Royal Dutch Shell plc (ADR) (NYSE:RDS.A) is among the largest oil and natural gas companies in the world. Despite its similarity to industry leaders, its dividend yield is roughly double that of giant Exxon Mobil Corporation (NYSE:XOM). The company looks well positioned to prosper in the future despite the inherent risks it faces, making it a top option in the oil patch for income oriented investors.
A Bitter Pill
Shell is a well-known brand and, generally, a well-respected company. However, a large reserve write down in 2008 didn’t do much for the company’s image with investors. That move has left the company in a position where it has to prove it is capable of executing. Unfortunately this “prove it” situation comes at the same time that finding oil and natural gas is getting harder.
These two issues are largely behind the company’s relatively depressed share price. However, in that is an opportunity. Knowing the big risks Shell faces is key to being comfortable with buying into this energy giant.
Finding New Reserves
Perhaps the biggest problem that Sell faces is finding new reserves to replace the oil and natural gas it pulls out of the ground. For example, in 2012 the company’s proved reserves were 13.6 billion barrels of oil equivalent, down from 14.25 in 2011. A falling number here is a bad thing because it means the company is slowly running out of product to drill and sell.
That said, Shell has made a massive commitment to natural gas throughout the world. This is similar to the move made by Exxon Mobil Corporation (NYSE:XOM) (notably with its purchase of gas focused XTO Energy). With natural gas prices so low in North America, both companies look to have made a mistake. In fact, Shell owns an array of properties that simply aren’t economically worth drilling right now.
Longer term, though, this focus should prove fruitful for both Exxon Mobil Corporation (NYSE:XOM) and Royal Dutch Shell plc (ADR) (NYSE:RDS.A), which both project that natural gas demand will increase materially in the years ahead as it displaces less environmentally friendly coal. With increasing demand is likely to come increasing prices.
Of course, Royal Dutch Shell plc (ADR) (NYSE:RDS.A) isn’t abandoning oil, with large projects coming on line and planned for the future here, too. Across oil and natural gas, the company has about 30 major projects in the works, with an equal number on the drawing board. So the company is clearly spending in an attempt to grow its reserves.
While this won’t help the company in the near term, it provides a silver lining to the reserve cloud that time, and continued investment, will likely heal.
Successful Completion of Big Projects
While tightly correlated with the search for new oil and gas, successfully completing big projects deserves its own review. Essentially, the easy oil and natural gas in the world has been found. Finding new sources of these commodities requires taking on riskier and more expansive projects.
The increased expense of such efforts will likely keep pressure on profitability. That’s an industry wide phenomena. However, individual project risk is something that can do severe damage to a company. Look no further than BP plc (ADR) (NYSE:BP) and its Gulf of Mexico oil spill for just how bad it can get. That company was forced to shed assets, materially changing its structure and outlook, simply to remain alive.
While BP’s dividend yield and dividend growth prospects rival those of Royal Dutch Shell plc (ADR) (NYSE:RDS.A), the risks associated with owning BP make it a less desirable purchase. But Shell’s history isn’t pristine, either. In fact, it had a ship run aground in Alaska last year, resulting in management putting its efforts in that region on hold and under review.
With 30 major projects going, execution is a big risk—but it’s one that has to be taken.
Energy Prices
No discussion of an energy company would be complete without examining energy prices. Oil and natural gas are commodities. Royal Dutch Shell plc (ADR) (NYSE:RDS.A) can’t change that. At present the company’s projections call for oil to be in the $80 to $100 a barrel range and for natural gas prices to rise from their recent historic lows.
While those numbers sound reasonable, there is always the risk that the market doesn’t cooperate. Should oil prices fall below that range or natural gas prices not recover, the company’s profitability will suffer. Natural gas, because of the company’s aggressive push into the space, will be a key issue to watch.
Of course, the company’s expectation that energy demand will increase 80% by 2050 because of economic development around the world suggests that any short-term weakness could actually be a buying opportunity.
A Good Combo
No investment is without risk. Royal Dutch Shell plc (ADR) (NYSE:RDS.A)’s combination of risk and reward, however, make it a good option in the oil and natural gas space for income investors seeking a well-positioned energy play.
The article The Oil Major With The Best Risk/Reward Profile originally appeared on Fool.com and is written by Reuben Gregg Brewer.
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