Royal Dutch Shell (NYSE:RDS.A, RDS.B) outlined a plan at its recent strategy update to manage the difficult environment in the downstream segment, an environment that the CEO of the company called the "weakest" in 20 years. The company will sell non core assets and continue its cost cutting. We'll look at the general plan meant to turn the company into a lean, profit-generating machine.

IN PICTURES: Learn To Invest In 10 Steps

Rough Shape
The poor operating conditions were caused by the addition of capacity that was planned several years back when margins were higher, along with a fall in demand for finished product due to the recession. This has reduced the return on average capital employed (ROACE) for Royal Dutch Shell in the downstream segment to the low single digits. This is far below the five-year average ROACE of approximately 12%. Royal Dutch Shell has decided to embark on a three pronged plan to improve profitability in the downstream.

Losing Weight
The company will sell some of its assets in the downstream that the company considers to be non-core. This will necessitate exiting 15% of its refining capacity by 2012, and 35% of its retail marketing operations with the intent to refocus the downstream segment into areas that yield the highest return.

The marketing portfolio of the company is diverse and operates in more than 100 countries, and Royal Dutch Shell feels that the best way to boost returns is to exit areas where it sells smaller volumes of product.

Refined Plans
Royal Dutch Shell will continue on its cost cutting efforts in the segment which has yielded billions in savings over the last few years. Last of all, Royal Dutch Shell will invest selectively in larger and more complex refining operations that the company hopes will capture higher margins. The Nelson Index, a scale used to determine the value added by a refinery, will measure this complexity.

Royal Dutch Shell is continuing the expansion of a refinery that it operates in Port Arthur, Texas. The refinery will have capacity of 600,000 barrels per day when the expansion is complete.

Other large refineries in the United States include the Baytown refinery in Texas owned by Exxon Mobil (NYSE:XOM) with a capacity of 573,000 barrels per day, the Texas City refinery owned by BP (NYSE:BP) with a capacity of 456,000 barrels per day, and the Pascagoula Refinery in Mississippi owned by Chevron (NYSE:CVX) with a daily capacity of 330,000 barrels per day.

Following Through
Royal Dutch Shell made good on its word, and just two weeks after announcing its plan in the downstream segment, the company reached an agreement to sell its New Zealand marketing operations for $492 million. The company is also reviewing its retail marketing, lubricant and commercial fuels businesses in 21 African countries for possible sale . Analysts estimate that the sale will yield as much as $1.5 billion in proceeds.

Bottom Line
Royal Dutch Shell is not alone in facing a harsh business environment in the downstream segment, and the company's plan to reduce its portfolio and focus on higher return areas where it has scale and a technological advantage seems the correct one. (For more, see our Oil And Gas Industry Primer.)

Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!

Related Articles
  1. Chart Advisor

    Watch This ETF For Signs Of A Reversal (BCX)

    Trying to determine if the commodity markets are ready for a bounce? Take a look at the analysis of this ETF to find out if now is the time to buy.
  2. Investing News

    What You Can Learn from Carl Icahn's Mistakes

    Carl Icahn has been a stellar performer in the investment world for decades, but following his lead these days could be dangerous.
  3. Stock Analysis

    Analyzing Dish Network's Return on Equity (ROE) (DISH, TWC)

    Analyze Dish Network's return on equity (ROE), understand why it has vacillated so greatly in recent years and learn what factors are influencing it.
  4. Investing Basics

    The Importance of Commodity Pricing in Understanding Inflation

    Commodity prices are believed to be a leading indicator of inflation, but does it always hold?
  5. Fundamental Analysis

    5 Must-Have Metrics For Value Investors

    Focusing on certain fundamental metrics is the best way for value investors to cash in gains. Here are the most important metrics to know.
  6. Stock Analysis

    Analyzing Altria's Return on Equity (ROE) (MO)

    Learn about Altria Group's return on equity (ROE) and analyze net profit margin, asset turnover and financial leverage to determine what is causing its high ROE.
  7. Fundamental Analysis

    Performance Review: Commodities in 2015

    Learn how commodities took a big hit in 2015 with a huge variance in performances. Discover how the major commodities performed over the year.
  8. Stock Analysis

    6 Risks International Stocks Face in 2016

    Learn about risk factors that can influence your investment in foreign stocks and funds, and what regions are more at-risk than others.
  9. Investing News

    Icahn's Bet on Cheniere Energy: Should You Follow?

    Investing legend Carl Icahn continues to lose money on Cheniere Energy, but he's increasing his stake. Should you follow his lead?
  10. Stock Analysis

    Analyzing Google's Return on Equity (ROE) (GOOGL)

    Learn about Alphabet's return on equity. How has its ROE changed over time, how does it compare to its peers and what factors are driving ROE for the company?
  1. When does a growth stock turn into a value opportunity?

    A growth stock turns into a value opportunity when it trades at a reasonable multiple of the company's earnings per share ... Read Full Answer >>
  2. What is the formula for calculating EBITDA?

    When analyzing financial fitness, corporate accountants and investors alike closely examine a company's financial statements ... Read Full Answer >>
  3. How do I calculate the P/E ratio of a company?

    The price-earnings ratio (P/E ratio) is a valuation measure that compares the level of stock prices to the level of corporate ... Read Full Answer >>
  4. How do you calculate return on equity (ROE)?

    Return on equity (ROE) is a ratio that provides investors insight into how efficiently a company (or more specifically, its ... Read Full Answer >>
  5. How do you calculate working capital?

    Working capital represents the difference between a firm’s current assets and current liabilities. The challenge can be determining ... Read Full Answer >>
  6. What is the formula for calculating the current ratio?

    The current ratio is a financial ratio that investors and analysts use to examine the liquidity of a company and its ability ... Read Full Answer >>
Trading Center