In my previous post I valued a high‑growth, highly uncertain company. That exercise was fascinating because we had to build a narrative to justify our numbers in a situation of almost pure uncertainty. In this post I turn to valuing a commodity company, which has its own distinct challenges and insights. Some of the tools that worked for the earlier valuation are not appropriate here, while new methods become essential. I will illustrate the process with Shell, an integrated oil major.
The value of a commodity producer is driven primarily by the price of the commodity itself. Accordingly, our key assumptions concern the future path of oil prices and the company’s operating margin (which is tightly linked to those prices). I performed the core valuation on 13 June 2025. Since then, the oil market has been buffeted by fresh geopolitical shocks: a flare‑up in the Middle East: Israeli strikes, Iranian responses, and temporary U.S. intervention, sent prices on a roller‑coaster: up ~5 % in one day, then down ~7 % a few days later. I will not attempt to forecast day‑to‑day oil prices; if I could do that reliably, I would trade futures, not build DCF models. Instead, I will show how to incorporate such volatility into a valuation framework.
We start with a brief overview of Shell’s business and strategic context, which anchors the narrative that will support our numbers.
I. Shell’s overview.
a. Corporate Identity
- Legal name: Shell plc (formerly Royal Dutch Shell plc; ticker: SHEL, FTSE 100 & NYSE‑listed).
- Headquarters: London, UK; operating in 70‑plus countries.
- Integrated energy major: Up‑ and mid‑stream oil & gas, LNG, chemicals, marketing, renewables and emerging low‑carbon value chains.
- Employees: ~92 000 (FY‑2024).
b. Current Strategic Priorities.
- More value, less volume in hydrocarbons – keep oil output roughly flat to 2030 but grow gas‑weighted LNG.
- Capital discipline – group capex $22‑25 bn p.a.; R&ES allocation capped at $4‑5 bn until returns exceed 12 % ROACE.
- Unit cost & overhead reset – $3 bn structural cost take‑out by 2025 (on track, $2.4 bn delivered).
- Balanced energy transition – 2030 targets: Scope‑1,2 emissions –50 %; customer‑product intensity ‑20 %; maintain CCS & nature‑based offsets pipeline (4 Mtpa captured equity share 2024).
c. Revenue‑Centred Overview (FY‑2024 & LTM Q1‑2025)
US‑$ billions | FY‑2022 | FY‑2023 | FY‑2024 | LTM Q1‑2025* |
Turnover / Sales | 386 | 323 | ≈ 310 | ≈ 315 |
Cash from operations | 68 | 68 | 62 | 63 |
Net debt | 48.5 | 43.5 | 40.0 | 38.7 |
Group ROACE | 13.6 % | 11.5 % | 10.8 % | ≈ 11 % |
* Figures rounded to nearest $0.5 bn and percentage point from Shell Q4‑24 and Q1‑25 databook.
d. Segment Sales Mix (FY‑2024)
Segment | Sales, $ bn | Share of group |
Integrated Gas | 72 | 23 % |
Upstream | 59 | 19 % |
Marketing (Mobility + Lubricants) | 128 | 41 % |
Chemicals & Products | 45 | 15 % |
Renewables & Energy Solutions (R&ES)** | 6 | 2 % |
**Shell’s own shorthand inside the segment P&L is R&ES; the public narrative sometimes calls it E&S or E&ES(“Energy & Emerging Solutions”).
As the Master of Marketing I was confused about the biggest Shell’s segment in the 2024, however in the commodity world the term Marketing do not mean the economical discipline. In commodity industries the verb to market means “to sell and physically move a commodity to the best‑paying customer.” Marketing is everything that happens after a molecule leaves the refinery or gas plant and before it reaches the end‑user: wholesale trading, logistics, retail service‑stations, B2B fuel sales, lubricants, bitumen, aviation, marine bunkering, even convenience stores.
II. Intrinsic Valuation
When valuing a commodity producer you can follow three broad approaches:
1. Commodity‑neutral asset DCF + real options
o Discount the cash flows from the company’s proved‑developed assets at a mid‑cycle commodity price.
o Value the undeveloped reserves as real options whose pay‑offs depend on future prices, and add those option values to the base DCF.
2. Cycle‑normalised DCF
o Normalise the operating fundamentals. Revenue, margins, and the reinvestment rate should be set at mid-cycle levels rather than at last year’s highs or lows.
o Normalise the commodity price (or use the long‑dated futures strip), since that assumption drives every other line item.
3. Monte‑Carlo simulation
o Skip point estimates and let uncertainty speak for itself: model a probability distribution for future commodity prices, run thousands of trials, and read the resulting distribution of per‑share values.
