Shell in shape for the year despite Q4 let down

Shell’s sharply lower than forecast profit doesn’t entirely spoil what the group calls a “good cash flow performance”, but it still has explaining to do for allowing market views to drift wide of the mark by $1bn. The unexpected $500m tax impairment charges that the group points to as having “impacted” profit are only a partial explanation.

With profit excluding items at $1.8bn, against consensus for $2.8bn, unforeseen disruptions probably at least partly accounted for an additional $300m of the shortfall.

The exponential reduction in underlying cost trend—down $10bn since the BG acquisition—is welcome, though depreciation, depletion and amortisation expenses need attention. Except for a one-off spike in Q3 2015, making an easier comparison in Q3 2016, depreciation and financing expenses were 30% higher on average each quarter. It’s a marginal cost that is beginning to look like a missed opportunity.

The chance that annual income has bottomed now looks much better, however. The forecast ramp in LNG volumes in particular is only partially being priced by the market. We are also becoming less sceptical about the planned pace of divestments, with $15bn done, leaving Shell on track and on time. Obviously there’s been some help from the oil price having doubled on the year to February. That means interest in assets for sale could still soften if the crude oil rebound stalls.

Still, as cash flow surges almost 70% in the year to Q4, production rises by about a quarter and with capex discipline holding, the group can certainly point to a faster rate of improvement than its most closely matched rival, Exxon.

We believe Shell surpassed the U.S. supermajor’s production growth rate—though not total production—during 2016 and Shell’s reserve replacement doubling from the negative figure seen in 2015 backs this.

In a still uncertain and challenging environment for E&P with unexpected potholes of the kind Shell reported in Q4, the view that it is on track to surpass its main competitor in terms of shareholder returns is gaining currency, judging by Shell stock’s 50% rise in 2016 against Exxon’s 15.8%. Further palpable wins on cost control and cash flow at the Anglo-Dutch producer will make that story more credible in the year ahead.

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