uploads/2016/06/Costs.jpg

How Will the Shell–BG Merger Save Costs for Shell?

By

Updated

Shell focuses on reducing costs

Until now, we’ve examined Royal Dutch Shell’s (RDS.A) overall strategy and its cash engines. In this part, we’ll discuss Shell’s costs, an important lever in managing the oil down-cycle.

One accelerator on this front has been the Shell–BG merger, which is expected to result in huge operational synergies for the combined company.

Shell plans to reduce its operating costs from $46 billion in 2015 to ~$40 billion in 2016. These cost reductions are expected to result in huge savings, directly adding to the company’s free cash flow. ExxonMobil (XOM), Total S.A. (TOT), and Chevron (CVX) are also focusing on cost reductions to improve their cash flows.

For global stock exposure, you could consider the Vanguard Total World Stock ETF (VT). The ETF has Shell, XOM, TOT, and CVX in its portfolio.

Article continues below advertisement

Shell–BG merger synergies

In terms of the Shell–BG merger, operational synergies are expected to spread around four major areas: selling, general, and administrative (or SG&A) expenses, procurement, marketing and shipping, and exploration.

The merged entity’s overlaying areas of operation are expected to result in processes and assets that will contribute to cost savings. These processes include administrative work, raw material procurement, marketing, and shipping operations.

It’s imperative to note that ~40% of the company’s operating costs are staff expenditures. Shell plans to right-size its employee strength, which is expected to benefit from the Shell–BG merger. Shell expects synergies of around $4.5 billion from the Shell–BG merger alone in 2018.

Exploration expenses

With the Shell–BG merger and recent discoveries, the combined entity’s need for heavy exploration spending has been reduced. Its focus will be more on producing assets. Its aim will be to limit exploration activity to the heartlands or areas where substantial discoveries can be made with comparatively lower spending.

Move on to the next part to learn about another major lever of Shell’s strategy: capital spending.

Advertisement

More From Market Realist