Shell’s 5% Dividend Yield (Part 2): Will Huge Capital Spending Pay Off?
Exxon-Mobil (XOM), the largest integrated oil and gas company reported 3rd quarter earnings 7% lower than a year earlier. Over at Royal Dutch Shell (RDS.B) -- the second largest energy company based on revenue -- the decline was 6%. That’s about in line with the 5.9% earnings drop S&P Capital IQ is forecasting for all of 2012 for the energy sector.
Commodity prices are largely to blame. Earnings and oil prices are attached at the hip.
After a strong start to the year, once it became clear toward the end of the first quarter that global economic growth was going to be slower, not faster, Brent crude oil's spot price fell 30% from March 1 through early summer. It’s since been creeping back up, but is still about 12% below where it was at the first-quarter high mark.
And for Shell the long collapse in U.S. natural gas prices -- a 60% decline over the past five years, including a 14% drop the past year -- has been an extra dagger, as the firm invested heavily in capturing a big piece of the growing market that has emerged in the age of fracking. Absent a pickup in U.S. natural gas prices, Shell is going to be hard-pressed to see a return on that investment anytime soon.
In fact, much of Shell’s current operations are focused on long-term investment that will take years of drilling and infrastructure building before it generates revenue. It’s the curse of the industry: to maintain -- let alone grow -- your reserves is getting more and more expensive as the easy deposits are long gone, or, in many emerging countries, are being earmarked for domestic (and often state-owned) companies.
So far this year, Shell has amped up its capital expenditures to more than $32 billion, a 23% increase over its spending for all of 2011. Shell said earlier this year that exploration spending would hit $5 billion in 2012, a 35% increase over 2011’s exploration outlays, which were already 30% more than what was spent in 2010. The firm has targeted a 25% increase in its oil and gas production by 2017-2018.
It doesn’t help when projects hit big speed bumps. Shell had planned to have six new wells fully drilled in the Chuckchi Sea (Alaska) before year-end, but snafus when it tested spill containment equipment and the onset of the winter freeze left it with no wells completed. According to the Wall Street Journal, that project alone has eaten up $4.5 billion over the past six years and there’s not one well fully drilled.
In a meeting with investors in November, Shell CEO Peter Voser ticked off how the firm is investing today to capitalize on long-term global demand. He highlighted the fact that Shell is the leading international company in the fast growing liquid natural gas market. He noted that Shell expects current construction projects for LNG in Australia (where all its LNG operations are based) to eventually deliver a 30% increase in its production capability. Accent on eventually. “I do want to be clear that this portfolio will take time to play out,” said Voser.
Ah, and there’s the rub for investors. Shell has been hammered this year, losing 5% over the past 12 months, compared to a 9% gain for Exxon-Mobil and the 12% gain for the overall S&P 500. Before you chalk that up to being based on the wrong continent (beleaguered Europe) keep in mind that over the same stretch a Euro stock index is up more than 8%.
But as mentioned earlier by YCharts, fresh money invested at today’s share price can pocket a 5% yield. In the next article we take a look at how safe that dividend payout is for patient investors.
Carla Fried, a contributing editor at ycharts.com, has covered investing for more than 25 years. Her work appears in The New York Times, Bloomberg.com and Money Magazine.