Below, I walk through each method in turn and show how it applies in practice.
a. Revenue outlook
For the commodity‑neutral valuation I anchor Shell’s top line to medium‑term demand rather than spot prices. Industry forecasts show global oil demand increasing by roughly 2.5 million barrels a day between 2024 and 2030, topping out near 105.5 mb/d before flattening. That squares with my own view: near‑term consumption is propped up by air‑travel recovery, AI‑driven power needs, and geopolitical stock‑building, even as electric‑vehicle adoption accelerates. Beyond 2030, however, renewables and efficiency gains should progressively trim demand.
Translating this narrative into numbers:
· 2025‑2029: I assume Shell’s consolidated revenue grows 2 % per year, in line with moderate demand expansion and incremental LNG volumes.
· 2030 onward: Growth fades, crosses zero, and settles at ‑2 % in perpetuity, reflecting a gradual, orderly decline in global oil use.
b. Operating margin. Although Shell’s margins have traditionally trailed the peer group, management asserts that cost‑discipline, portfolio high‑grading and a shift toward higher‑return projects will close the gap. The plan is to lift the operating margin to about 14 percent once the company reaches its long‑run, sustainable phase.
c. Reinvestment rate. Shell’s sales‑to‑capital ratio is expected to remain close to its current level. Because the upstream oil portfolio will shrink over time, free cash flow should increasingly exceed maintenance needs. As a result, the reinvestment rate is modelled to turn negative in later years—the company returns more cash to investors than it deploys in new projects.
d. Cost of capital. We start with the CAPM to estimate the cost of equity. Because the valuation is in USD, the base is the yield on a U.S. Treasury bond. Since the U.S. sovereign is no longer rated Aaa/AAA by all agencies, I treat Treasuries as quasi-risk-free and deduct the U.S. CDS spread from the bond yield.
· 10-yr T-bond yield: 4.41 %
· 5-yr U.S. sovereign CDS: 0.45 % (45 bp)
· Adjusted risk-free rate: 4.41 % – 0.45 % = 3.96 %
For the equity-risk premium (ERP) I use the implied U.S. market premium, back-solved from the S&P 500’s current level and dividend/earnings yield.
Because Shell operates globally, we layer on country-risk premium (CRP):
· Developed markets (e.g., U.S., U.K.) – use the local sovereign CDS as the CRP.
· Emerging markets – scale the sovereign default spread by the relative volatility of equities to bonds. Equity volatility is measured with the S&P Emerging BMI Index; bond volatility with the iShares J.P. Morgan USD EM Bond ETF. The five-year average of the equity-to-bond volatility ratio (see Table below) gives the uplift factor.
Table 3. Relative equity volatility for the emerging market.
Year | Std Dev (BMI) | Std Dev (JPM Sov Bond) | Relative volatility |
2020 | 23.01% | 19.13% | 1.20 |
2021 | 14.32% | 6.90% | 2.07 |
2022 | 18.67% | 15.53% | 1.20 |
2023 | 11.16% | 9.88% | 1.13 |
2024 | 11.89% | 7.21% | 1.65 |
Average Relative Volatility | 15.81% | 11.73% | 1.35 |
Because oil companies derive most of their value from the reserves they develop, the key risk driver is where the assets sit, not where the barrels are ultimately sold. Accordingly, we weight each region’s equity‑risk premium by the proportion of Shell’s assets located there. Shell discloses exposure only at regional level, so we apply the average ERP for each region. The resulting weights and premium are shown in Table 4.
Table 4. ERP by assets value
Region | Assets | CRP | ERP | Weight | Weighted ERP |
United Kingdom | 15,822.00 | 0.27% | 4.50% | 6.76% | 0.3038% |
USA | 55,245.00 | 0.45% | 4.68% | 23.59% | 1.1041% |
Other Americas | 49,372.00 | 4.07% | 8.30% | 21.08% | 1.7500% |
Other Europe | 25,149.00 | 1.60% | 5.83% | 10.74% | 0.6261% |
Asia, Oceania, Africa | 88,588.00 | 7.34% | 11.57% | 37.83% | 4.3772% |
Total | 234,176.00 | | | 100.00% | 8.1612% |
The cost of debt was estimated from an imputed credit rating and the corresponding historical default‑spread. Although individual Shell bond issues carry slightly different ratings, the group’s senior unsecured debt has historically centered on A1/A+. Our own rating‐imputation caltucaltion, based on the firm’s interest‑coverage ratio, yields a slightly lower A2/A grade, which we adopt to maintain a conservative stance. The long‑run default‑spread for that rating bucket is 0.85 %. Given that the cost of debt equals the risk‑free rate plus the default premium, the base figure would be 3.96 % + 0.85 % = 4.81 %. However, because our valuation already incorporates regional exposure risk, we take an additional conservative step: we add Shell’s implied CDS spread and a country‑risk premium (CRP). The final cost‑of‑debt inputs are summarised in the table below.
