The Critics Got This One Wrong…

Published Tue, Sep 25th, 2012   Jason Simpkins, Energy Editor

Shares of Royal Dutch Shell (NYSE: RDS.A, RDS.B) are on a tear, having surged 15% since June 1.

You’d never guess that by reading headlines in the mainstream press, which are preoccupied with the company’s recent retreat from the Arctic.

Analysts are fleeing from the stock, as well. Santander has downgraded the stock to “reduce” because it’s worried about Shell’s costs.

But there’s a good reason Shell is on the move: It’s a darn good stock.

Now, it’s certainly disappointing that the company didn’t accomplish what it set out to do this year, which was to strike oil in the Chukchi Sea near Alaska. But you really have to consider both the ambition of the effort and the reality of today’s energy landscape.

Remember, the Arctic is the most challenging environment on the planet.

In fact, one of the setbacks Shell suffered in the region was due to a 30-by-12 mile sheet of ice that snapped off a glacier and careened toward a drilling ship. The vessel had to halt operations and move 30 miles south to make way.

There have been other setbacks, too. The decisive delay came last week when a huge containment dome, which would cap the proposed oil well in the event of a leak, cracked during testing.

The dome in question was based on the device BP plc (NYSE: BP) used to cap its spill, which leaked about 53,000 barrels of oil per day into the Gulf of Mexico. So the apparatus is actually overkill for Shell’s drilling operation, which would only be capable of spilling 25,000 barrels per day.

Why is Shell jumping through so many hoops?

Mostly because all of the world’s easily recoverable oil is already spoken for – and in many cases dried up. But also because many countries with large reserves are protective of their resources.

More and more countries are reluctant to share the bounty of their oil with Western majors. Furthermore, they often require those firms to share technology, expertise and profits with smaller state-run companies.

As a result, Western oil majors are scrambling to the Arctic, which is home to some of the few remaining untapped and available fields. And persistently high oil prices and technological advances have accelerated the process.

The International Energy Agency (IEA) estimates 30% of the world’s undiscovered natural gas and 13% of its oil are buried beneath the Arctic’s icy waters. We’re talking about as much as 90 billion barrels of oil – 13% of the world’s total recoverable supply.

The fields that Shell’s drilling are estimated to contain 26.6 billion barrels of recoverable oil and 130 trillion cubic feet of natural gas. The company has spent $4.5 billion to develop these projects – about one-sixth of its capital spending budget – since 2005.

So Shell may be behind schedule now, but that won’t matter once its wells start producing. And in the meantime, the company’s done a good job of corralling other, less challenging projects.

For instance, last week Shell said it’s on track to meet a key production target in Iraq. It aims to get 175,000 barrels a day out of the giant Majnoon field by the end of the year. The field holds some 12.6 billion barrels of oil, from which Shell will ultimately be extracting 1.8 million barrels a day.

Shell also just acquired a stake in the Permian shale basin from Chesapeake Energy (NYSE: CHK), and is working to develop liquefied natural gas assets in China.

This aggressive approach is what made Shell one of the few oil majors to actually increase oil and gas production in the second quarter.

Shell’s oil and gas production rose 1.4% to 3.55 million barrels a day. And the company’s on track to pump out four million barrels per day by 2018.

This is evident in the company’s bottom line. Earnings from upstream operations in the second quarter rose 16% to $6.71 billion, and downstream profits rose 13% to $1.32 billion.

That’s why, despite Santander’s downgrade, 14 other firms still rate Shell stock as a “Buy.” That… and because the stock comes with a juicy 4.8% dividend yield – the fourth-highest yield in the oil and gas industry.

So don’t buy in to the negativity. This company’s been doing business for 112 years. It knows what it’s doing.

Cheers,

Jason Simpkins