Shell: the big bet on natural gas is now paying off

Oil company profits are widely held to be a function of the commodity’s price. Yet, with Brent crude trading on average almost where it was in 2014, Shell managed to deliver $40bn of net earnings last year, more than 70 per cent higher than eight years before. That says something about how the UK oil major — and the industry — have changed over that time.

The first big difference is that refining margins are five times as high. More important, the normally quiet European natural gas market has suffered massive shortages. The Ukraine war meant European gas prices averaged $40/Mmbtu in 2022, almost four times what they were in 2014.

That is a boon for an industry making natural gas — which has about a quarter less CO₂ than oil — a pillar of its energy transition strategy. None has bet larger than Shell, which bought gas specialist BG Group for $54bn in 2015.

That has paid off handsomely in 2022. Income at Shell’s midstream “integrated gas” division has grown by half since 2014 to $16.1bn, and now accounts for 40 per cent of Shell’s overall result.

In 2014, oil and gas companies focused on volume growth, allowing costs to run wild and free. The intervening lean years have done much to sharpen operations. Shell’s cost per barrel in 2022 was about half what it was in 2014, say Bernstein analysts. That, coupled with much higher prices for natural gas, means net income from upstream operations was some 2.5 times that in 2014 — despite 7 per cent fewer barrels being produced.

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Higher natural gas prices, refining margins and lower costs have all helped push Shell’s return on capital employed to about 16 per cent, more than double the amount in 2014. That the £170bn group still trades roughly in line with its book value of its assets suggests that the cost of capital for oil companies really has climbed since then. Otherwise the market simply does not believe these sorts of profits are for keeps.