Royal Dutch Shell Group Business Opportunities And Challenges Finance Essay

Published: November 26, 2015 Words: 4101

This study is an attempt to provide overview of the Royal Dutch shell Group, businesses, opportunities and challenges. It starts by presenting the company business, structure and the challenges and risks that faced the company. It is also discussed the company capital structure, foreign exchange exposure. To archive it objectives the study also provides the strategies that adopted by Shell such as expand in new market, and strategies to face changes in the environment and competition. The study ended by making some recommendations and concluded that despite the current world financial crisis and rescission, Shell is doing quite well compare to its peers in the sector.

Globalization refers to the integration of global economies through the reduction of barriers to the movement of people trade capital technology. In other words its means that companies can move and produce were it is most cost effective and selling their product where it profitable. The advantage of globalisation encouraged many companies to become known as international companies operating subsidiaries, branches or affiliates located in foreign countries (Eiteman et al., 2010 and Daniels et al., 2009). The Royal Dutch Shell group is a best example as international company. The main aim of this study is to provide overview of the Royal Dutch Shell Group: Its businesses, opportunities and the challenges that face in the international market.

Overview of Shell

The Royal Dutch Shell is group of energy and petrochemical companies operated around the global established in 1890. The Head-offices of the company are in The Hague, the Netherlands. The company is one of the 5 biggest companies in energy and petrochemical operating in 90 counties worldwide and directs its operations with a staff of 101000 employed. It produces 2 per cent % of world's oil and 3 per cent of gas. The company has more than 44.000 services stations and 35 refineries and chemical plants around the world. Shell has ranked as a number one in 2009 by Fortune 500 magazine. Shell made profit in the 2009 amounted to 12.7 billion compare to 2008 which was 26.5 billion. There is decline in the profit of 2009 compared to 2008 by almost 44 per cent. There are many reasons in my view responsible to this decline; some of them due to the decline on oil demand globally; decline on natural gas demand in Europe. In addition to lower oil price and OPEC quotas were a partly responsible as well. During the 2009 the company discovered two new gas fields namely: North America and offshore of Western Australia (Royal Dutch Shell Annual Report, 2009).

Shell's Businesses

Shell businesses divided into three categories namely: Upstream Business: this group searches for and recovers crude oil and gas. This part of business segmented into: Upstream Americas which manages the business in northern and southern America. Upstream International: this group dealing with the rest of the Shell's business around the globe. According to this category the company liquefies natural gas to cooling gas in order to transport it into the markets around the world, the company also refining crude oil to produce petrol, diesel etc. Shell also has many locations worldwide to develop and generate electricity from wind power and other sources (Royal Dutch Shell, 2009).

Downstream Group: the group deals with a number of businesses such as the crude oil and refined products namely: moved and marked them national and international for industrial and transport use. Chemicals business belongs to the Downstream Group as well but it has its own manufacturing and marketing sections. Also Downstream Group manages the carriers and oil tankers. Project and Technology: this part of the company provides functional leadership; safety and environment across Shell Group. Also it is responsible for supplying technology capability and technical services in upstream and downstream activities (Royal Dutch Shell Annual Report, 2009).

The Company Structure

The Royal-Dutch Shell is a multinationals group of companies namely: Shell Transport and Trading Company PLC (UK) and the Royal Dutch Petroleum Company: Netherlands. Shell Transport and Trading Company PLC (UK) own 40 percent while the Royal Dutch Petroleum Company own 06 per cent of the following 3 subsidiaries: (a) Shell Petroleum NV (Netherlands). (b) Shell Petroleum Company LTD (UK). (c) Shell Petroleum Inc. (USA). The company businesses overall are managed by Shell International Head-offices which is in located in t Hague city -Netherlands (Royal Dutch Shell, 2009).

