At its annual strategy update, energy major Royal Dutch Shell PLC (RDSA) unveiled its business policy. In particular, the company outlined plans to increase production by 11% by 2012 and at the same time cut costs by selling some of its refining and retail assets and reducing more headcount.

According to the company, these initiatives are expected to improve the organization’s efficiency and sharply boost cash flow from operations.

The strategic actions became necessary as Shell’s downstream operations have struggled in recent times due to weak demand for fuel, leading to mounting losses in this segment. The company, which has a high exposure to refining, has lagged rivals such as BP Plc (BP) in cutting costs to cope with the new climate.

Shell will now focus on growth in its gas business. The company also pegged its capital expenditure budget at a minimum of $25 billion for the next several years.

Highlights of the meeting are summarized below:

Job Cuts & Asset Sale

The integrated major said that it plans to cut an additional 1,000 jobs by the end of 2011 (on top of 1,000 job cuts planned for 2010). Shell aims to save at least $1 billion in 2010. Last year, the firm slashed 5,000 jobs (or 5% of its worldwide staff of roughly 100,000). Further, the company plans to sell $1 – $3 billion per year in non-core assets.

Downstream Operations to Be Trimmed

To help fund its ambitious growth plans, Shell has decided to do away with some of its less profitable businesses. It will sell 35% of its petrol station operations, while reducing refining capacity by 15%.

Upstream Focus

The Anglo-Dutch supermajor also said that it expects its annual production to increase 11% by 2012 (up from the previous estimate of 6 – 9%), driven by a new wave of project startups. Shell’s targeted output rise, to 3.5 oil-equivalent barrels per day (MMBOE/d), would reverse the declining trend in the last several years. In 2009, the group’s volumes averaged 3.15 MMBOE/d. The Hague-based oil producer is currently assessing more than 35 new projects that should guarantee upstream growth to at least 2020.

In line with other supermajors like ExxonMobil Corp. (XOM) and Chevron Corp. (CVX), Shell sees natural gas playing an important part in its future. The company’s targeted volume growth will be achieved primarily by new natural gas projects coming onstream in Qatar, Australia and North America. Shell said that it expects natural gas to represent 52% of total volumes by 2012.

Cash Flow Boost

As new projects come onstream, Shell expects cash flows to increase significantly by 2012, by around 50% with oil at $60 per barrel, and by over 80% at $80 per barrel.

Capital Expenditure & Funding

To meet these targets, the company expects to spend at least $25 billion annually in capital expenditure in the years to come, quite high by industry standards.

In order to finance this huge capital spending and keep its balance sheet strong while waiting for the production and cash-flow increases to materialize, Shell has decided to maintain its 2010 dividend at the 2009 level. Thereafter, the oil giant would look for a payout hike.

Our Take

In view of the increasingly bearish outlook for the marketing and refining operations, we believe that Shell has taken the right decision by looking to streamline its loss-making downstream portfolio, a plan that has been followed by several other oil majors Incorporatedluding Chevron and ConocoPhillips (COP).

The company plans to boost returns and remain competitive in this difficult environment by embarking on aggressive cost reduction initiatives, exiting unprofitable markets, and streamlining the organization. As of now, Shell has decided to boost focus on the more lucrative and well performing ‘upstream’ exploration and production end of the business mainly natural gas.

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