Shell says fundamentals of business still strong as it books $16.8 billion impairment

London —

Shell on July 30 signaled likely further reductions in upstream and LNG production in the third quarter as it defended its business model, including a big shift into natural gas in recent years, following massive coronavirus-related impairments.

In its Q2 results, Shell confirmed a financial impairment of $16.8 billion, or 6.1% of the company's average capital employed, of which almost half relates to its Australian gas and LNG projects -- the Queensland Gas Company and Prelude Floating LNG -- with $4.7 billion relating to a broad swathe of upstream assets, including US shale, assets in Brazil and Europe, and individual assets in Nigeria and the US Gulf of Mexico. The total also included $4 billion relating to refineries in Europe and North America.

Shell had already flagged likely impairments when it cut its crude price assumptions at the end of June.

It said upstream oil and gas production in the current quarter would be in a range of 2.1 million-2.4 million b/d of oil equivalent, down from 2.61 million boe/d in Q3 2019, and production from its LNG-focused "integrated gas" unit would be in a range of 820,000-880,000 boe/d, down from 957,000 boe/d a year earlier, with LNG liquefaction expected to fall to 7.6 million-8.2 million mt, from 8.95 million mt.

Production in Q2 was hit by asset sales and curtailments by OPEC+ nations, Shell said. Chief financial officer Jessica Uhl said output cuts by OPEC+ countries would account for about 70% of Q3 production reductions, with the remainder mainly a result of Shell holding off North American shale production in the expectation of prices recovering later.

Shell's overall oil and gas production fell by 6% on the year in Q2 to 3.38 million boe/d, with upstream oil output falling a more modest 2% to 1.61 million b/d, and upstream gas production falling 17% to 4.67 Bcf/d. It operates in a number of OPEC+ countries that have pledged to compensate for under-compliance in the early stages of the OPEC+ cuts.

The company flagged a likely pick-up in refining in the current quarter as coronavirus lockdowns ease, particularly in Europe, with utilization expected to be in a range of 68%-76%, compared with 70% in Q2.

However, Uhl reiterated the company's plans to reduce its downstream footprint from 15 refineries to 10 "over time," saying: "Some of the refining assets that we've impaired this quarter will be strategic for us as we evolve these into new low-carbon value chains."

DEMAND UNCERTAINTY

On the demand side, CEO Ben van Beurden said it was unclear whether the world faced a "massive" second wave in the coronavirus pandemic or more containable outbreaks, or how to judge prospects for a vaccine, but Q2 2020 was likely to prove the low point for overall demand.

He said aviation demand was likely to take until the end of the year "at best" to reach 50% of pre-COVID-19 levels, but other areas, such as petrochemicals, were benefiting, with increased demand for cleaning agents, hygiene products, packaging and medical equipment.

"It's early days. We are indeed probably going to live with this for some time to come. There's no doubt in my mind that the world will settle in a different place and... demand will take a long time to recover if it recovers at all," he said.

Uhl added that Shell's role in manufacturing oil products had contributed to a "stellar" performance in oil-product and crude trading.

She cited as an example the company's 400,000 b/d Pernis refinery in the Netherlands, which the company had switched away from jet fuel toward other products, while taking corresponding positions in the market. "Being physically in the market gives you relatively deeper insight and quicker insight in terms of what's practically happening every day. We're able to make physical changes to our assets and use those assets to respond more quickly. That plays to blending, that plays to the nature of the products we produce," she said.

Van Beurden defended Shell's overall business, including its growing focus on gas and LNG in the last decade, accentuated on his watch by the $54 billion purchase of BG in 2016.

He said the company had four "crown jewels" in its LNG, deepwater, marketing and trading units, and he still believed in the growth prospects of gas. He said the LNG market was likely to pick up in the coming decade, helped by project cancellations and delays, including Shell's own decision in March to pull out of the Lake Charles LNG export project in the US.

"If you look at today's environment you have to assume that the demand for natural gas will be affected -- we've seen that -- but I nevertheless believe that the fundamentals of LNG remain strong. When we said in the past we will have a stronger growth in LNG than in any aspect of the carbon-based energy system -- I still believe that is the case. I still believe the growth rate in the long run will be around 4% a year. In the near term of course we will see delays, we will see some softening, very much dependent also on how industrial activity and therefore global economic outlooks will evolve, but the fundamentals for gas as a transition and bridging and destination fuel will remain strong," van Beurden said.

"The supply picture is also receiving of course a dent from COVID, a number of projects being shelved, postponed... so there is a certain degree of cancelling out."

FINANCIAL IMPACT

Shell made a loss of $18.4 billion in Q2, excluding inventory effects, and an adjusted profit, excluding impairments and other items, of $638 million.

It warned its integrated gas unit faced a greater financial hit in Q3 due to a lag in the impact of oil prices on oil-linked contracts.

Van Beurden said the company had the option to maintain its capex cuts this year into future years if necessary, and noted the company had cut its exploration drilling plans for this year from 77 wells to just 22. Shell cut its capital spending budget for this year in March from around $25 billion to $20 billion.

The company's debt gearing ratio rose to 32.7% at the end of the first half of 2020, up from 28.9% at the end of Q1 and 27.6% at the end of June 2019.

Van Beurden said the company had generated $2.6 billion of cash flow from operations in Q2, down from $11 billion a year earlier. "Shell has delivered a resilient cash flow in a remarkably challenging environment," he said.