Can Shell close the valuation gap with US rivals?

Since Wael Sawan took charge at Shell two months ago, staff and investors say he has been focused on one thing above all others: its share price.

Shell’s stock rallied 37 per cent last year as it made a record $40bn in profits from the turmoil in energy markets unleashed by Russia’s full-scale invasion of Ukraine. But Exxon and Chevron have risen even further, widening an already yawning valuation gap between Shell and its US rivals that Sawan wants to close.

“Shell is a great company and we’re changing to ensure we become a great investment too,” the new chief executive said in January as he streamlined the executive committee in his first major shake-up of the business.

Like European peers BP and TotalEnergies, Shell has committed to cut emissions by gradually transitioning from selling fossil fuels to providing low or zero-carbon energy. Exxon and Chevron have stuck more closely to their traditional oil and gas roots and been rewarded by US investors more willing to back fossil fuel companies for longer.

On the US market, Exxon and Chevron are valued at about six times their cash flow, compared with about three times for Shell.

To close the gap, analysts say, Sawan must either convince investors that Shell can deliver more attractive returns from its future low-carbon businesses or maintain higher oil profits for longer, potentially by softening an earlier commitment to allow oil output to fall.

“Shell hasn’t yet grabbed the bull by the horns either way,” said Christyan Malek, head of European oil and gas research at JPMorgan. “Either by deciding to transition and putting money behind it, or investing in what they know, which is oil and gas.”

Concern within Shell about the higher valuation of US rivals and the risk of becoming a transatlantic takeover target is not new. In 2021, executives including Sawan even debated addressing the issue by moving the company from Europe to the US, the Financial Times reported this week.

Shell, which was then dual listed in Amsterdam and London, ultimately decided to consolidate its headquarters and listing in the UK. About 40 per cent of its investors were based in the UK and the move required the approval of 75 per cent of shareholders.

Inside Shell it was recognised that moving to the US would have been far more complicated structurally and culturally, according to people familiar with the discussions. One hurdle was that the US, like the Netherlands, has a foreign dividend withholding tax, something that had already been problematic for the company when it was dual listed, one of the people said.

Furthermore, a US move alone might not have resulted in a major re-rating of the shares, according to investors who said the company would also have needed a new strategy that watered down the company’s energy transition ambitions.

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

A second top-15 Shell shareholder said it was no “slam dunk that a change in listing would result in an automatic re-rating . . . It might not be a clear enough strategy to get US investors excited.”

The energy transition strategy Shell has communicated involves investing in renewable power, hydrogen and biofuels to help its customers decarbonise, while reducing its own emissions partly by allowing oil output to fall.

The company says a third of its $64bn in combined operating and capital expenditure went to low and zero-carbon projects last year. However, some investors say Shell has not spelt out clearly enough how these will replace the revenues earned from oil and gas.

“They need to be much clearer on explaining the role they see themselves playing, why they have a unique competitive advantage and what they think the returns will be,” said the first top-15 Shell shareholder. “It’s not a difficult thing to articulate but right now they are definitely failing to”, he added, noting that the same applies to BP.

A top-20 shareholder agreed: “We’d like them to give us more information on the quality of the investment opportunities they have and the returns they can make in these new sustainable energy areas. That’s key to the re-rating.”

One portfolio manager at a US shareholder argued that Shell’s transition efforts were failing to fully satisfy any investor.

Owners of supermajor stocks have historically been willing to accept the higher volatility associated with oil investments in exchange for the higher returns. In pursuing lower-return renewables while remaining exposed to the oil market’s volatility, Shell was alienating its traditional base without appealing to a new one, he argued.

“The average owner . . . doesn’t know how to do the math on renewables”, he said.

Shell staff say Sawan is keenly aware of what of is required. Externally he has emphasised financial discipline and the need to maximise value for shareholders. Internally he has told divisional heads they will have to justify the cost of running their business and defend the potential returns.

The biggest open question is whether Sawan retains Shell’s commitment to allow oil output to decline 1-2 per cent per year from 2019 — a target Sawan set when he ran the oil business. Faster divestments than planned mean Shell’s production is already down more than 10 per cent from 2019, giving him some room for manoeuvre.

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

Shell needed to be clear about its decarbonisation strategy, but also give “line of sight” to how it could either hold oil and gas output flat or increase it, said the US portfolio manager. “They’re being more punished because they’re not growing.”

Such a move would risk provoking an immediate backlash from climate activists, some shareholders and even among staff. In Europe in particular, many recent hires joined Shell to help overhaul both the company and the global energy system, one European employee said. Even if the rest of Shell’s energy transition strategy is left unchanged, any upwards movement on oil output would be seen by some as a betrayal, the person added.

Sawan has said he is committed to the strategy and that adjustments will only be made to help the company achieve its goal of transforming the company.

Ultimately, the best way to close the valuation gap may be to stay the course. “If European oil and gas companies do the shift [to a low or zero-carbon future] they will close the gap in the long term,” said a third top-15 shareholder. “They should stick to the their climate strategy because the climate challenges are not going away, even with the high oil price.” 

The challenge is giving investors enough confidence in current and future returns so they stay the course too.

“My impression is that there’s a bit of fatigue among European oil and gas companies,” the third top-15 shareholder added. “They are more advanced in their climate strategy but not recognised for the transition they’re making.”