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Financial Times: Lex COLUMN: Royal Dutch/Shell

Financial Times: Lex COLUMN: Royal Dutch/Shell

Apr 30, 2004

Surprises from Royal Dutch/Shell are not normally prefaced with the word “welcome”. Fortunately for shareholders its reserves debacle has played out against a backdrop of high oil and gas prices. First-quarter earnings are strong, enabling the oil group to announce a $2bn share buyback and an increase in capital expenditure of up to $2bn. Investors can also draw comfort from the fact that excess cash flow has not been directed towards costly acquisitions to address the problem of Shell’s paltry reserve replacement ratio.

The buyback should provide welcome support for the share price. But the company would not elaborate on the oil price assumptions underlying the buyback. Dutch law no longer requires a share buyback to be of a minimum size, so uncertainty remains if oil prices should drop.

Much of the increase in capital expenditure is to address cost overruns in Russia and Nigeria. Only $200m is additional expenditure on pure exploration. The base level for exploration capital expenditure will also probably increase next year, and more than half is now directed at larger discoveries. But $500m in additional spending is a switch in investment to “short-term payback projects in high margin areas”. Shell may wish to bolster short-term returns, which will not be helped by the spending on cost overruns and exploration. The suspicion remains, however, that the former focus on development near established assets – which Shell admits was a mistake – has not been entirely eradicated.

On the day, the announcement has understandably led to share price gains. With investors keen to back a recovery Shell may regain further lost ground. But with no proposals on changes to governance likely until the end of the year, and no quick fix on the production profile, the discount to BP should remain significant.

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