Royal Dutch/Shell Group of Companies Strategy Presentation & Conference Call (London) - Final.

Original Source: FD (FAIR DISCLOSURE) WIRE

JEROEN VAN DER VEER, CHAIRMAN CMD, PRESIDENT OF ROYAL DUTCH PETROLEUM, ROYAL DUTCH/SHELL: Thank you very much. So, again a real welcome. Today is a big day for Shell because we, the new team, they are still sitting there, and you will see them shortly with all the presentations. The new team can share with you how we take Shell forward.

It is about actions and it is about urgency. Over the past 6 months we have done already a lot, but much more has to be done. We attacked that with energy and realism, and we drive Shell to be a different company.

How are we going to do that? Only a few words about our half-year results. I think they were good. So Tim will say a bit more about that, but we think it is a solid financial performance. It is not only oil and gas prices; we have some good performance of our assets as well.

I will be brief, but I will address the reserves issue. I will talk a bit about structure and culture, but the main emphasis today is on our strategy and the choices we make there.

So let me start with the slide 'Strategy and Priorities'. If you asked me what is the vision for Shell or the strategy for Shell, I'd like to just explain that in 5 words. So the strategy for Shell is more upstream and profitable downstream. But okay, what does that mean?

First of all you have to make sure that you are happy with your portfolio. So given where we are, you have to reshape the portfolio. We can do that but we do that in 3 ways.

First of all, in organic growth we have brought up or we bring up the investment level to $15b per year. That's a lot more than over the past years. In the '90s we were below the $10b level; in the intermediate years we were at about $12b, so we bring that up to $15b. And that's mainly upstream.

But as tools in the toolkit we use divestments - we have already seen a whole stream of divestments announced and partly completed, and you'll hear more today. And of course we can use acquisitions. Acquisitions are not easy to do when oil and gas prices are where they are today. But if they create value for our shareholders, we will do that and we have done it in the past.

So that's about the portfolio. But it is very important, of course, that what we have, you run it well. We have established a top quartile performance philosophy and we have rolled it out. What do I mean by that? If you compare the deepwater unit cost to produce oil or gas from Shell with the competition, we like to be in the best 25%. But if we compare the uptime of our refineries with that, with the competition, that's 25% for our leading marketing positions. So that is the top quartile performance philosophy.

Secondly, for the future of this industry it is essential to have a very good capability to execute all those multi-billion dollar projects. So your projects should be on time, on specification, on budget. And we do many projects well, but not all of them. And we have to pull up our socks to do it better there.

The combination of having the right portfolio and top quartile performance and project execution capability will give you good returns, good competitive returns and of course good cash.

But I think management, the top leaders, have to do more. We have to make sure that we have the organization that we like to have and we have to set the company culture. And this company culture, which is always the start of something big, you have to realize what is it in Shell to make us more successful. And we have made and rolled out since May this year a whole program about leadership, accountability and teamwork, and we think that on those 3 aspects we can do it better.

And that will of course very much help because we would like to reduce complexity by simplifying our organization and making even more global operating models that will help us, this combination, to give us a sustained cost competitive position.

Let me update you about the reserves issue. Mainly in the top boxes, what we have done or which is underway to be completed. So we have counted the reserves, they are restated. We have strengthened our procedures, that is the internal organization for reserves accounting. Consolidated all the processes, not only reserves, how we [weren't quite as] organized - Tim Morrison will come back to that. Basically, there's a lot of measures in the organization in our business processes that we can [make] drop another shoe.

Then of course, what is the focus for the future - and Malcolm will go in great detail about that - since we have to grow the reserves basis. And in parallel to all of that is we have at this moment 5 alternatives. Or we have 5 alternatives we were investigating as we settled with the SEC and the FSA, and we cooperate with the other 3 authorities fully.

And of course, there is litigation against us. For instance, class actions in the US. We will defend ourselves.

Then I'll give you an update about structure and governance. We started this in March, and what did we set out in March to do? We would like, if we look at the very top structure of the Company - so that's Royal Dutch and Shell Transport and Trading. How can those work, those 2 entities work together with a better effectiveness, a very clear accountability, very transparent so it is easy to understand, and of course look at our annual report. I think we can make it more simple.

