(Bloomberg Gadfly) -- The oil price stages a dramatic recovery yet free cash flow at Europe's biggest oil company goes nowhere. Royal Dutch Shell Plc retains a capacity to disappoint.
Shell has been dogged by doubts over whether it can afford to maintain its quarterly dividend. Late last year it sought to silence skeptics by moving to make the payout entirely in cash instead of partly in shares. Furthermore, it recommitted to a $25 billion share buyback program. It is clear that such an ambition exceeds current reality, judging by the business today.
The contrast between earnings and cash flow in the first quarter was stark. Earnings ignoring one-offs rose 42 percent year-on-year to $5.3 billion -- a performance harking back to the days of $100 oil. Shell's gas business, boosted by the acquisition of BG Group in 2016, was the star performer. Return on capital employed was 6 percent, against 3.3 percent a year ago, albeit still shy of the 10 percent target.
Yet free cash flow was flat at $5.2 billion. True, that covered the firm's dividend and interest bills, with a little help from disposals. But average Brent crude prices were more than $10 higher than in the same period last year. On Shell's given sensitivity this should have added about $1.5 billion of operating cash flow in the quarter. Moreover, investment spending was relatively restrained.
The benefits of these tailwinds were wiped out mainly by higher cash taxes due to unexpected settlements of disputes in certain countries. The details weren't given. A one-off? The same happened in the fourth quarter.
As a result there were scant resources to cut borrowings. Net debt rose slightly from the year-end. Progress on reducing gearing -- net debt as a percentage of total capital -- was glacial. Shifting to an all-cash dividend will add a further constraint. The prospects for share buybacks have dimmed for sure, hence a share price drop of as much as 4.8 percent on Thursday.
Based on this quarter's run-rate, there's some way to go before Shell is generating the $25 to $30 billion of organic free cash flow that it says it aims to average annually over 2019 to 2021. To hit the target, it needs to deliver on new projects that will bring real growth. There are reasons to have faith: underlying volume growth in its upstream business is encouraging.
The cash equation could stay tight for a while. Investors clamoring for buybacks should savor the dividend and remember there are more worthy demands on Shell's cash -- investment, debt reduction and the tax man.
Chris Hughes is a Bloomberg Gadfly columnist covering deals. He previously worked for Reuters Breakingviews, as well as the Financial Times and the Independent newspaper.
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