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Financial Times: Shell profits up but costs spark concern

By Carola Hoyos in London

Published: July 27 2006 07:59 | Last updated: July 27 2006 19:08

Royal Dutch Shell, Europe’s second largest listed energy group, on Thursday reported profits had surged, but prompted concern by announcing it would go ahead with a major Qatari project even though costs had trebled.

The company said it had given the green light to its venture to turn natural gas into cleaner-burning auto fuel. But the gas-to-liquids (GTL) venture will now cost around $12bn, compared to the $4bn the company had anticipated when it first mooted the plan in October 2003.

Shell on Thursday said its earnings on a current cost of supply basis – the industry standard that excludes changes in inventory values – had risen 36 per cent to $6.3bn in the second quarter compared with the same period a year ago. Revenue was up 1 per cent at $83.1bn, as high oil prices helped to offset flat production volumes.

The company blamed its disappointing production volumes on the fact that half its Nigerian output had been shut down by rebels and on the ongoing loss caused by the hurricanes that swept through the Gulf of Mexico last summer. It also announced that it had set aside $500m to settle the class-action lawsuits stemming from its reserves scandal of two years ago.

Merrill Lynch analysts said Shell’s financial results were better than expected, but questioned the quality of the GTL project. The project could cost as much as $18bn at the top range of estimates.

Other analysts pointed out that ExxonMobil, the world’s biggest energy group, which on Thursday surprised analysts with better-than-expected production results and second quarter earnings of $10.4bn, up 32 per cent, appeared to be backing off GTL because of the cost pressures.

Nevertheless, none of the world’s energy companies is escaping cost inflation.

Frank Harris, analyst at Wood Mackenzie, the independent Edinburgh-based consultancy, said: “While costs have risen over the last couple of years, the up-shift in oil prices has largely camouflaged the impact on returns. Our concern now is that with current capital costs, returns from new projects could get hit hard unless the oil price fundamentally shifts up again.”

Lord Browne, chief executive of BP, Shell’s closest European rival, had long sought to downplay BP’s exposure to higher costs. But at this week’s earnings conference, he highlighted the issue, pointing out that renting drilling rigs for ultra-deep-water projects now cost $500,000 a day compared with $200,000 two years ago.

Other parts of the industry have also been hit. Two years ago, building a liquefied natural gas plant, which prepares natural gas for transport via tanker to distant markets, would have cost $300 a ton; today those costs are closer to $800 a ton.

In London, shares in Shell ended the session 2.1 per cent higher at £19.81.

Additional reporting by Sheila McNulty in New York

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