Why did Royal Dutch Shell shares surge 70%?

Jay Yao writes why he thinks Royal Dutch Shell shares have surged 70% since late October, and what he thinks might be ahead.

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Since 28 October, the Royal Dutch Shell (LSE: RDSB) share price has surged around 70%. This has made it one of the best performers in the FTSE 100 over that span. This rally is a sharp contrast to earlier in 2020 when the stock badly underperformed.

Given the rally, here’s why I think Royal Dutch Shell shares rose so much.

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Why I think Royal Dutch Shell shares surged

I think the main reason why Royal Dutch Shell shares have rallied strongly is that Brent crude oil prices have risen. While Brent averaged around $43 per barrel in the third quarter of 2020, the price is now around $52 per barrel.

Royal Dutch Shell benefits from that rise. According to an update note from December, the company’s cash flow from operations (CFFO) price sensitivity is estimated to be around $6bn per year for each $10 price movement in a barrel of Brent. That means RDSB very likely makes billions more in CFFO given the rally so far in the commodity.

With that extra CFFO, management could potentially achieve their key target of strengthening the balance sheet more easily. Specifically, management is intent on reducing RDSB’s net debt to $65bn to potentially get better credit ratings. According to management’s estimates, the company reckons it would then be at the threshold of the AA credit rating range.

With the extra CFFO, RDSB could also potentially reach $65bn net debt earlier and return more capital back to shareholders sooner. RDSB management has committed to returning a portion of CFFO back to shareholders after the $65bn net debt target has been achieved.

Management said, “Once we have reduced our net debt to this level, we target to further increase total shareholder distributions to be in total, in the range of 20 to 30% of our cash flow from operations, through dividends and share buybacks”.

Transition to green

If oil prices continue to surge, I think the Royal Dutch Shell share price will continue to rise in the near term. Whether oil prices will continue to rally is unknowable, however, given that the commodity depends on so many variables.

In the long term, I think how well shares do depends on how management does on their green transition. In that regard, I reckon management will succeed. The company is already a leader in liquid natural gas, which is regarded by many as a bridge to low carbon energy forms. RDSB also has several promising green energy initiatives such as its hydrogen business. The hydrogen business is small right now. However, it has potential for a lot of growth in the future, given the right government policies. With its stock, management can also potentially do M&A to help with the transition in the future. 

I think Royal Dutch Shell has the resources, management talent, and the time to make a successful transition. As a result, I’d buy and hold Royal Dutch Shell shares. 

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Jay Yao has no position in any of the shares mentioned.  The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

Should you invest the value of your investment may rise or fall and your Capital is at Risk. Before investing your individual circumstances should be considered, so you should consider taking independent financial advice.

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