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Shell's second-quarter adjusted earnings of $9.8 billion exceeded expectations, driven by higher commodity prices, wide refining margins, and strong trading performance, which were offset by lost volumes due to Middle East disruptions. Share buybacks were unchanged at $3.0 billion for the quarter.

Why it matters: Shell's exposure to Middle East disruptions is relatively high with a large footprint in Qatar. While it has lost volumes due to shut-ins and damage at its LNG and GTL projects, the impact of higher prices and greater trading opportunities from the disruptions make it a net beneficiary. Gearing fell during the quarter to 18.7% from 23.2% at the end of the first quarter on strong cash flow and the expected reversal in working capital builds. Continued volatility in oil prices likely means large working capital movements continue to influence cash generation each quarter. Shell maintained its payout guidance of 40%-50% of operating cash flow, even as it kept repurchases at $3 billion amid surging cash flow. If current conditions persist, it will likely need to increase the rate to achieve its guidance, as the ratio is at 44% over the last 12 months

The bottom line: Our EUR 40.9/GBX 3,580/$95 fair value estimates for no-moat Shell are unchanged, leaving shares modestly undervalued. If a deal was struck tomorrow and the Strait of Hormuz opened, oil prices would fall, but refining margins and LNG prices would likely remain elevated, benefiting Shell. Aside from the near-term price outlook, we maintain a favorable view on Shell's strategy, execution, and management. As such, we'd see any selloff on a deal as an opportunity, as management remains focused on improving full-cycle returns on capital.

Key stats: Shell has already delivered $5.8 billion of its targeted $5 billion-$7 billion cost-reduction program. Over half has been through operational improvements, with the remainder through portfolio high-grading.

Shell's announced acquisition of Arc Resources will likely close in the second half of 2026. We think the deal largely makes strategic sense and was done at a fair price. It boosts production but does not meaningfully alter Shell's long-term outlook, as it marks an extension of its current strategy. The resource base fits well within Shell's existing asset base and provides scale to its Canadian operations, particularly its LNG Canada project, while creating a new low-cost "heartland." Arc shares were under pressure given concerns over its product pricing and the Attachie field. Within Shell's portfolio, these issues can be better addressed than if they remained part of a smaller independent firm. Shell has also identified $250 million in synergy opportunities.

Our fair value estimate of $101 per share incorporates the latest financial results, strategic plan and guidance, and updates to our midcycle and near-term oil and gas price and foreign-exchange rate decks. It corresponds to a forward enterprise value/EBITDA multiple of 4.5 times our 2027 EBITDA forecast of $80.0 billion.

Our fair value estimate is derived using Morningstar’s standard three-stage discounted cash flow methodology. With this methodology, a terminal value is derived using our assumptions for long-term earnings growth and return on new invested capital. This valuation methodology also more explicitly incorporates our moat rating, which reflects how long we expect a firm to deliver excess returns on invested capital from a discounted cash flow analysis.

In our DCF model, we assume Brent prices of $90 per barrel in 2026 and $88/bbl in 2027. Our long-term oil price assumption is $65/bbl. We assume a cost of equity of 9% and a weighted average cost of capital of 7.8%.

Oil and gas production, including LNG, remains the primary source of earnings throughout our forecast. We forecast total production volumes to grow slightly below management’s guidance of 1% CAGR through 2030 as natural gas production increases due to new LNG projects, while oil volumes mostly hold steady. We do not expect much earnings growth in chemicals and products as Shell divests facilities, but returns should increase as asset quality improves. Marketing and low-carbon earnings should grow slowly. We also include improved firm profitability, attributable to structural cost reductions.

We do not think Shell has an economic moat, as our forecast for excess returns is too low relative to the company’s future uncertainty.

Shell has made significant headway in reducing operating costs in its existing production base and capital intensity of new projects, so we forecast it could earn adequate excess returns at our midcycle price assumption of $65 a barrel. However, uncertainty about excess returns 10 years from now has increased due to changes in the business' composition and potential commodity price levels over the next 10 years.

Although previous transition plans have been moderated, we are not confident that investment in renewable and low-carbon businesses will create competitive advantages or that commodity prices will be sufficiently consistent to generate excess returns over the next 10 years. As such, Shell fails to meet key criteria for our Narrow Morningstar Economic Moat Rating. As time passes and Shell demonstrates a high level of competence and execution in these newer areas, new management modifies investment plans, or our view of commodity prices changes, we could revise our rating.