Challenges and Risks Faced Shell Group

Shell operating around the world therefore, it is subjected to many challenges and risks e.g., change in economic situation, political, legal, competition, business and financial fields etc. One of those factors that affect the company the most is the instability of the oil and gas prices. There are many factors affect the demand and supply of the oil and gas prices. For example, weather, political instability and conflicts are hardly affected the prices. These factors are always beyond the Shell control. Low price hardly effect the company expected revenue also high price means; less demand. To avoid such risks the company must hedge against these challenges and also work with other companies and countries to make the price more stable.

The company faced also many challenges e.g., uncertain geology, technology, skilled engineering and workers and other conditions in developing large capital projects. Failure to finish those projects and getting another one will affect the company future production and its cash flows. Competition in oil and gas sector is very high and to achieve it strategic objectives, shell has to react promptly to the competitive factors. This could be by adopting good strategies that guarantees differentiation of its products and reduce the cost with maintain same level of quality.

Other challenges and risk that Shell faced is the failure to following the principles and code of conduct that governors how the company should conduct its business. Any frailer to follow the aforementioned policies or not comply with the regulatory authorities can severely harm the company name and make it hard to secure resources and also affect the company's financial conditions. Shell invested in Iran which expected to be under sanction by the US and other countries soon. If this happened, it will affect the company operational performance and could be subject to penalties in connection to their current and future operations in that country.

The company has invested highly in Nigeria where is on stabilities and security become very big issue. In addition the Nigerian government is expected to pass new legislation which could increase the company tax. However, the risk of uncertainty of the oil and gas reserves are one of the main challenges and risk that faced the company. If the actual outcome was lower than has been estimated the production and income could be negatively impacted. Failure to develop new technology and create new innovations or not have free access to them might affect the company future. The climate change issue which has taken seriously by many governments and green groups is raising concern that some regulations might change and new restrictions imposed. The nature of Shell operations which exposes to many countries that have different health, safety, environment role, regulations, political and social instability, real information etc, all these factors can affect the company current performance and future.

Capital Structure

The Capital structure refers to the way, how a corporation finance its assets. Finance can be done through the combination of various financial instruments, like equity, debts e.g., common equity and preferred equity, long term debts, short term debts. Shell has a mixture of long term debt, specific short term debt, common equity and preferred equity. According to the company balance sheet in the end 2009, Shell has US$292,181 million of total liabilities and equities which is US$154,046 million of debt and $138,135 million as equity capital (Shell Annual Report 2009).

Cost of Capital

The cost of capital is defined as the cost of a company's funds, both debt and equity. Shell follows the successful efforts of accounting for oil and natural gas exploratory costs. These costs are regarded in income when incurred, except that exploratory drilling costs which are included in property, plant and equipment, pending determination of proved reserves. These explorations are subjected to expectation of returns from the investor's point of view. It is used to evaluate the new projects of company. From these new projects, investors first calculate the minimum possible return for providing capital to the company, thus these returns set the bench mark that a new projects has to fulfil (Royal Dutch Shell, 2009).

Debt and Equity Ratio

In the end of 2009, Shell has $35033 million of total debts. The Debt/Equity ratio of shell is almost 25 per cent, which is very good comparing to other companies in the same sector such as BP and also according to the market. The ratio is good singe that the company using capital market in financing its projects and by using this strategy the company has lower interest rates of expenses. Despite the economic down turn in last three years, Shell still making good profit also managed to increase its assets and business around the globe. This may be due to diversifications of the company business. For example in 2009, the company invested in Singapore, in 2008 Upstream business in Nigeria, Germany, UK, the United States and Downstream business in France. Similarly in 2007 there was increase in the company business in Norway and Russia and while fall down in the USA. In the 2007 the company made about of US$952 million as a profit. This changed the destiny of Shell and become the world 3rd company having earned huge profit which was actually reclassified from accumulated other comprehensive income following the sales of securities.

