Shell’s Debt Nears Edge of Comfort Zone as Rout Boosts Borrowing

Shell Misses Earnings Estimates by More Than $1 Billion
  • Gearing rose to 28.1% last quarter, double year-earlier level
  • Debt ‘close to the maximum’ but may still climb, company says

Royal Dutch Shell Plc is on the verge of breaching “comfortable” levels of debt as low crude prices force Europe’s largest oil company to borrow more.

Net debt increased to a record $75 billion at the end of June from $70 billion three months earlier, Shell said Thursday as it reported a slump in second-quarter earnings. Additional borrowing drove up the ratio of net debt to capital, or gearing, to 28.1 percent -- more than double the year-earlier level.

“We’re close to the maximum level and it could go up still with the oil price where it is,” Chief Financial Officer Simon Henry said on a conference call. “Thirty percent is an upper limit to where we can describe our position as comfortable.”

Oil’s collapse over the past two years has pummeled earnings and cash flow at the world’s biggest energy producers and pushed many smaller ones into bankruptcy. Shell’s balance sheet has been further strained by the company’s record acquisition of BG Group Plc this year, for which it had to borrow billions of dollars, resulting in credit-rating downgrades.

Funding Dividends

Oil’s decline has drained finances so much that Shell is unable to fund dividends and investments with cash from operations and asset sales. The Anglo-Dutch company, like European competitor BP Plc, has pledged to maintain shareholder payouts, and for that it needs to borrow.

BP said this week that its gearing rose to the highest in at least 16 years as debt ballooned. Yet borrowing costs are currently so cheap that Chief Executive Officer Bob Dudley said he doesn’t mind taking on more debt, despite BP’s own 30 percent target.

For more on BP’s swelling debts and plans to borrow more, click here.

While Dudley has long said BP’s top financial priority is the dividend, his counterpart at Shell, Ben Van Beurden, has switched his focus to reducing debt, saying borrowings must come down following the BG purchase.

S&P Global Ratings cut Shell’s debt rating this month, reducing it for a second time this year. The ratings company said that while management had committed to lowering debt, credit metrics and cash flow remained below desired levels.

Asset Sales

Van Beurden is cutting capital expenditure, slashing operating costs and selling assets to keep finances in order. Shell is currently working on divesting 17 assets and will start price negotiations in two to three months, CFO Henry said Thursday. It’s in talks with potential buyers for some of these, he said, without identifying the assets.

While low oil prices make it difficult to meet disposal targets, they help to reduce some expenses. Shell intends to lower operating costs to $40 billion this year from $49 billion in 2014. 

The company plans to spend $29 billion in 2016 and $25 billion to $30 billion a year to the end of the decade. Van Beurden has said he has the option to cut spending further and defer more projects if crude prices stay below $50 a barrel. Brent traded below $44 on Thursday.

Volatility in the oil price makes it difficult for companies to plan their finances. Brent increased more than 88 percent from a 12-year low in January to early June, and has since dropped 18 percent. Oil-market movements will to a large extent determine Shell’s gearing.

“The drivers will be the oil price and the pace of divestments,” Henry said. “In the short term, it will be oil price, on which I can’t make any other comments. In the short term it could just as easily go down as up.”

Shell on Thursday reported a 72 percent decline in adjusted quarterly profit, missing analyst estimates by $1 billion. Van Beurden said lower oil prices continue to be a “significant challenge” across the business.

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