Shell’s (LSE: SHEL) share price is basically a product of two key factors, in my view.
First, the oil price — largely a function of supply and demand, overlain with geopolitical factors related to both.
Second, market perceptions of how much its energy transition strategy is likely to disadvantage it compared to its competitors.
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Oil prices to stay higher for longer?
In the short term, geopolitical risks remain in abundance. The war between Russia (a top three oil and gas producer) and Ukraine grinds on. And the Israel-Hamas War has escalated to involve direct attacks on each other’s soil between Israel and Hamas-backer Iran.
The World Bank said that further escalations could push oil prices over $157 per barrel (pb). The benchmark Brent oil price is currently around $86 pb.
Longer term, oil cartel OPEC sees demand increasing to 116m barrels per day (bpd) by 2045. This year, it’s expected to average 103m bpd.
On the supply side, the International Energy Agency estimates that underinvestment could lead to oil supplies falling below 95m bpd by 2030.
Demand outstripping supply to this degree is very positive for oil prices.
Is it undervalued?
Shell has long suffered from a valuation gap to its fossil-fuel-focused competitors, according to CEO Wael Sawan.
The figures bear him out, with the company currently trading at a price-to-earnings (P/E) ratio of just 11.7.
ExxonMobil, Chevron, and ConocoPhillips — the big US firms still concentrated on oil and gas — trade at 13.2, 13.8, and 13.9, respectively. Saudi Arabian Oil – also unswervingly focused on oil and gas drilling — is further ahead at 16.2.
Shell’s UK counterpart BP isn’t in its peer group due to its smaller operational scope and size. But, also trying to pursue a balanced energy transition, it trades at just 7.
A subsequent discounted cash flow analysis shows Shell to be around 34% undervalued at its present price of £28.52.
So a fair value would be around £43.21. This underlines to me how undervalued it looks, although it may never trade at that level, of course.
Moderating its energy transition
Consequently, a key risk for Shell is how it balances its energy transition strategy from here.
If it increases oil and gas drilling too much then it may encounter government pressure to cut back. But if it doesn’t increase it enough, then the big valuation gap to its key peers will remain.
Another risk is that the energy market reverses into a sustained period of lower prices.
Shell has made an adjustment already — targeting a 15%-20% net carbon cut by 2030 compared to 2016 levels. Previously, it intended to achieve a 20% cut by 2030.
It’s also scrapped its 45% net carbon reduction target for 2035 but remains committed to a 100% reduction by 2050.
Additionally, it will keep oil production at 1.4m bpd until 2030 and will expand its LNG gas business.
To me, Shell’s 2023 results show it may be on the right track. Q4 saw adjusted earnings of $28.25bn against consensus analysts’ expectations of $26.82bn. Expectations now are that earnings per share will grow by 9.5% a year to end-2026.
Given this strategy, its strong core business, and its apparent undervaluation, I’d buy the stock right now if I didn’t already own it.