Table 5. Pre-tax Cost of debt calculations
Region | Assets | CRP | Imputed Shell CDS | Cost of debt | Weighted cost of debt |
United Kingdom | 15,822.00 | 0.27% | 0.0085 | 5% | 0.34% |
USA | 55,245.00 | 0.45% | 0.0085 | 5% | 1.24% |
Other Americas | 49,372.00 | 4.07% | 0.0085 | 9% | 1.87% |
Other Europe | 25,149.00 | 1.60% | 0.0085 | 6% | 0.69% |
Asia, Oceania, Africa | 88,588.00 | 7.34% | 0.0085 | 12% | 4.60% |
Total | 234,176.00 | | | | 8.74% |
The next input is the equity beta, after which we can finalise Shell’s cost of capital. Using a bottom‑up approach, we compiled a peer set of 300 publicly‑traded oil‑and‑gas companies and took the median levered beta for the group. That beta was then unlevered with the peer‑group’s median debt‑to‑equity ratio and a marginal tax rate of 42 % (representative for mature oil producers).
The calculation yields an unlevered beta of 0.48. Re‑levering this beta with Shell’s own capital structure produces the equity beta used in the final WACC; the full numbers are presented in Table 6.
Table 6. WACC calculation
Tax Rate = | | $ 0.42 | |
Estimating Market Value of Straight Debt = | | $ 49,409.54 | |
Value of Debt in Operating leases = | | $ 25,482.99 | |
Levered Beta for equity = | | 0.58 | |
| |||
Equity | Debt | Capital | |
Market Value | $215,561.97 | $ 74,893 | $ 290,455 |
Weight in Cost of Capital | 74.22% | 25.78% | 100.00% |
Cost of Component | 8.70% | 5.07% | 7.77% |
e. Real options. A critical step in valuing an oil company is estimating the worth of its undeveloped reserves. These acreage blocks give the firm the right—but not the obligation—to invest and produce in the future, so they are best viewed as real options to expand. We can price those options with the Black‑Scholes framework, provided we map the input variables to oil‑field fundamentals:
Table 7. Black‑Scholes model inputs
Black‑Scholes input | Oil‑reserve analogue |
S (stock price) | Present value of the cash flows that the undeveloped reserves could generate if developed today. |
σ (volatility of S) | Historical or implied volatility of oil prices. Higher σ makes the option more valuable. |
K (strike price) | Development cost. CAPEX required to bring the field on stream. |
r (risk‑free rate) | Dollar risk‑free yield matching the option’s term. |
q (dividend yield) | Cost of delay: economic rent lost each year the project remains undeveloped. If rights expire evenly over n years, a simple proxy is q = 1 / n. |
The Table 8 bellow has the summury of the Shell’s undeveloped reserves. With these inputs we treat each undeveloped tract as a European call option:
Table 8. Shell’s undeveloped reserves (oil price was around 73 USD)
Plot | Primary Resource | Development Lag (years) | Development Cost ($ bn) | Extraction Cost ($/boe) * | Recoverable Barrels (mn boe) * | Years of Use | Gross profit ($ bn) |
Whale | Oil | 3.00 | 3.00 | 35.00 | 490.00 | 30.00 | 13.99 |
Sparta | Oil | 5.00 | 2.50 | 35.00 | 245.00 | 30.00 | 5.78 |
Bonga North | Oil | 6.00 | 5.00 | 35.00 | 350.00 | 15.00 | 7.51 |
Gato do Mato | Oil | 4.00 | 3.30 | 30.00 | 370.00 | 30.00 | 10.87 |
Jackdaw | Gas‑condensate | 3.00 | 0.61 | 25.00 | 185.00 | 25.00 | 6.67 |
Manatee | Gas | 3.00 | 4.00 | 12.00 | 480.00 | 19.00 | 22.00 |
Rosmari–Marjoram | Gas | 4.00 | 1.00 | 15.00 | 213.00 | 20.00 | 8.44 |
Crux | Gas‑condensate | 5.00 | 2.50 | 20.00 | 340.00 | 12.00 | 11.19 |
| | 4.13 | 21.91 | 25.88 | 2,673.00 | 22.63 | 86.44 |
* All volumes already expressed in million barrels of oil equivalent (mn boe), so totals are comparable across oil and gas projects.
