Big oil companies like to be predictable; they rarely issue profit warnings but when they do it is for two reasons: there is a new boss clearing the decks of the mistakes of his predecessor or there is something fundamentally wrong.
Shell's previous red flag – the warning in 2004 about a huge hole in its reserves – was clearly a case of the latter. This time, there is certainly an element of the former: Ben van Beurden, the chief executive officer who replaced Peter Voser at the start of the year, is taking full advantage of his honeymoon.
The new CEO is writing down the value of some upstream assets by $700-million (U.S.), thus shrinking profits in 2013. This serves two purposes: it will set a lower baseline from which to compare Mr. van Beurden's performance in 2014 and subsequent years. Less cynically, perhaps, it provides a further signal that the new boss wants to change the direction of Shell to one more in line with current market sentiment: lower investment levels and more attention to cash generation.
Yet, things are not going well for Shell. Earnings for the final quarter will be almost halved from the same period in 2012, the company says, even before the writedown, and cash flow will be down by a third. Such a big decline suggests either that Shell has got it badly wrong or the environment for big integrated oil companies is even worse than we thought.
The answer, again, is a bit of both. Shell spent $45-billion (U.S.) last year and existing commitments will take the outlay above $50-billion this year. Far too much, think some investors, who worry that a lot of Shell's industrial kit is not yielding great returns. Mr. Van Beurden has promised to raise $15-billion from asset sales, and in December Shell cancelled a mammoth natural gas-to-liquids project in the U.S. No doubt, the company remembers the cost inflation that took Pearl – its flagship GTL plant in Qatar – from an outlay of $5-billion to $18-billion.
Shell can cut spending, albeit slower than it would like: Supertankers take time to alter course. But what it cannot do is change the environment. And for a company with big investments in manufacturing, the outlook is poor.
The margins for making fuel in Asia have collapsed, thanks to a huge refinery overbuild. A survey of refining analysts by Reuters concluded that Asia's fuel factories will be producing three million barrels per day (bpd) in excess of demand by 2018.
The outlook is worsening for refiners, such as Shell, which has a large fuel plant in Singapore. The Middle Eastern OPEC countries are building aggressively in a bid to create badly-needed jobs and get more value from their output of crude oil. This will add another 1.8 million bpd of refining capacity to the fuel glut.
Margins are poor because the feedstock crude oil price is high and, in a bid to stem losses, Asian refiners have been forced to replace crude inputs with fuel oil, a cheap byproduct which can represent half of the output of refining heavy Middle Eastern crude oils.
This circular process is indicative of the huge imbalances in the refining business. Europe's fuel factories find themselves hamstrung between high crude prices and weakening demand, with consumption of road fuel in long-term decline. Meanwhile the U.S. has suddenly emerged as a major fuel exporter, thanks to the cheap feedstocks available from the expanding output of shale oil.
Oil refining has throughout history been a business with a few years of boom followed by a decade of bust. The outlook of overcapacity and weakening fuel consumption in America and Europe suggest there will be a fierce fight to capture the rising markets of Asia. It's not clear that shareholder-owned multinationals will be the winners, Even with better technology, they are likely to face less-than-fair competition from state-backed refiners. We should expect to see more assets sales from Shell.