Shell Oil Output in Focus After BP Pivot

The Issue

As oil and gas majors change their transition strategies to reflect the upheaval in energy markets over the past year, all eyes are on new Shell CEO Wael Sawan. In the strategy set out by his predecessor, Ben van Beurden, in 2021, Shell said it intended to make gradual cuts in oil production by the end of the decade. But asset sales have brought output down more quickly than expected and markets have responded well to plans from rival majors to produce hydrocarbons for longer. Could Shell be rethinking its transition strategy to include more oil and gas production?

Eight Years Early

Unveiling the "Powering Progress" strategy two years ago, Van Beurden said the company’s oil production had peaked in 2019 — at 1.824 million barrels per day — and expected it to decline by 1%-2% per year, including divestments, until 2030. It did not set a similar target for natural gas.

Only months later, however, Shell sold off its Permian Basin assets in the US to ConocoPhillips for $9.5 billion, shedding 175,000 b/d, or around one-tenth of its total oil output at a stroke. Applying the maximum guided annual cut of 2% to Shell’s 2019 oil production, its output gradually declines to 1.461 million b/d by 2030. But — after planned divestments and the unexpected loss of Russian barrels — that’s exactly the volume of liquids Shell produced in 2022.

Like smaller counterpart OMV or rival BP, which have also lost substantial Russian production, Shell finds itself well ahead of schedule on its medium-term output cut target. The question now is whether it will continue to allow production to ebb or look to arrest the slide. Shell is “reflecting on what is the right guidance to the market,” Sawan said in an interview with Times Radio earlier this month. In that discussion, he described near-term cuts in oil and gas production as “not healthy.”

Upstream Longevity

While Sawan subsequently claimed his radio remarks weren’t a specific comment on Shell’s future production trajectory, a look back at the company’s fourth-quarter earnings call with his words in mind makes for interesting reading. As HSBC pointed out in a note last week, Sawan and CFO Sinead Gorman used the phrase “longevity” with regard to the upstream business no fewer than five times on the call with analysts. Sawan was perhaps most explicit when he said the company wants to have “a much longer period of ability to be able to produce our oil profitably.”

“Simply, given where the world is, we continue to believe that oil has a role to play,” he added. With the promised pruning and high-grading of Shell’s upstream portfolio already done, “what you see right now is a lot more strength and stability in that business, and I'd like to extend that strength and stability into the coming years,” Sawan said. He declined to go into any further detail until Shell’s Capital Markets Day in June.

HSBC’s inference is that Shell is set to announce a refreshed strategy in June, retiring its previous guidance of a 1%-2% annual decline. A flavor of what lies ahead could even come at this week’s Shell ESG day, the bank said. It sees a “return to modest growth in oil and gas” for Shell this decade, as well as a rebalancing in capital allocation away from renewable power toward other low-carbon areas such as bioenergy and electric vehicle charging — in line with what its US peers are doing.

That Shell will soon retire its old oil guidance appears to be a broadly held view. “Everyone knows and expects this,” one analyst said, adding that it wouldn’t be accurate to label such a move a “backtrack” given how much oil production Shell has cut already.

BP-Style Share Boost?

If Shell does withdraw the 2021 guidance, the company is sure to face a backlash from climate activists, who are angry the company is still refusing to set interim targets for Scope 3 (end-use) emissions cuts. But the potential share price gain could outweigh the negatives in Sawan’s mind. The CEO has spoken openly about his desire to boost Shell’s valuation, which lags that of its US peers, and couldn’t fail to have noticed a 15% jump in BP’s share price around the time it said it would scale back plans to reduce oil and gas output this decade.

Sanford Bernstein analysts said in a note that Shell “could, or should, announce three updated strategic elements” in June to help close the valuation gap on its US rivals: (1) a flatter oil portfolio, (2) an increase in annual dividend per share growth above the current 4%, and (3) a multiyear share buyback program. Maintaining, or even modestly growing, oil production would put Shell in the same category as TotalEnergies, Equinor and Eni, which plan to lift output by 2%-3% over the next few years, said HSBC, which believes no oil company "can afford to step off the upstream treadmill" for now.

BP’s higher production guidance for 2030 — which was accompanied by an easing of its interim Scope 3 emissions target — was met with dismay from some climate-focused investors. But European oil majors are finding it hard to transform their portfolios more quickly than society is changing its patterns of energy demand.

Shell itself appears to have altered an April 2022 pledge from Van Beurden that its 2050 net-zero goal was “no longer conditional on society’s progress” — a statement that was seen as underpinning a more ambitious shift away from hydrocarbons. In its Energy Transition Progress Report last week, the company warned that “if society is not net zero in 2050, as of today, there would be significant risk that Shell may not meet this target.” If Shell is recalibrating its approach to match global consumption, a bump in oil and gas production could be in order.