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Investors Chronicle: The Matthew Vincent Report: Reserve replacement ratios

TRANSCRIPT OF VIDEO
Introduction
Hello and welcome to our weekly look at what's been happening in the markets and how it affects you and your pocket. I am Matthew Vincent, Editor of Investors Chronicle, so lets have a look at the stories in this week's edition.
Everybody's talking about them – oil companies' reserve replacement ratios. We explain what they are and why they matter.
BAA finds itself being courted by a Spanish suitor but will it succumb to Ferrovial's Iberian charms.
And this latest curious website is the latest wheeze from the Financial Services Authority aimed to educate the public about the murky world of finance.
Reserve replacement ratios
Q.
Now, reserve replacement ratios are terribly important things when it comes to judging the strength of our two major oil players. So, to find out exactly what they are and why I should sit up and pay attention to them, I am joined by Investors Chronicle's online Editor, Jonathan Ely. Jonathan, everyone's been paying an awful lot of attention to the profits made by Shell and BP but why are the reserve replacement ratios important?
A.
Well Matthew, oil is getting more and more difficult and expensive to find. Companies are having to operate in geographically very remote locations and in quite inhospitable environments to find the reserves they need to replace the oil they are already taking from the ground. A lot of the oil that is coming out of the ground is in very nice, safe, known about locations such as Alaska or the North Sea. A lot of the oil that they are replacing that production with is from much more tricky environments.
Q.
How will all this affect the prospects for Shell and BP?
A.
Well, if we look at Shell, they really have had substantial problems replacing their reserves over the past year. If you go back further in history, Shell has actually been quite successful at replacing reserves. Now the big worry for Shell is that if they continue to struggle to replace the reserves, they will be forced to go out and make an acquisition. And with oil prices where they are in the cycle at the moment, now is emphatically not the time to be doing the big acquisition, especially as they will have to compete with Chinese and Indian companies who are usually state run and are not answering to shareholders. Their goal is to secure oil reserves for strategic national reasons rather than for wealth creation.
Q.
And the billion dollar question for investors – what is your recommendation on Shell and BP shares?
A.
Well historically at the Investors Chronicle we have been very keen on Shell because they had this mighty credit rating – AAA credit rating – so it was almost like owning government debt, and it paid this wonderful dividend yield and dividend was declared in sterling and paid in sterling. Now, Shell's finances don't look quote so secure as they once did, although they are still very solid and, in addition, the dividend is now declared in euros and converted to sterling so there is an element of currency risk that wasn't there before.
Now if you add in the risk of them doing a big expensive acquisition and if you add in things like the project management failures that we've seen over the past year or so, particularly the major cost overrun on the Sakhalin Project in the Russian Far East, then Shell looks a lot more risky a proposition than it did even a few years ago.
At BP, the management there has done a much better job. They have been the first mover. They were the first company to do these very big acquisitions back in the late 90s. They stole a march on everybody else into Russia and, of course, Lord Brown, BP's Chief Executive, is very highly regarded in the City. So, at the moment, we think that their shares are the better bet, even though they are marginally more expensive in relative terms than those of Shell.
Q.
Well Jonathan, I think I'd better go and buy a new pocket calculator. Thank you very much.
A.
Thank you.
Matthew Vincent is Editor of the Investors Chronicle – the UKs leading retail investor magazine. Click here for www.investorschronicle.co.uk

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