Shell’s trading arm is a colossus, estimated to have generated about a fifth of the company’s record profits last year. But ask your average investor in the company and you could forgive them for knowing very little about it.
Trading has long been the black box of the European energy majors. It acts not just as the glue that holds together the disparate part of their operations, from production to refining, but also as a means of juicing returns whether times are bad or good.
But Shell and peers such as BP and TotalEnergies are incredibly reticent about revealing just how important trading is to their profitability. None of them provide a proper breakdown in quarterly or annual results that shows just how much profit they generate from trading. But when estimates of the figures emerge they tend to be eye-popping.
Analysts at Bernstein said last week that they estimate Shell made $16.6bn in earnings before interest, tax, depreciation and amortisation last year from trading, while TotalEnergies and BP made $11.5bn and $8.4bn respectively. None of the companies have tried to cast serious doubt over the numbers.
To put Shell’s bumper trading earnings in context, that was more than Italy’s own energy major, ENI, made in net profit in 2022 from all of its operations, including producing oil and gas. Shell’s estimated earnings from trading in 2022 were even larger than the ebitda in the year to March 31 of AstraZeneca, the only company with a bigger market capitalisation in the FTSE 100.
The volumes it trades are equally eye-catching, with Bernstein estimating that Shell’s oil and gas dealers move roughly 14mn barrels of oil equivalent a day — many multiples of what it actually produces. BP is estimated to be trading about 11mn boepd. Both are higher than the largest private commodity traders such as Vitol and Trafigura.
Keeping such a large part of Shell and BP’s business hidden from view is arguably not good for investors. There may be sound commercial reasons not to reveal the exact mechanics of a trading operation, but a publicly listed company should be more transparent about a branch of its business that generates almost 20 per cent of its earnings.
The opacity might not be helpful either in closing the valuation gap between Shell and BP with US peers such as ExxonMobil and Chevron. Shell and BP executives have long been frustrated by this divide, which they believe is larger than the difference in their underlying earnings justifies. On a multiple of price-to-expected-cash flow, Exxon and Chevron both trade above 6, while Shell and BP are below 4.
The reasons generally offered for this include the perception that European majors are more focused on the energy transition, the deeper pools of capital in the US and less investor squeamishness about fossil fuel companies in North America.
These arguments have some merit, but shouldn’t be overstated given that the valuation gap is a long-term trend. Another explanation is that investors struggle to correctly value the European company’s muscular trading arms, which are far larger than the marketing operations of US peers. Many in the energy sector would acidly say most equity analysts certainly do.
The risk is that investors discount the high profits earned by Shell and BP in trading as nice-to-have-when-the bets-come-in rather than a predictable, recurring part of their business they can put a valuation on.
Bernstein argues that the trading operations should be treated as an “increasingly material and sustainable source of value creation”. The returns on offer have not gone unnoticed across the pond. Exxon is trying to rejuvenate its initial stuttering foray into trading, which it launched last decade.
More importantly, trading is going to be an increasing part of the European majors’ business model. As renewable power grows as a source of energy, trading will play a big role in helping boost the thinner margins on offer in the future. And few in the industry expect volatility — the lifeblood of trading — to dissipate substantially as the world tries to transform its energy system.
“Ultimately, the primary energy system is fast becoming the most complex energy system we’ll witness in history,” Bernstein said. “While complex systems are difficult to model, increased market volatility will certainly be one key feature.”
For oil companies, volatility should mean profit for their trading arms. It’s time they lifted the hood a little higher to let investors appreciate just what’s going on.