Raising Capital

From reviewing the company annual report, 2009 it's clear that Shell has access to international debt market to financing its assets. Shell has made access to financial market through two commercial paper programmes (CP programmes)

Euro Term Note Programme (EMTN)

US Universal Shelf Registration

These programmes are supported by committed bank facility and cash. Under these programmes Shell can issue debt up to US$10 billion with maturities not exceeding 270 days, this type of obligation comes under short term lending's, also US$10 billion with maturities not exceeding 397 days. The EMTN programme is validated annually, most recently in June 2009 for overcoming recession battle. Shell has issued US$10,524 million debt during 2009 under this programme.

While as the US shelf registration programme provides Shell with the flexibility to issue debt securities, ordinary shares, warrants and preferred shares. The registration for the US shelf programme is updated every three years and at the last update in November 2008 and was upgraded to unrestricted, reflecting Shell's status as a well know seasoned issuer. Under the US shelf programme, Shell has issued US$7,500 million debt during 2009. The committed bank facility is available on same day terms at pre agreed margins and is due to expire in 2012. One more important thing is that these terms and availability are not conditional on Shell's financial ratios or its financial credit ratings.

Foreign Exchange Exposure

The foreign exchange rate exposure in a company is calculation of the sensitivity of the cash flow to change in exchange rate. As cash flow is not easy to calculate, many academicians have evaluated exposure by seeing how the company's market value, the present value of its future cash flow, change with the changing exchange rate.(Adler & Dumas, 1984), It is also known as bad impact on corporate incomes and balance sheet account due to the fluctuation in foreign currency exchange rate. Foreign exchange exposure can take several forms, including: transaction exposure, accounting exposure, translation exposure, commitment exposure, economic exposure, invisible transaction exposure and revolving transaction exposure (Allayannis, 1997).

Market value and risk management

Market value is defined as the present quoted price at which investor buy or sell a share of a bond or common stock at a particular time. It is called as market price to. It can also be defined as the market capitalization including the market values of debts (Yakov, 1994). Companies dealing in many currencies have a risk- unanticipated gain/loss due to sudden change in exchange rate defined in number of exposures. The method of evaluating risks seen by the company and using the method of protection from the risk by operational and financial hedging is called as foreign exchange risks management (Bodnar & Gentry, 1993).

Foreign Exchange Exposures

The types of foreign exchange exposures do the firm face as a result of foreign exchange rate movements? How does the company hedge these exposures? There are 3 types of foreign exchange risks faced by Shell:

Transaction Risk

When Shell has a payable or a receivable in a foreign currency, the foreign exchange rates might get altered resulting in a rise in the liability of the home nation's currency or a lessening in receipt in the home nation's currency (Choi & Prasad, 1993).

b. Translation Risk

When a home nation firm is needed to strengthen its foreign subsidiary's incomes, statement and balance sheet in the home currency, exchange rate might alter resulting in a rise in the liabilities or a lessening in asset as calculated in home nation currency term (Flood & Lessard, 1986).

c. Economic Risk

The impact of exchange rates change on the long term future income stream such as expected net worth of home nations' stockholder. This risk is generally taken care of by physical location of liabilities and assets (Griffin & Stulz, 1997). Following are the various ways to hedge the exposures for Shell:

Having all payables and receivables denominated in the home currency which will shift the foreign exchange risks to the other parties.

Use product pricing strategy that keeps room for enough profit to see for likely foreign exchange losses

Use lagging and leading- Use the payables and receivables to counter the expected depreciation in the foreign or home currency

Use a standard spot

Use a forward hedge

A forward contract is a surety between 2 parties to buy or sell assets at a particular point of time in future.

Use the futures market

A futures contract is a systematic contract which is exchanged on futures exchanges, to buy or sell particular underlying instruments on a specific date in the future at a certain price.

Use options

An Option is a contract which gives the right and not the obligation, to buy in future transactions some underlying securities or futures contracts. There are 2 possibilities on options:

1. Options on Cash.

2. Options on Futures

Swaps

Foreign exchange swap is transaction that includes the buying of one currency against another at a pre determined date and a pact to reverse those transactions on a future date and particular rates.

