Shell is having a use-of-cash flow crisis

No one does embarrassment of riches quite like the oil and gas industry. Amid a cost of living crisis, Shell has the opposite problem: the UK-listed energy group made a record annual net profit last year of almost $40bn, double an already banner year in 2021.

That translated into organic free cash flow of $48bn, up nearly 80 per cent after oil and gas prices soared following Russia’s invasion of Ukraine. The questions about how Shell and its peers are deploying that haul aren’t getting easier to answer.

The first issue is tax. Last year, as Shell hailed a “momentous year” at its results, then chief executive Ben van Beurden initially pushed back on the calls from politicians for a windfall tax on oil and gas company profits. At the time, the government of the day was also resisting the idea, before folding on the principle of windfall taxes, and then disintegrating all together.

There will be more political aggro to come. Labour is calling for a stiffer windfall tax, backdated to the beginning of the price spike and at a higher rate. Shell is paying more tax, thanks to windfall levies in the UK and Europe. But its cash taxes paid of $100mn in the UK, expected to increase to $500mn this year, won’t silence the critics.

The trickier question for management is how Shell and others are choosing to spend their spoils. Shell returned $26bn to its investors last year, of which over $18bn came through purchases of its own shares. True, that was boosted by the sale of its Permian basin business in 2021. But the company on Thursday announced a $4bn buyback plan for just the first quarter of this year. Buybacks have the potential to become the next political flashpoint, with think-tank IPPR calling for the UK to follow the US and Canada in levying a tax on share repurchases.

Shell and its peers face an almost impossible task in terms of continuing to provide an increasingly detested product that the world still desperately needs, investing in new technologies that give the business a future, and promising enough to sceptical investors to keep them on board for the ride.

But it is awkward that Shell handed more back to its shareholders last year than it invested in any type of future energy, clean or dirty: its overall capital expenditure was about $24.8bn, of which just $3.5bn was spent in its renewables and energy solutions business, up 47 per cent on the previous year.

The company says that doesn’t fairly reflect spending on low or zero carbon technologies, which also sit in its marketing or chemicals units for example: it points out that a third of its operating and capital spending combined is focused on low carbon products or services. It expects to keep renewables investment about the same this year, and its overall guidance for $23bn to $27bn in capital expenditure is unchanged.

The impression is of a company with boatloads of cash and few easy ways to spend it. It can’t keep paying down debt forever. Oil and gas companies need strong balance sheets to ride out increasingly volatile cycles but Shell’s net debt has nearly halved since the end of 2019. Its gearing is the lowest since 2009, notes Citi.

Investors, basically, don’t want more investment. New chief executive Wael Sawan talks about the need for a “balanced energy transition”, code for “we must still spend in oil and gas”. But history suggests that with oil prices at these levels “anyone who sanctions a huge capex budget . . . regrets it,” says Bernstein’s Oswald Clint.

Sawan also argues that the world (including governments, customers and energy companies) is moving too slowly on the energy transition, which grates against unchanged investment plans. There could be a strategic shift, or clearer targets, at his first investor day in May. But it is no secret that big energy groups have struggled to find green investments offering attractive returns.

Not long ago the concern was that major oil companies didn’t have the cash flow to invest in fossil fuels, grow in green businesses and give shareholders the returns demanded. Now the reverse is true, in spades. It’s not much clearer how they want to handle it.

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