The development lag column in the table shows how many years Shell must spend building out each field. During that period the project generates no cash, so we discount the gross profit back over the development lag at Shell’s weighted‑average cost of capital. With these inputs in place, we can now price Shell’s real‑options portfolio. Picture 1 summarizes the resulting option values.
Picture 1. Value of Shell’s real options
1. Commodity‑neutral asset DCF + real options. With all inputs in place, we can now build the valuation model and estimate Shell’s intrinsic value. Figure 2 (below) shows the full valuation dashboard—assumptions, calculations, and the narrative links that justify them. The commodity‑neutral valuation indicates that Shell’s shares are currently undervalued.
Picture 2. Shell oil neutral valuation
2. Cycle‑normalised DCF.
a. The operating fundamentals. In the fundamentals‑normalisation approach we select a span that is long enough to smooth out the vicissitudes of the oil cycle. For Shell, we use median values for revenue, operating margin, and reinvestment over 2010‑2024 – a period that captures both boom and bust years. Table 9 summarises the results. We run two scenarios:
• Baseline: median margin for the period, about 8 %.
• Upside (“conservative”) case: a 10 % margin.
Why label the higher margin “conservative”? Because Shell’s current margin already exceeds 11 % and management actions show no sign of reversing the improvement. Using 10 % therefore strikes us as the more defensible long‑term assumption. As one can observe from the results, Shell’s value is highly dependent on its margins.
Table 9. The fundamentals‑normalisation approach.
| Baseline | Conservative Estimation |
Revenues | $ 344,877.00 | $ 344,877.00 |
Operating Margin | 8% | 10% |
EBIT | $ 26,066.43 | $ 34,487.70 |
Tax Rate | 0.42 | 0.42 |
EBIT (1-t) | $ 15,118.53 | $ 20,002.87 |
Reinvestment | $ 10,554.00 | $ 10,554.00 |
Reinvestment rate | 40% | 31% |
FCFF | $ 8,997.21 | $ 13,881.55 |
Invested Capital (last LTM) | 255,324.00 | 255,324.00 |
ROC | 5.9% | 7.8% |
Growth rate | 2.4% | 2.4% |
Value of operating assets | $ 171,624.32 | $ 264,794.48 |
- Debt | $ 73,505.99 | $ 73,505.99 |
- Minority interests | $ 1,856.00 | $ 1,856.00 |
+ Cash | $ 35,601.00 | $ 35,601.00 |
+ Non-operating assets | $ 25,700.00 | $ 25,700.00 |
Value of equity | $ 157,563.33 | $ 250,733.49 |
- Value of options | $ - | $ - |
Value of equity in common stock | $ 157,563.33 | $ 250,733.49 |
Number of shares | 5,946.54 | 5,946.54 |
Estimated value /share | $ 26.50 | $ 42.16 |
Stock was trading at | 36.25 | 36.25 |
Result | overpriced | underpriced |
b. Commodity price normalization. In the commodity‑price normalisation step, the first task is to gauge how closely Shell’s revenue tracks the oil price. To do that we plotted a simple overlay chart (Figure 3) showing Oil prices and Shell’s annual sales. The two lines move largely in tandem, confirming revenue’s heavy dependence on the commodity cycle.
Picture 3. Oil price relative to Shell's revenue
We first confirmed the link between oil prices and Shell’s revenue with a simple overlay chart (Figure 3). To quantify that relationship, we ran a linear regression:
with an R‑squared of 90.8 %, indicating that changes in Oil price explain almost all of the variation in Shell’s top line.
With this regression in hand we estimate “normal” revenue two ways:
1. Spot‑price normalisation. Assume today’s Oil price is the long‑run equilibrium. Plugging that price into the regression gives the revenue Shell would earn if the current price persisted indefinitely.
2. Cycle‑average normalisation. Use the average Oil price for 2010‑2024, the same period we used to normalise operating margin and reinvestment.
Both approaches yield an intrinsic share value above the market price, implying that Shell is currently undervalued.