Market Value

The market value of the firm is possibly affected by the strategies used in exchange rate risk management, expansion to new markets and international financing of operations. The market value of Shell is affected by exchange rates in 3 ways:

Shell might produce at home for export sale and domestic sale

It might produce with imported and domestic component

It might make the same or a differentiated product at plant abroad (Jorion, 1990)

In exchange rate movement strategies, the Shell's value is hedged at a particular rate and it is pretty much constant in a complete hedge. However, naked positions put the market value in danger as then it is left to fluctuations of the market. During expansion to new markets, the market value of Shell incorporates the future expected revenues into its firm value and thus the firm value increases or decreases by the same value. In international financing of operations, there is a risk of sovereign default where the nation refuses to pay the debts. This will really erode the market value of Shell and put it in danger of liquidation (Hagelin and Bengt, 1997).

Shell's Strategies

The strategy in any organization can be defined as the direction and scope of an organization over the long term which achieves advantage in a changing environment through configuration of resources and competences with the aim of fulfilling shareholders expectations (Johnson et al., 2006).

Strategy to Expand in New Market

The motives for expanding into new markets are mainly because exploring the oil and gas resources upstream (ensure the increasing oil and gas supply resources in the future) and target to potential consuming markets downstream to strengthen the profitability. Usually, shell entry into a new market by the form of joint venture with international oil company or with the national owned oil company (the many countries foreign oil companies are not permitted own the 100% of the project for protecting domestic economics), also it expands by acquiring shares in an associated enterprise.

Joint venture and associated companies enable shell avoid many law barriers and cooperating with the local oil companies reduced both the political and economic risks (Marios, 2006). For example, In China, the first project shell participated in the offshore XinJiang fields was from 1964 (shell interests ranging from 24.5% to 47.8%) and it operates the onshore Changbei tight gas field since 2005, which it has 50% interest average under a PSC with Petro China. Other shell interests in China include the North Shilou coalbed methane project (shell interest 55%) and the Yueyang coal gasification plant, a 50% joint venture. In the aspect of associated companies, for example in Egypt, Shell signed agreements to acquire a 40% holding and become the operator on the Alam El ShawishWest Concession, where oil and gas discoveries have been confirmed.

Strategy to Face Changing Environment

Shell always on the line with the changes and developments in the market and the environment by adopting the right strategies and also by reviewing and changing these strategies from time to time. On July, 2009, the Shell's Chief Executive Officer named the year 2009 as the transition year and the following year said will be implement year. A series of changes in the responsibilities of senior management and organization became effective in order to improve the accountability for operation performance and technology improvement, improve the decision- making process as well as reduce the cost increase the profitability. In Upstream, shell focus on exploration for new oil and gas reserves and developing major projects where our technology and know-how adds value to the resource holders. The greatest strategy change happened as the milestone of Shell is concentrate their resources on the upstream production, to increase the output of the oil and gas world-wild. Oil and gas production is expected to be 3.5 million barrel per day in 2012 (natural gas has been converted to oil). While in 2009 was 3.1 million barrel per day an increase of 11.5 per cent. However, in the past 7 years the oil and gas production of shell decrease consistently, which is a very bad sign for the oil enterprise.

To ensure the increase of oil and gas production, capital investment into exploration and mining the oil and gas is expected to be $25 to $30 billion per year for 2011 to 2014. In 2009 cash flow from operations excluding working capital was $24 billion. Shell expects cash flow to grow by approximately 50% from 2009 to 2012 assuming a $60 oil price and a more normal environment for natural gas prices and downstream. 2012 cash flow should be at least 80% higher than 2009 if the oil price increased to $80.

Currently, the production capacity under constructing (period roughly 3 to 5 years) is about 11 billion barrel; in addition, shell is assessing 35 new projects which may increase 8 billion barrel production, in order to ensure the increase trend till 2020. In the area of refining oil, there will also great adjustment to reduce and the oil refining volume 15% from 2009 to 2012. Shell expects to sell oil refining factories in some areas however build new factories in the territories have greater potential markets, and reduce the number and increase the scale the factories.

