On September 30, 2020 Shell announced that it will cut up to 9,000 jobs in response to the severe reduction in revenue as a consequence of the COVID-19 pandemic.
Acting now is a matter of urgency for Shell
This announcement is hardly a surprise – Shell has been hit very hard by the pandemic. Its market capitalization has been hit hardest of all the oil majors. The company lost 54% of its market value, compared to Total losing "only" 34% of its value in the market. Moreover, its share prices are still effectively in free-fall.
Yet, this is not an emergency measure
Even though there is a strong impetus to act now for Shell, this measure should not be viewed as an emergency cost-cutting measure in our opinion. Since the start of the pandemic, Shell has announced a number of measures that should be viewed in relation to each other and to the transition that Shell is committed to. In the words of the company's CEO, Ben van Beurden: "We will have some oil and gas in the mix of energy we sell by 2050, but it will be predominantly low-carbon electricity, low-carbon biofuels, it will be hydrogen and it will be all sorts of other solutions too."
The series of measures Shell has implemented in response to the COVID-19 crisis amounts to a consistent restructuring that will enable the company to become more agile, financially, in its assets and in its organization, in the transition to becoming a low-carbon energy company.
Obviously, the measures are also a direct response to the severe loss of income due to COVID-19. If anything, the crisis has helped to accelerate tremendously what would otherwise have been a much more cautious gradual process of restructuring.
Increased financial agility by reducing dividends
Integrated O&G companies had an average weighted average cost of capital (WACC) of about 7.1% at the start of this year. Capital is more expensive to them than it is to electric utilities, with an average WACC of 6% in the sector, but less expensive than to the chemical industry, which has a sector average WACC of about 9%. If Shell's future is to sell "predominantly low-carbon electricity," then it will have to compete with companies that can access capital at a substantially lower cost than Shell. From that perspective, it makes more sense for the oil and gas industry to evolve into chemical companies. However, that is not attractive from the point of view of market size. Renewable electricity is the growth market for the industry, as energy use is shifting away from fuels toward electricity. Chemicals will only see moderate growth in comparison, and the incumbent companies (including the O&G majors themselves) in the space will easily fulfill the demand increase. The future of the oil and gas industry is to grow in renewable energy and to stand its ground in chemicals.
The O&G sector has been working hard already to reduce the WACC, as evidenced by the trend in the figure below. The main determining factor in the WACC is the cost of equity. One of the first measures Shell announced in response to the crisis on April 30 was reducing its dividend by 66%. This was a landmark move, as the company had not reduced dividends since WWII, and that includes the oil crises. The measure helps immediately by saving €2.5 billion in the second quarter alone, but more importantly, it increases the financial agility of the company to invest in electricity production and meet its future industry peers on an equal financial basis.
Increased agility in the portfolio by writing off assets
The second major measure announced in July was to write off €20 billion on its oil and gas assets. This affects upstream production assets for oil and gas and refineries. It is a sensible measure to reflect the new reality of low oil prices that will last for at least a couple of years. In addition, it reflects the economic outlook for these assets in light of the energy transition. Reducing the value of these assets now makes Shell more agile in its portfolio management. The company can proceed to sell some of these assets more easily, while it still has the option to negotiate a premium price if it sees an opportunity. Biting the bullet now and writing off these assets relieves the company of the burden of having to optimize the use and profits of its oil assets at all costs. It can take a more balanced approach to investments in the future and in this way be more agile.
Shell is not the only company that has taken this measure. Chevron, Total, BP, and more recently, ExxonMobil, have all announced similar steps.
The announced layoffs make the organization not just leaner but also more agile
The third measure announced was to then lay off up to 9,000 staff members. This will result in cost savings of approximately €750 million (Lux's estimate). The measure will take until 2022 to implement and will also cost money in the short term for severance packages. Altogether, it is a substantial contribution to the bottom line but certainly not the most effective measure to counter the immediate effects of COVID-19 for a company like Shell. To be really effective, the company would have to cut much deeper and faster.
In the past, Shell has always combined such large rounds of layoffs with structural changes to prepare for the future. This happened when the company integrated its upstream and downstream R&D in one innovation and engineering organization, for example (around 2008). The current announced round of layoffs will allow the organization to realign itself with the future business and create the room to grow with new people and competencies as of 2025. Even though the announced layoffs will help keep Shell financially healthy during the COVID-19 crisis, their main effect is to accelerate the organizational changes needed to transform the company into the versatile global energy company it wants to become.