Financial Times: Hedging proves gusher for oil groups

By Kevin Morrison
Published: April 4 2006 03:00 | Last updated: April 4 2006 03:00
As business strategies go, it is hard to argue with. Oil companies such as BP and Royal Dutch Shell are selling hedging services to help industrial customers mitigate the soaring cost of the oil they sell them.
Heavy energy consumers such as airlines, road transport companies, miners and utilities are increasingly turning to oil companiesfor financial risk management services instead of going to investment banks, which are the traditional dominant operators in energy hedging.
“In the past, customers saw energy prices as a small and irritable part of their cost base; now it forms a large part of their costs and therefore becomes a necessity for them to manage their risk to energy prices,” says Mike Conway, vice-president of global product and trading at Shell International Trading and Shipping Company, the trading unit of Royal Dutch Shell.
Mr Conway says the demand from customers for advice and help prompted Shell to bolster its risk management capabilities in the past two years to offer it as a service to its traditional industrial customers as well as fellow oil and gas producers.
BP says that, although the company has been providing risk management services to customers for nine years, it is only in the past two years, as prices have risen, that the company has stepped up its efforts in the area.
It has hired more staff, including former traders from investment banks, and it has been more active in marketing the services, including setting up a dedicated website for the small but expanding BP unit.
Both BP and Shell employ between 10 and 15 people in this area, with staff split between London and New York.
Total, the French oil company, also provides risk management services to its customers, and Chevron-Texaco is looking at the area.
ExxonMobil has no plans as it has a strict policy of not hedging on its own behalf.
Mr Conway says the oil companies are not a competitive threat to the banks. “The market has grown so much in the past threeyears that it has opened up to new customers rather than the oil companies coming in and trying to take clients away from the banks,” he says.
However, one senior energy trading executive at an investment bank says: “They [oil companies] could have an advantage over the [investment] banks in the area of credit, particularly in emerging markets where they [oil companies] may have a long-term relationship with a company and are therefore more comfortable to provide credit to it than a bank.”
He added, however, that energy producers or a refiner may not feel comfortable dealing with BP or Shell because there are competitors.
Mr Conway said he did not see any conflict of interest by conducting riskmanagement services on behalf of a fellow oil and gas producer.
Oil companies are highly skilled in energy trading. The large listed oil producers such ExxonMobil, ChevronTexaco, BP, Total and Royal Dutch Shell have few peers when measuring their combined networks of production, shipping, refining and distribution.
These networks provide them with knowledge and expertise of the oil and gas market that can often give them the edge over investment banks.
This scale and competitive advantage is reflected in the bottom-line.
BP reported a pre-tax and interest payments profit of $2.97bn (£1.7bn) from its trading activities in oil, natural gas and power last year. The bulk of this profit came from the trading it did on its own behalf rather than third parties.
The trading profitformed a significant part of BP's 2005 net profit of $22.3bn.

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