In the Downstream businesses, shell emphasis remains on sustained cash generation from the existing assets and selective investments in growth markets. As the plan of Peter Voser shell will give up roughly 35% of the retail market world-wide, expects to exit some countries and strengthen the investment in growth markets, and reduce the downstream businesses. For increasing the cash flow and saving the cost, shell reduced the number of employed greatly. In 2009, more than 5000 staffs were cut which saved $2 billion and another 2000 people will be dismissed by the end of 2010 to save about $1 billion. Shell faces fierce competition in each of their businesses. Increasingly, they compete with state-run oil and gas companies (which control vastly greater quantities of oil and gas resources than the major publicly held oil and gas companies), particularly in seeking access to oil and gas resources. Hence, shell tries to differentiate their products, manage their expenses adequately in order to maintain their competitive position and co-operate with some state owned oil companies to access the desirable projects. All these strategies seek to reinforce shell's position as a leader in the oil and gas industry in order to provide a higher shareholder return while helping to meet global energy demand in a responsible way.

Competition Strategy

The main differences about shell's competition strategy worth mentioning is its Counter-Cycle Competition Strategy, which means shell decreases its investment and increase its cash flow when the industry in good time while increases its investment in the bad time. In contract, most of its competitors invest in the good time more.

To explain this strategy the figure 1 and 2 below shown the net cash that used in investing activities of Shell and BP in the years 2005-2009. From comparing Shell with its competitor BP, the investment of shell decreased sharply from US$ 20816 million in 2006 to US$14570 million in 2007 (Good Time Strategy).

Figure 1: The net cash that used in investing activities of Shell and

BP in the years 2005-2009 (in millions)

Figure 2: The net cash that used in investing activities of Shell and BP in the years 2005-2009

(In millions)

Years

2005

2006

2007

2008

2009

Shell

8761

20816

14570

28915

26234

BP

1729

9518

14837

22767

18133

Source: the annual report of Shell and BP, 2009

On the other hand BP increases its investment from US$ 9518 million 2006 to US$ 14837 million in 2007. Using Bad Time Strategy in 2008 and 2009, Shell has increased its investment more than BP. By using this Counter-Cycle Competition Strategy, Shell can buy cheaper assets (asset depreciation during bad time period) and maintain a high cash flow level in the bad time which can reduce the risk. For example, during the year 1973-1974, Shell became the only big oil company who can survive the crisis caused by the oil export prohibition by members of Organization of Arab Petroleum Exporting Countries (OPEC).

Recommendations

Shell should pay more attention to the research and development of alternative fuels, which may be the core energy in the future.

Shell has to adopt newer modes of training, to keep their employees up dated with latest technologies prevailing in the international market.

Financial institutions are reluctant to financing that much nowadays due to the current financial crisis and recession, therefore Shell should keep more on the retained earnings to be able to develop and finance future projects

Most currencies change in value over times and therefore Shell should diversify to counter the risk of holding currency that plummets in value, by having competing currency which is gaining in worth. Changing profits into separate foreign currency reserves and coordinating cash flows with basic hedging strategy should be the means to diversify.

Operational hedging which guides the shifting of production and sourcing at a foreign place to match revenue in foreign currency should be used extensively by Shell to lessen the exposure levels to moderate level

Conclusion

This study aim is to overview of the Royal Dutch Shell Group, its businesses, opportunities and challenges. It starts by presenting the company businesses, structure and the challenges and risks that faced Shell. It is also discussed the company capital structure, foreign exchange exposure. To achieve it objectives the study also provides overview to the strategies that adopted by Shell such as strategies to expand in new market and strategies to face changes in environment and competition. All in all, the study concluded that Shell is in the right direction and as it has invested huge amount in many countries around the globe which will rapidly and steadily boast Shell future in the coming years.