SINGAPORE (Feb 11): Royal Dutch Shell appears at first glance to have arrived at its destination. The Anglo-Dutch oil major made enough cash last year to pay its dividends and cut debt, seemingly confounding sceptics who feared the payout would need to be cut. But this is not yet a sustainable performance. Shell is still travelling.

The company’s dividend yield hit about 9% in 2015 as falling oil prices and the acquisition of BG Group, funded partly by debt, sowed doubts over whether the payout was affordable. Shell has since cut costs and capital expenditure and brought new production on stream. Add an oil price recovery and the group generated US$53 billion ($71 billion) of operating cash flow last year. That left it able to fund US$14 billion of capital spending and other investments, net of disposals, and a US$20 billion bill for interest payments and dividends.

Shell has used the surplus cash to cut debt and buy back its own shares. Net borrowings of US$51 billion at the end of the fourth quarter are down from nearly US$80 billion in the aftermath of the BG takeover and stood at 20% of total capital, Shell’s target.

Job done? Not so fast. This is still only a snapshot, rather than sustained proof. The debt reduction was aided by a huge boost from working capital movements in the last three months of 2018. The volatility in Shell’s working capital as inventories jump around is one reason why investors cannot be sure just yet that its leverage will stay at or below the threshold.

The average price for Brent crude in the fourth quarter was about US$69 per barrel. It is around US$62 currently. While Shell could have afforded its cash dividends for 2018 had the oil price averaged out at that lower level over the whole year, it is hard to be confident about crude’s buoyancy right now.

And despite Shell’s progress, its 7.6% return on average capital employed was below its estimated cost of capital and its 10% target. The company simply is not earning enough.

The fixation has been on getting Shell’s financials in shape by 2020. It looks on track to achieve that even if the latest results are not the last word. The bigger strategic issue remains unresolved: Shell’s needed long-term transformation into a company that produces more of its energy from sustainable sources. Management pay is now being linked in part to environmental targets, which is something.

Investors clearly harbour doubts that this all hangs together. Shell’s dividend yield is still 6%, the 11th highest in the FTSE 100. No doubt, management can always find more cost cuts and disposals to channel cash to shareholders. But doing this while generating higher returns and investing in renewables is a brainteaser yet to be solved. — <i>Bloomberg LP</i>

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