Table 10. Commodity price normalization approach
| Current oil price | Median Oil price |
Oil price | $ 73.00 | $ 75.85 |
Revenues | $ 342,275.72 | $ 355,210.91 |
Operating Margin | 10% | 10% |
EBIT | $ 34,227.57 | $ 35,521.09 |
Tax Rate | 0.42 | 0.42 |
EBIT (1-t) | $ 19,851.99 | $ 20,602.23 |
Reinvestment | $ 10,554.00 | $ 10,554.00 |
Reinvestment rate | 31% | 30% |
FCFF | $ 13,730.67 | $ 14,480.91 |
Invested Capital (last LTM) | 255,324.00 | 255,324.00 |
ROC | 7.8% | 8.1% |
Growth rate | 2.4% | 2.4% |
Value of operating assets | $ 261,916.51 | $ 276,227.57 |
- Debt | $ 73,505.99 | $ 73,505.99 |
- Minority interests | $ 1,856.00 | $ 1,856.00 |
+ Cash | $ 35,601.00 | $ 35,601.00 |
+ Non-operating assets | $ 25,700.00 | $ 25,700.00 |
Value of equity | $ 247,855.51 | $ 262,166.58 |
- Value of options | $ - | $ - |
Value of equity in common stock | $ 247,855.51 | $ 262,166.58 |
Number of shares | 5,946.54 | 5,946.54 |
Estimated value /share | $ 41.68 | $ 44.09 |
Stock was trading at | 36.25 | 36.25 |
Result | underpriced | underpriced |
3. Monte‑Carlo simulation. Commodity price and operating margin are the two variables that drive Shell’s valuation – and they are themselves highly correlated. Equity investors should not try to speculate on short‑term oil prices, and even margins are hard to pin down because they move with the commodity. A practical way to handle this uncertainty is to run a Monte‑Carlo simulation.
We start by modelling the distribution of oil prices. Using data from 2005 through June 2025, we fit a beta distribution; Figure 4 shows the resulting curve.
Picture 4. Oil price distribution
For the operating margin we use a triangular distribution – defined by its minimum (5%, most‑likely (10%), and maximum values (15%), shown in the figure below.
Picture 5. Operating marin distribution
As noted earlier, oil price and operating margin move together, so we should embed their correlation in the simulation. Using the 2010 – mid‑2025 data set we calculated a Pearson correlation of 0.59 between the two series. This 0.59 correlation is fed into the Monte‑Carlo model, ensuring that higher simulated oil prices are matched with proportionately higher operating‑margin draws and vice‑versa.
Picture 6. Correlation between Oil price and operating margin
After running a 100,000 trials, we have the result which is the frequency distribution of value of Shell stock.
Picture 7. The the frequency distribution of value of Shell stock
The simulation yields a median (50th‑percentile) value of $40.50 per share, comfortably above Shell’s market price. This aligns with the conclusions from the earlier valuation methods, reinforcing the view that the stock is undervalued.
III. Pricing game
The pricing dynamics of commodity producers differ sharply from those of the high-growth firms we valued earlier. For a mature commodity company like Shell, a perpetual-growth (terminal-value) approach is inappropriate because its long-run cash flows are tied to cyclical commodity prices, not sustained expansion. Instead, this analysis relies on relative pricing, benchmarking Shell against 12 close peers in the oil sector as of 6 June 2025. Both current and forward multiples are compared, with the forward figures based on consensus five-year growth forecasts for net income, EBIT and revenue.
Table 11 shows Shell trading slightly above peers on the current P/E and markedly above them on the forward P/E. P/E multiples depend mainly on payout policy and expected growth: Shell’s rising payout ratio and declining reinvestment rate, as well as the boost from ongoing share buy-backs, explain the modest premium in the current P/E. The larger premium in the forward P/E reflects analysts’ unusually low growth expectations for Shell over the next five years.
Shell appears undervalued on both current and forward EV/EBIT. Although consensus EBIT growth for Shell is below the peer average, the gap is narrower than for net income or revenue, and improved operating margins drive the multiple lower.
Finally, Shell trades slightly below peers on the current EV/Sales ratio but turns expensive on a forward EV/Sales basis because analysts project a negative five-year revenue CAGR for the company.
Table 11. The ralative pricing
IV. Conclusion
We’ve wrapped up our valuation and pricing exercise for Shell, a mature commodity producer. Along the way we tested several oil-company approaches, each with its own quirks.
Personally I favour the commodity-neutral method: value the producing assets first, then layer on real-option value for undeveloped reserves. That keeps the lens on Shell’s future corporate performance rather than on a commodity-price forecast anchored in the past. Even so, it’s still worth stress-testing how different price decks affect margins and cash flow.
The Monte-Carlo simulation helped on that front. By letting Brent, margins and reinvestment rates fan out across thousands of paths, we could see the distribution of equity values and our risk appetite at a glance. In the base run there’s a 55.9 % probability that Shell is undervalued, which was convincing enough for me to buy shares.
Of course, any forward-looking model has blind spots, and I’m sure I’ve missed something. Now that you’ve seen the same analysis, the decision like that catchy ’60s refrain – is up to you, it’s up to you, it’s strictly up to you.
