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Big Q4 write-down could challenge Shell's debt reduction efforts

Anglo-Dutch major Royal Dutch Shell PLC's disclosure that fourth-quarter earnings could be negatively impacted by at least $500 million and that it will write-down as much as $2.3 billion in the period could slow down the company's efforts to cut debt and hike returns, analysts said.

"This reduction in guidance and impairment appears to show that management underestimated how much weaker oil prices would be in the latter part of this year, as well as underestimating future demand for oil, along with its by-products," Michael Hewson, chief market analyst at CMC Markets, said in a Dec. 20 note.

In the last several years, Shell has been working to contain debt. In the third quarter, the company's gearing — a ratio of its debt to equity — was 27.9%, little changed from 27.6% in the second quarter but up from 23.1% a year earlier.

As a sluggish world economy could slow its ability to trim debt, Shell executives surprised the market in November by saying the company might have to delay the completion of its $25 billion share buyback.

In fact, if current oil prices of about $60 per barrel continue into 2020, gas prices remain weak, and refining and chemical margins stay at current levels, Shell's cash flow levels could take a hit of as much as $9 billion by the end of 2020, Shell CFO Jessica Uhl said during the company's third-quarter earnings call.

But going forward, analysts believe that ongoing debt reduction will be key to Shell's financial metrics and returns.

"Even though cash flow generation has remained resilient, we believe further reduction in net gearing will be necessary for Shell to raise its cash return," according to a Dec. 14 report from CFRA Research.

Like many of its peers, Shell knows that capital discipline remains critical to keeping a lid on financial leverage. In its Dec. 20 trading update, Shell said its capital spending for the full year 2019 is likely to come in toward the lower end of a range of $24 billion to $29 billion.

Amid the depressed energy price environment, Shell is not the first integrated oil company to disclose impairments in the last few months. Chevron Corp. said Dec. 10 that due to expectations for continued softness in oil and natural gas prices, it will write down $10 billion to $11 billion in the fourth quarter. About $5 billion to $6 billion of that figure is related to the company's Appalachian shale assets.

Before that, BP PLC disclosed in October that it would take an after-tax charge of $2 billion to $3 billion in the third quarter, and Norwegian state-controlled Equinor ASA wrote off $2.8 billion in the third quarter — $2.24 billion of which was related to its unconventional onshore assets in North America due to "more cautious price assumptions."

At 12 p.m. ET, Shell's B shares on the London Stock Exchange, the most widely traded, were down 1.6% to 2,232 pence, alongside a slight gain on the FTSE 100 Index.