What we will do is we have various options that we study. But here you have to go through the details. You cannot come out to say this is a preferred option and then to discuss 2 weeks later that, for instance, there is a major taxation problem that we didn't foresee. Or if we come out with a preferred option, that is clearly to explain that to some shareholders it is not a fair proposition. So you have to do a lot of precise homework before you can come out with your preferred option.

We have to draw a line in the sand, where we stick our neck out. We will be there in November, and then we will present our preferred option.

Also, we do not wait to make changes in our governance in the meantime if we can do that. You'll see the list already done. I'd like to point out that RD stands for Royal Dutch priority shares, they will be exited in April next year. You need an Annual General Meeting to do that.

Very important to me as well is that the new executive team is now nearly in place. Linda arrived on August 1 and Peter Voser, our new CFO, will arrive on October 1.

And then please realize that below the Managing Directors, we made a lot of governance and structure changes. We have now global CEOs who have very clear accountability, and they are really simplifying their organization. So another way to look at it, we have only to do the top layer and we announce that in November.

Business environment, oil prices. This is the whole topic nearly every day in the news at this moment. What I'd like to say to start this slide is we have changed our view about the oil and gas price outlook compared to some years ago. And let me explain why that is.

If you look at the left-hand slide, that contains basically 3 messages. For the coming 25 years, not a long time [actually], oil is still growing. So the demand for oil will grow and the supplies are there. And gas growth as well, it grows faster than oil.

Please note that we expect it is quite possible that OPEC's share increases as well, and [the derivatives] to the oil.

If you look at the right-hand side, [you'll understand] the total industry is at an investment level, as you see, about $125b. The recent IEA reports indicate that the investment level of this industry goes up to $200b per annum. This is huge. It is probably the largest, or one of the very largest of all industries, subject to your [calculations]. And it shows what a lot of people don't realize normally, that the energy industry, or the oil and gas industry, is a growth industry.

But if you take the combination of this increased demand and the increased investments, we think that will lead to a higher oil and gas price outlook. And I'll come back when I talk about the financial underpinning of our strategy.

[But now I go] is how we needed the new team, how we drive Shell forward. And this is the kind of high level slide that shows that. We have to, if we say more upstream - and after the recent events you will understand if we say we had to regain up some strength.

We have a good platform to start from. We have many good producing assets. We are proud of our Gas business and certainly of our LNG - liquefied natural gas - positions. But we realize we have to do more to grow our reserves. We still can do better in our operations and project delivery, it's simply a key capability. We have to get that full effect for the future for us in our industry. But it is not only to do those reserves and operations and projects, it is to do them with urgency.

And that is one thing we really would like to change in Shell - that we settle do all the things we do with enough urgency.

Downstream, Rob Routs will come to the portfolio. There's a lot to say there, how he deals with the top quartile performance strategy and of course what he is doing to globalize, further his organization and standardization.

What we do as well, which is maybe strange but it is new in this industry, I think, we integrate our Chemicals manufacturing into the Oil manufacturing, or into the refineries. We think we have certain synergies in hydrocarbons, in utilities and in people, and that we'll bring the systems together - the chemical manufacturing and the refineries - that you can achieve better sustainable cost competitive positions.

Now I come to the financial underpinning of our strategy. Of course we have good strong cash generation, oil prices but good performances as well. But that is what we aim for. In our industry, with the inherent high risks that we have, we should have a conservative balance sheet, we should be conservative about our balance sheet. And we have set out, as in the past, to do that.

So the aim is conservative balance sheet. Then the priorities are dividends, investments. And you have to note there is a good dividend in doing our own investments, our organic growth up to $15b. And [in the numbers], still space, and that will be if you're at the high oil prices of today, plenty of space for buybacks and we do that, as we have announced that we are this year doing.

But that is very important and that comes back to what I announced in the business environment. We have to base our cash planning, that is not the screening criteria for projects but the cash planning that's like your household at home, when are you neutral? And in the past we were neutral at $20 per barrel. That is how we set out the cash planning. But if you look now at the expected outlook for oil and gas prices, we set the cash neutrality from $25 per barrel.

