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Shell and Oil Prices: Integrated Model Dynamics

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Jan. 11 2016, Updated 8:07 a.m. ET

Shell and oil prices

Royal Dutch Shell (RDS.A), an integrated energy company, has two main segments: upstream and downstream. Upstream explores and produces oil. Downstream refines and markets petroleum products.

In the entire supply chain, crude oil plays an important role. The upstream segment earns from the sale of crude oil. On the other hand, the downstream segment incurs costs in the purchase of crude oil. So changing oil prices affect both business segments inversely. All other things being equal, a fall in oil prices will usually be detrimental for upstream and beneficial for downstream, and vice versa.

According to Shell, a $10-per-barrel change in Brent prices affects its annual earnings by ~$3.3 billion. Similarly, a dollar-per-MMBtu (one million British Thermal Units) change in natural gas prices impacts its earnings by ~$300 million annually.

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Shell’s upstream earnings fall

Changing oil prices have changed segment dynamics within Royal Dutch Shell (RDS.A). Earnings from the upstream segment have fallen steeply. The upstream segment, which contributed 74% of the total earnings in 3Q14, became a loss-making segment in 3Q15, even after excluding identified items discussed in the first part of the series.

This is on the back of falling crude oil prices. Brent prices that averaged $102 per barrel in 3Q14 fell to $50 per barrel in 3Q15. The situation is similar for Shell’s peers Exxon Mobil (XOM), BP (BP), and Chevron (CVX).

Shell’s rising downstream segment earnings

Shell’s downstream segment earnings have done quite well. From 3Q14, downstream earnings, excluding identified items, rose 46% to $2.6 billion in 3Q15. In fact, the downstream segment was the only contributor to 3Q15 earnings.

While overall earnings have slumped from $5.8 billion in 3Q14 to $1.8 billion in 3Q15, the downstream segment has notably resisted the fall. Now, in the falling oil price scenario, the downstream segment is an earnings savior for Shell.

For exposure to energy sector stocks, you can consider the iShares Russell 1000 Value ETF (IWD), which has ~12% exposure to the energy sector.

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