Shell crystalizes billions of dollars of losses in Canadian Duvernay project sale.
Second multi-billion-dollar loss
crystallization for Shell in a year.
Seems to be focusing on the E in ESG over the G.
Shell is continuing the race to the bottom by oil majors I first identified in “Covid-19 Breaks the Super Major Business Model” and then expanded on in Shell (RDS.A RDS.B) specific analysis. Shell lost billions of dollars recently in yet another fire-sale of assets, this time to Crescent Point (CPG) in the Duvernay in Alberta, Canada. Selling quality assets at less than 3x cash flow, especially assets with low breakeven and sustaining capital costs in the midst of a cyclical downturn, is questionable at best. Doing so repeatedly, and then warning that most of the remaining assets will be depleted soon, is indicative of either extreme financial duress or governance failure. Despite governance being unfortunately overlooked, governance is the third letter in the ESG acronym: failing at governance means Shell is, by definition, failing at ESG.
I highlighted this problem with Shell’s business model and apparent go-forward strategy in August 2020, after an $18 billion dollar loss and I identified serious issues when Shell realized a loss of $4.1 billion in the Marcellus earlier that year. The ostensible purpose and strategy of oil and gas super-majors are to behave counter-cyclically. Leveraging strong balance sheets and low costs of financing to acquire distressed assets in cyclical downturns and monetizing those assets in up-cycles – either through sales or through producing out the reserves and using proceeds for dividends and share repurchases.
Shell and others’ inversion of this, selling assets and crystallizing huge losses at a low point in the cycle, indicates a deviation from this business model. With a continued extremely low cost to borrow, it appears this is not driven by financial distress:
Source: Shell website – “outstanding bonds”
This recent transaction, the sale of the Duvernay asset to Crescent point, continues the trend of crystalizing large losses. This one is even more troubling than the Marcellus sale because it is priced almost as cheaply as transactions completed at the bottom of the cycle, but the oil price has recovered somewhat and is closer to multi-year highs than lows:
The astute observer will notice that the Duvernay asset is economically weighted to liquids while the Marcellus asset is gassy, but Shell’s economic position was far stronger in February 2021 than in May 2020, due to higher oil and liquids prices, as well as higher global natural gas prices relevant to their LNG business. Crystallizing multi-billion dollar losses is generally problematic in the context of the Super-Major business model, but is at least more easily understood in a more strained economic situation than in the context of recovering hydrocarbon prices.
Shell appears to recognize the inconsistencies inherent in a downcycle asset sale through its disclosures in its announcement press release:
Shell has approximately 500 producing wells in the Groundbirch acreage in Northeast British Columbia, of which roughly 75% of those wells have joint venture ownership, and the Gold Creek asset in the wet Montney play where Shell has about 40 wells on-stream, averaging approximately 4,000 boe/d.
Shell’s global Upstream strategy aims for a more focused, competitive, and resilient portfolio to deliver cash. It includes nine core positions globally and lean Upstream positions that will either mature into core positions, be repurposed, or be monetized through divestment.
In Shales, Shell has built resilient, low break-even positions by focusing on high-margin tight oil positions and low-cost gas assets. In the Permian, Shell has a very attractive position. Shell’s acreage lies in areas with the thickest formations and provides more than 50% of total Shales production.”
Source: Shell press release
However, having 500 producing wells in British Columbia is not relevant to selling dozens of highly economic wells and a large acreage tract in Alberta. And “aim[ing] for a more focused, competitive and resilient portfolio” is a solid aspiration, but until recently the Duvernay asset was listed as one of the “core positions globally” and the Duvernay margins, inventory and free cash flow are competitive with Shell’s best assets, including those in the Permian.
It is worth highlighting Shell’s poor relative performance over the past year through these multiple loss crystallizations and other questionable governance moves. Shell underperformed competitors Exxon (XOM), Chevron (CVX), an index of mostly oil majors (XLE), and an oil producer index (XOP):
Data by YCharts
Shell seems to continue to struggle to navigate through the Covid-19 pandemic, and its business model seems to at least be strained, if not broken, by the challenges of these times. It is hard to not worry about the “shift to green”, as some may argue, as assets are sold for multi-billion dollar losses repeatedly. The business model flaws I first pointed out almost a year ago are still relevant. Investors may continue to brace for additional large loss crystallization, amid refocus on economically questionable projects that emphasize the E in ESG and may be ignoring the G.
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