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The Sunday Telegraph: Buy Shell for the long term

Equity view
Edited by Sylvia Pfeifer
(Filed: 07/05/2006)

Buy Shell for the long term

More than two years after it was forced to downgrade its proven oil and gas reserves by about a third, Royal Dutch Shell (£18.73) is still dogged by the same problem.

Last week it announced record first-quarter profits of $6bn (£3.2bn), a rise of 12 per cent, but the gloss was taken off the results by the admission that it might miss its target of replacing its reserves over the coming years.

Oil companies need continually to replace the oil they pump out of the ground and Shell had previously promised to raise its reserve replacement ratio to 100 per cent between 2004 and 2008, compared with a 72 per cent average over the past five years.

Shell's chief executive, Jeroen van der Veer, blamed the drop on the US Securities & Exchange Commission's strict rules for defining proved reserves. The rules do not allow the inclusion of “unconventional” reserves such as oil sands and gas-to-liquids, which are likely to feature increasingly in Shell's explor-ation.

On the face of it, the news doesn't look good. Nevertheless, Shell is not the only oil company to have fallen foul of the SEC's strict guidelines in recent years. On the plus side, Shell remains committed to opening up some 20bn barrels of resources by the end of this decade and is increasing capital investment from $19bn this year to $21bn next year. It also still plans to lift production from 3.8m to 4m barrels equivalent a day by 2009.

Relative to its peers, Shell's shares are undervalued. Critics argue that the discount is warranted given the chance of few medium-term catalysts to boost the shares. Nevertheless, we believe investors should be comforted by the company's progressive dividend policy.

The shares, which are yielding 3.5 per cent, are likely to be supported by a continuation of the strong macro envir-onment.

Although securing reserves from unconventional resources is more expensive, it is a bet that could pay off handsomely if oil prices remain high. Buy for income.

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