In any other industry and at any other time, record profits, a dividend hike, and billions of dollars in share buybacks would be more than enough to keep shareholders happy. But not in oil in 2023, with companies caught between needing to prove their environmental commitments while making most of their money from dirty hydrocarbons — a dilemma that will get worse in the coming years. Shell Plc, Europe’s largest energy company, is a case in point. On Thursday, it reported adjusted net profit last year surged to an-all-time high of nearly $39.9 billion, easily beating the previous record of $28.4 billion in 2008. Wael Sawan, who became chief executive officer in January, went ahead with a previously announced 15% dividend increase, and added a $4 billion buyback.
Yet, the market clearly wants more. On a price-to-earnings ratio, Shell is trading at just five times, compared to the 8-9 times of its American rivals ExxonMobil Corp. and Chevron Corp.Shell executives say they aren’t happy with the company’s share performance. That’s a positive development, since the first step to resolving a problem is to acknowledge it. For too long under previous CEO Ben van Beurden, Shell pretended all was well. Once, Shell had ambitions to become the world’s largest international oil company by market value. Today, it’s the third biggest, behind Exxon and Chevron.Sawan has announced a capital markets day, when companies typically announce changes in strategy, for June 14, meaning he’s going to take time before making significant changes. His first actions, including reviewing the loss-making UK retail electricity businesses for potential sale or closure, indicate he’s prepared to break things. Good. He has also downsized management, with a stronger emphasis on fossil fuels and less focus on alternative energy.Shell and its European peers BP Plc and TotalEnergies SE face an identity problem. For investors seeking to profit from fossil fuels, they offer a mixed bag of oil and renewables, while US companies offer a more direct exposure to oil. For shareholders more interested in renewables and climate change, Shell isn’t green enough. They see its investments in wind and electric-vehicle charging as greenwashing.In politics, appealing to moderate voters in the center is often a winning strategy. In the world of corporate energy, it’s the opposite: executives need to go right or left. For too long, Shell has insisted on trying to stay in the middle. It hasn’t worked.The new CEO has an advantage his predecessor lacked: The Russian invasion of Ukraine has lifted oil and gas prices, bailing out Shell’s balance sheet. Net debt has fallen to $44 billion, down from $75 billion at the end of 2020. Although the company would like to cut it to less than $40 billion, the job of repairing its finances is almost done. That means in the future it will be able to allocate more cash to shareholders rather than servicing debt.Sawan should focus on three areas. First, investment discipline, convincing shareholders that his sole compass will be a higher internal rate of return on capital rather than pursuing fifty shades of green. The fact that Shell has pulled out of a couple of windfarm projects in recent months, due to low profitability, is a good indication of the new direction of travel, as is the review of the UK retail business.Second, Shell needs to lay out a medium-term strategy for oil and gas production. As time goes on, it’s becoming increasingly difficult to see where future output will come from. Shell is asset-short; Citigroup reckons that its oil and gas reserves are equal to 8.8 years of production, compared with 11 to 12 years for its rivals.Third, the company needs to improve financial transparency. Shell has a trading business that’s typically a cash machine. Last quarter, for example, the gas trading unit delivered billions of dollars in profit. For shareholders, however, it’s a volatile black box that’s impossible to value. The trading business also obfuscates working capital flows. Again, last quarter was an example: Cash from operations surged to more than $22 billion, but more than $10 billion was due to working capital inflows. As much as $5 billion will flow back out this quarter, reducing cash on hand.
Sawan needs to be ruthless in shedding unprofitable ventures, however green they are. Providing more visibility on trading profitability and working capital would help to also help to improve Shell’s market valuation. Investors will need to stay patient.
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Javier Blas is a Bloomberg Opinion columnist covering energy and commodities. A former reporter for Bloomberg News and commodities editor at the Financial Times, he is coauthor of “The World for Sale: Money, Power and the Traders Who Barter the Earth’s Resources.”