Royal Dutch Shell is taking steps to cut costs and sell refining assets after reporting a 76% drop in fourth-quarter earnings to $1.2 billion from $4.8 billion a year ago. These steps make sense, but we need to see timely execution of asset sales and effective cost-cutting measures before giving much credit to Shell's plans.
Lower gas prices plus a sharp decline in refining margins outweighed benefits of higher oil prices, resulting in year-over-year earnings declines at both upstream and downstream businesses. Fourth-quarter upstream earnings of $2.5 billion were 45% below year-ago earnings of $4.7 billion. Downstream results swung from fourth-quarter 2008 earnings of $561 million to a loss of $1.8 billion in the 2009 fourth quarter as weaker demand and high inventory levels drove down refining margins.
Shell managers are not expecting a quick economic recovery to drive improvement at its operations, prompting them to look for more cost cuts and staff reductions. Shell pared its 2010 capital budget to $28 billion from $29 billion invested in 2009. After announcing plans to cut 5,000 jobs in 2009, the company announced another 1,000 job cuts in 2010. The firm is also targeting $1 billion more in cost reductions in 2010.
The firm is moving forward with upstream projects, but is slowing the pace of development at Canadian oil sands projects. More of Shell's retooling efforts will be on the downstream side. After selling $1.2 billion of downstream assets in 2009, the group announced plans in early 2010 to convert its Montreal East refinery in Canada into a terminal. Another 566,000 barrels per day of refining capacity, or 15% of Shell's total, and marketing operations are under review for divestment. As the global economy remains weak, Shell may be hard-pressed to realise good value for its refinery sales. We think Shell's divestments could take longer than expected, forcing the firm to take additional cost-cutting measures. The company, in our view, will be challenged in achieving strategic goals this year and may be forced to take further action with staff cuts or asset divestments and restructuring.
On the downstream side, Shell managers want to refocus its footprint to fewer, more profitable refineries and marketing operations. As part of its desire to shift its refining focus away from Europe to more profitable regions, Shell put its Stanlow refinery in the UK, Heide and Harburg refineries in Germany, Whangarei in New Zealand, and Gothenburg in Sweden under review for divestment. The firm plans to move ahead with growth projects, including expansion of its refining and petrochemical complex in Singapore, expansion of the Port Arthur refinery in Texas, and completion of its Pearl gas-to-liquids facility in Qatar.
On the upstream side, Shell may be slowing the pace of development at its oil sands operations in Canada, but is moving ahead with other projects. The firm decided to proceed with its Gorgon liquefied natural gas project in Australia and Caesar/Tonga project in deep-water Gulf of Mexico. It started front-end engineering and design study for a floating LNG platform for the Prelude gas field in Australia. Shell is also seeing good results at North American tight gas and Western Australia gas operations. During its analyst call, management indicated it was looking forward to working with partners to expand production at Iraq's Majnoon and West Qurna 1 fields and at unconventional North American operations. We may see the firm take further steps to develop North American unconventional oil and gas operations this year.
Catharina Milostan is a Morningstar equity analyst.
