstream business, its major natural gas focus, as well as lofty capital spending, which may result in reduced returns going forward.

Royal Dutch Shell ADRs currently retain a Zacks #3 Rank, which translates into a short-term Hold rating. We are also maintaining our long-term Neutral recommendation on the stock.