And why do we do that? That is quite simple, because if we do the cash planning on a lot lower figure, as it was in the past, what will you do, you'll cut back on your investments. And you will see because the investments, as you see here, mainly in the upstream, you cut back there. That's not good for the future of Shell, nor good for shareholder value.

On the other hand, if we take a higher figure - you may say $25, oil prices were $43 this morning. But if you take a higher figure there is still a lot of uncertainty about long-term oil and gas prices. I realize a lot of our investments are not for the coming year but for many years to come. And then we don't like that we have to stop/start projects. That is not a good way to do [either].

This means, in this cash neutrality, that we plan now for $15b CapEx. A lot more than it was in the past, and you'll see how we filter to the upstream. So out of this $15b, $11.5b in EP and Gas & Power. At the same time, we use this divestment tool. It is, I note it is about 3 years, $10b to $12b, and of course difficult to time. They are not always about the proceeds, and Tim will explain that this is in fact a risk figure that may be more.

Ladies and gentlemen, I come now to the end of my introduction, but I would like to share that you say words but you talk about action and urgency. So how do we judge ourselves and how can you judge us? And I think that are 5 key aspects to measure our success.

Our returns, our earnings, our returns on capital, is better than the competition. And do we have our assets in the top quartile? That is where we aim, and if we don't have it, you'll either make the plan to have it there or you may have to consider portfolio action.

How very important, how important the shares are and how you can measure them. We have to meet project milestones. I touched on that as well.

But last but not least, I think it is still one of the very best indicators, how is our total shareholder return doing vis-a-vis the competition? So what is our share price, taking into account our dividend payments, how does it perform to the other big multi-nationals?

Ladies and gentlemen, I spent a few minutes touching on the key items. How we drive more upstream and profit flow downstream. In the coming presentations, you will see in more depth how we will make Shell a different company. I'll give it now over to Tim.

TIM MORRISON, ACTING DIRECTOR OF FINANCE, ROYAL DUTCH/SHELL: Thank you Jeroen. Although indeed we are having a tough year, we are a very strong company with strong enough people, with strong enough finances.

This year we've paid a good dividend. We've increased our dividend. We've restarted the buyback program. We've paid down debt and we've funded a heavy investment program. We'll move ahead with a healthy balance sheet, the capability to fund this multi-year program with a balance bringing current distributions and investing to grow the Company.

Now, before I say more about the financial framework, I would like to just say a few words on controls.

Following the reserves problem, we said in our annual report that we'd implement a whole range of remedial measures and these are being implemented with great commitment across the Company. A lot are already complete, others take a bit longer, particularly widespread training programs.

For example, the new and expanded reserves audit team is now fully functioning, fully operational, and it has the use of external reserve specialists. As Jeroen mentioned, business CFOs report to the Group Finance Director and with the arrival of Peter Voser at the beginning of the month, the finance leadership will be back up to full strength.

We're also in a world of externally mandated change. I'll just mention Sarbanes Oxley and International Accounting Standards. We have a large project running through to the end of 2005 for implementing Sarbanes Oxley section 404, which covers internal controls on financial reporting. The simplification and standardization activities in our businesses, which both Rob and Malcolm will mention, as well as improving operational efficiency and producing cost savings, also help produce a more controlled environment.

And finally, we're on track with our International Financial Reporting Standards project, and we'll be briefing you more about that in quarter 4.

If I now move on to the financial framework. As you will note, we performed solidly in the first half. And this performance comes on the back of 3 years of consistent earnings from the business. So we do want to improve this portfolio further, but it's worth mentioning that the current portfolio has delivered cash flow growth over the last 3 years consistently. And the first half of 2004 continues this pattern, helped of course by high prices and margins.

I have to say our return on capital is not as competitive as we would like it to be. This is partly portfolio weakness, which we're working on. It's also due to the high spending on big programs, lengthy projects, which leads to quite a high level of capital not yet in use, it will come into use. And we have more of this than some of our competitors.

We also see the weak US dollar having an impact there.

