When Shell announced its bid for BG Group earlier this year some eyebrows were raised at the cost of the deal, as well as the forecast estimates for oil and gas prices, that were being used to justify the $70bn price tag. Those numbers are likely to come under greater scrutiny the longer oil prices remain at their current lows levels, and the recent slide in the share price would appear to suggest that investors have similar concerns about Shell’s belief that we will see oil prices back at $80 a barrel in the next few years. In July the company announced a 35% drop in profits for the 3 months to 30th June to $3.4bn, while at the same time announcing 6,500 job losses. At the time the company said it was planning for a “prolonged downturn” in oil prices as the company looked to cut its capital expenditure further. This morning’s announcement that the company was abandoning its Arctic drilling campaign off the coast of Alaska appears to be the latest evidence that the company is finding it difficult to sustain long term investment expenditure without any clear evidence of a payback in the near term. This appears to be quite an about turn from July when the company embarked on the hugely controversial project against a backdrop of environmental concerns. It would appear that early indications of a large oilfield may have been overestimated and the company will have to take charges in the region of $4.1bn, a sizeable sum at a time when revenues continue to get squeezed. This morning’s news is the latest in a number of setbacks for Shell since the deal with BG was announced and judging by the share price performance since the deal was announced it appears that investor’s initial early optimism is starting to wane as well. Since April Shell’s share price has declined 25% and is now trading at levels last seen in 2009, giving it a dividend yield now of nearly 8%. Even BG Group’s share price has slid back after the initial euphoria of April’s deal subsided. With regulators in China and Australia looking closely at the deal and yet to approve it there is a concern amongst nervous investors that the economics of the deal are looking increasingly questionable. It is becoming apparent that 2015 is going to be a difficult year for the UK’s biggest oil giant with pre-tax profits already expected to drop from $28.3bn in 2014, to $17.2bn for this year, with revenues also expected to fall to $268bn from $421bn. The big concern is likely to surround Shells dividend which is currently at a very healthy 8% after the 25% fall in the share price in the last six months and as we all know from the financial crisis of 2008 a healthy dividend does not a good company make. All the banks had healthy dividends and we know what happened to them, and the decline in the share price is making some investors rather twitchy. That being said Shell is a huge company with plenty of assets and the Shell CEO will not want to spook investors by indicating the dividend might be under threat, particularly since investors who piled into Shell in the last six months are currently sitting on a 20% capital loss. Cutting the dividend now could well inspire further sharp falls in the share price, the last thing management would want. As recently as this month Mr Van Buerden reiterated the company’s commitment to maintain the current pay-out. The need to diversify still remains a priority for Shell and while the BG deal may look more expensive now, pulling out of it now is likely to be more costly in the longer term, which suggests that the deal will still proceed. This would suggest the likelihood of further cuts to capital expenditure and jobs over the next few years if oil prices remain subdued, and this morning’s news would appear to be yet another example of the economics of a project falling victim to the accountant’s scalpel. The material (whether or not it states any opinions) is for general information purposes only, and does not take into account your personal circumstances or objectives. Nothing in this material is (or should be considered to be) financial, investment or other advice on which reliance should be placed. No opinion given in the material constitutes a recommendation by CMC Markets or the author that any particular investment, security transaction or investment strategy is suitable for any specific person.
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