Shell has improved the cost position of its upstream segment, including existing production and new projects. By 2024, it improved its upstream cash margins by 50% compared with 2014, despite lower commodity prices. It did so by reducing unit development and operating costs and focusing investment on the highest-quality assets. According to Shell, its new projects due to start by 2030 have an average break-even price below $35/bbl. Based on Rystad data, we estimate Shell’s project queue (sanctioned and unsanctioned) has an average break-even price of $42/bbl, well below our assumed midcycle price of $65/bbl.

Regardless, the excess returns we forecast for Shell at our midcycle price are too narrow to instill the confidence that it can endure the cycle across a range of price environments; thus, our no-moat rating. An increase in our midcycle price assumption, greater cost reductions, or an improved upstream cost position could prompt a change in the moat rating if excess returns are sufficient.

Through its integrated gas segment, Shell holds the largest LNG portfolio among peers with 73 million tons per year in LNG sales volumes in 2025, including 28 million tons per year of its own production. The segment has delivered strong returns over the last three years, driven by high prices and global gas disruptions following the Russian invasion of Ukraine, which created extraordinary trading opportunities. Shell is investing heavily here and plans to bring on another 12 million metric tons per year of capacity by 2030, which should benefit from a decline in LNG technical cost (capital and operating) per million British thermal units of 40% since 2015 and should deliver returns of 14%-18%. Meanwhile, the long-term outlook for gas demand remains favorable, with most third-party forecasters calling for continued demand growth, given emissions savings from substituting coal in power generation, the need to supplement intermittent renewable power generation, and expanding applications in shipping and road transport. Finally, prices for Shell’s integrated gas production are primarily tied to global crude benchmarks, which results in higher prices than typical pipeline gas pricing.

We view the legacy chemical and oil products business (refining) similarly, as Shell is investing in what it knows. The segment’s returns have recently benefited from strong market conditions, while long-term returns should benefit from plans to reduce its refining footprint to a few core facilities that produce refined products and chemicals that typically deliver higher returns, given lower costs and greater flexibility among feedstocks and final products. Given the stronger demand outlook for chemicals relative to refined products and lower emissions, it also plans to reduce fuel production at these sites and increase production of higher-value performance and intermediate chemicals. Eliminating higher-cost, lower-return facilities, along with the mix shift toward chemicals, should improve returns in the segment.

Shell plans to invest in its marketing business. Although this is a legacy business with a record of strong returns, we think its outlook is uncertain. Shell’s plan calls for growth in its branded service stations, convenience stores, and electric vehicle charging points, and market share growth for its lubricants business to increase earnings 50% by 2025. The plan calls for combining EV charging and improved convenience options to drive traffic through its retail sites in a lower-carbon world. This plan has risks, in our view. Unlike drivers of internal combustion engines, who have only one option (gas stations) to refuel, EV owners may have multiple options, including at home, at work, and at retail locations such as shopping malls. It's unclear why an EV owner would need to go to a Shell station to charge outside a long-distance trip. As such, already tenuous switching costs will seem to weaken further. Furthermore, EV chargers deliver relatively little energy and operate at low utilization rates, likely making them a poor earnings substitute for gasoline sales. A growing number of grocery delivery options may threaten demand for enhanced offerings at retail locations.

Shell stands to benefit from rising global gas demand and likely strong prices over the next decade, as LNG becomes integral to managing renewable intermittency.

Shell's new CEO has reined in its transition strategy and refocused the company on capital discipline and returns, which should pay off for shareholders with greater cash returns.

Downstream returns should improve as Shell reduces its downstream footprint to fewer integrated refining and chemical facilities while reducing fuel production and increasing higher-value chemical volumes.

Shell’s large LNG position puts it at risk if renewable power generation grows faster than expected or intermittency issues are solved, meaning natural gas will no longer be needed as a bridge fuel.

Shell is increasing hydrocarbon production but is doing so through LNG, as it lacks the oil volume growth of some of its peers.

Shell’s transition strategy fails to fully satisfy either oil or ESG-minded investors, leaving both avoiding the shares, resulting in a trading discount to more focused peers.