Cash generation, including active portfolio management, has been strong from both the upstream and the downstream parts of the business. And I think overall, particularly taking into account the very active portfolio management, momentum has been maintained through this time.

Jeroen said a bit about prices. Clearly the growing debate in our industry, which many of you participate very actively in, about both future price levels and about the level of investment needed to meet buoyant demand. We do think that the pricing structure has shifted, driven by demand growth but also rising cost of supply, and affected by geopolitical uncertainty. And these are clearly not academic matters, they affect how we make decisions this year and over the next few years.

So we've decided to use $25 a barrel as our medium-term basis for cash planning. At the same time, we screen projects for viability at $20 a barrel. We still want that robustness. The world is an uncertain place. But it's important now to note that when we're making choices and deciding where to invest, we're looking at the upside above $25 a barrel.

Now clearly, if screening for viability left us with a pipeline that was short of opportunity, that would be an issue. But that's not the case at present.

In the medium term, in particular during this period of heavy capital investment, we'll be cash neutral at around $25 a barrel. And I think it's also worth making the link between the high divestment level and high investment level. We're not liquidating the portfolio, we're shifting value. We're recycling capital to higher value uses.

That increase in our capital spend, to $15b a year, reflects a number of factors. We've got growing capital intensity in the industry. Dollar cost pressures from both underlying inflation and from dollar weakness. We've got this commitment to major growth projects. We've also got plenty of spending in what you might call routine investment in our profitable core businesses.

As Jeroen also said, $11.5b will go to the upstream, to Gas & Power and to EP, as we move our portfolio in line with strategy.

The $10b to $12b divestment figure for the 3 years 2004 to 2006 includes divestments of $4b already announced, the divestments already announced in 2004, and some $5b to come from further rationalization of the E&P portfolio.

This is a risk number. Clearly, if timings and negotiations all go in our favor, this number could well come out higher.

The investment program reflects our strategy of regaining upstream strength and delivering downstream profitability. Capital spend in 2004 is taken further down this road, with a major part going into the upstream where we expect the higher returns.

And if you look at our capital base in the pie chart, we now have over 50% of our capital employed invested in the upstream. This compares to about 40% in 2000. And going forward we expect that around 75% will go into EP and GP.

Funding priorities, which Jeroen briefly covered. As we've stated before, we aim to grow the dividend at least in line with inflation over time. This is something we've managed for many, many years. We invest to sustain our existing business, including a very large number of long-life projects to ensure continued profitability and performance.

Now having a strong balance sheet is important for the enterprise. With high prices we expect the total debt ratio to get down to around 14% to 15% by year-end. This is the low end of the target range. We take into account in that target range other obligations, such as operating leases, and our intent is to stabilize around this point. We value strong balance sheet for the flexibility it brings, particularly in a price downturn.

But also in a price downturn it enables us to maintain continuity of investment. We don't want any stop/start. We've got very big programs. And when you've got very big programs, if you have to have stop/starts, it can be things like exploration which take a hit. We've been there, we don't want to be there again. So we believe in keeping a strong balance sheet going forward.

Then if more cash is generated than we require, we will make the choice between additional investment only if those opportunities make sense, as Jeroen made clear. And the alternative of returning cash to shareholders.

We are well on track with our 2004 program of buybacks and hedging. We've not made any decisions yet for 2005, but those priorities remain the same.

Finally, let me take a look at the cash cycle, which is probably fairly familiar by now. This now incorporates the changes to our assumptions. We're cash neutral at $25 a barrel with this level of investment and divestment. I should point out that $25 a barrel does come from an analysis of the external environment. It's not the number required to make us cash neutral. The point is, as Jeroen said, that assumption about likely available cash does fund this large investment program.

Just to be clear, cash neutrality is the condition where cash flow from operations and divestments is sufficient to fund the dividends plus any stock option hedging from the capital to maintain a strong business and maintain that balance sheet.

$25, we generate around $20b of cash flow a year. Add to that these risk divestments of $10b to $12b and cash in on that basis is about $23b to $24b. And from that you'll see we cover the dividend, currently running at about $7.5b a year; capital investment $15b; option hedging now at a lower …