Can Shell close the valuation gap with US rivals?

Since Wael Sawan took over Shell two months ago, colleagues and investors say he has focused on one thing above all else: the share price.

Shares in Shell rose 37 percent last year as it made a record $40 billion profit from the energy market disruption caused by Russia’s full-scale invasion of Ukraine. But Exxon and Chevron rose even further, widening the already gaping valuation gap between Shell and its US rivals, which Sawan wants to close.

“Shell is a great company and we are changing to be a great investment,” the new chief executive said in January as he streamlined the executive committee in the first major overhaul of the business.

Like BP and TotalEnergies in Europe, Shell is committed to reducing emissions by gradually transitioning from selling fossil fuels to providing low- or zero-carbon energy. Exxon and Chevron have clung more closely to their traditional oil and gas roots and have been rewarded by American investors who are willing to support fossil fuel companies for longer.

In the US market, Exxon and Chevron have about six times their cash flow, while Shell has about three times that.

To close the gap, analysts say, Sawan will either have to convince investors that Shell can deliver more attractive returns from its future low-carbon businesses or maintain higher oil profits for longer, possibly by relaxing earlier commitments to cut oil emissions.

“Shell hasn’t taken the bull by the horns yet,” said Christyan Malek, head of European oil and gas research at JPMorgan. “Either they decide to transition and put money behind it, or they invest in what they know, which is oil and gas.”

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Concerns about the higher valuation of US rivals and the risk of becoming a transatlantic takeover target are not new within Shell. In 2021, the managers, including Sawan, even discussed moving the company from Europe to the United States, reports the Financial Times this week.

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Shell, then dually listed in Amsterdam and London, eventually decided to consolidate its headquarters and listing in the UK. Around 40 per cent of its investors were in the UK and the move required the approval of 75 per cent of shareholders.

Shell recognized that a move to the United States would have been structurally and culturally more complicated, according to people familiar with the discussions. One obstacle was that, like the Netherlands, the U.S. has a foreign dividend tax, which was already a problem for the company when it was dual-listed, one of the people said.

Also, a U.S. move alone would not have resulted in a major upgrade for the stock, according to investors, who said the company would also have needed a new strategy that would have diluted the company’s energy transition ambitions.

“Delisting and repositioning a major European stock market suggests a change in strategy that would happen kicking, screaming and tearing our hair out,” said one Europe-based top 15 shareholder.

According to one of Shell’s 15 largest shareholders, it is not a “slam dunk” that the change in the stock market listing will result in an automatic reclassification. . . It may not be a clear enough strategy to excite US investors.”

Shell’s announced energy transition strategy includes investing in renewables, hydrogen and biofuels to help its customers decarbonise, while reducing its own emissions in part by enabling oil emissions to decline.

The company says a third of its $64 billion in combined operating and capital spending went to low- and zero-carbon projects last year. However, according to some investors, Shell has not been clear enough about how these will replace revenues from oil and gas.

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“They need to explain much more clearly what role they see themselves in, why they have a unique competitive advantage and what they think the return will be,” said Shell’s top 15 shareholder. “It’s not hard to articulate, but it’s definitely not going to work right now,” he added, noting that the same applies to BP.

The top 20 shareholders agreed: “We would like them to give us more information about the quality of their investment opportunities and their returns in these new sustainable energy areas. That’s the key to reappraisal.”

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A portfolio manager for one US shareholder argued that Shell’s turnaround efforts are not fully satisfying any investor.

Owners of supermajor stocks have historically been willing to accept the higher volatility associated with oil investments in exchange for higher returns. He argued that Shell pursued lower-return renewables while exposed to oil market volatility and alienated its traditional base without seeking new ones.

“The average owner . . . doesn’t know how to account for renewable energy,” he said.

According to Shell’s staff, Sawan is very aware of what is needed. Externally, he emphasized financial discipline and the need to maximize shareholder value. Internally, he told department heads that they needed to justify the costs of running their businesses and protect potential returns.

The biggest open question is whether Sawan will keep Shell’s commitment to cut oil production by 1-2 percent a year from 2019, a goal Sawan set when he ran the oil business. Faster-than-planned sales mean Shell’s production is already down more than 10 percent from 2019, giving it some room to maneuver.

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Sawan visited US investors in February and is considered by many to be “friendly to the US”. But unless it allows oil output to rise again, even just a little, it may not be able to get as much North American support as it hopes, the U.S. portfolio manager warned.

According to the US portfolio manager, Shell needed to be clear about its decarbonisation strategy, but at the same time provide “vision” on how it can maintain or increase oil and gas output. “They get a better punishment because they don’t grow.”

Such a move risks an immediate backlash from climate activists, some shareholders and even employees. In Europe in particular, many employees have recently joined Shell to help transform both the company and the global energy system, a European employee said. Even if the rest of Shell’s energy transition strategy is left unchanged, some would see the upward movement in oil output as a betrayal, the person added.

Sawan said he is committed to the strategy and that the changes are only being made to help the company achieve its goal of transforming the company.

Ultimately, the best way to close the valuation gap is to stay the course. “If European oil and gas companies make the switch [to a low or zero-carbon future] they will close the gap in the long run,” said a third top 15 shareholder. “They need to stick to their climate strategy because climate challenges will not go away even with high oil prices.”

The challenge is getting investors to have enough confidence in current and future returns to stay the course.

“My impression is that there is a bit of fatigue among European oil and gas companies,” added the third of the top 15 shareholders. “They are more advanced in their climate strategy, but they are not recognized for their transformation.”