Waiting game

Downstream cushions Shell while it waits for BG

As with BP and Total, refining profit alleviated the lower oil price pain felt by the Anglo-Dutch major. Short term, Shell will struggle. But there is value to be had from the $70-billion tie-up with BG beyond what has been advertised.

Shell's net profit was down 56 per cent in the first quarter to $3.2 billion, ahead of expectations thanks mostly to a 68 per cent rise in downstream earnings. Refining margins were high because input costs - crude oil - fell more than the price of petrol and other products. The fact that some US refineries were out for maintenance also helped. Unfortunately, the boost will likely prove temporary given the glut in European refining capacity.

Despite the cushion, Shell's cash from operations wasn't enough to cover capital investment and dividends. Net debt is a comfortable 12.4 per cent of total capital and should help protect the dividend. Shell will cut capex this year by $2 billion from a $35-billion budget, which is reassuring but also more modest than peers. Cost cuts unrelated to currency movements reduced the underlying cost base by 3.5 per cent, according to Barclays estimates. Shell sold $2.2 billion in assets, including scaling back in Nigeria. But selling assets is getting harder to do thanks to the oil slump.

In the medium term, though, BG will help by adding relatively low-cost deepwater barrels from Brazil, enabling Shell to cut spending and sell assets elsewhere. There may well be other benefits not captured by the $2.5 billion in synergies pencilled in by Shell.

The combined liquid natural gas (LNG) portfolio should bring chunky benefits from scale. Barclays reckons the combined LNG businesses could wring out another $1 billion in savings. Shell managed to boost cashflow from Repsol's LNG business a year after purchase. And the mega-oil mergers of the late 1990s largely over-delivered on synergies. The 5 per cent drop in Shell's share price since the deal was announced suggests investors are sceptical. But there is room for upside surprises too.