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Financial Times: Royal Dutch Shell: It used to be said that “you can be sure of Shell”… before a large chunk of reserves went missing

Published: February 1 2007 14:14 | Last updated: February 1 2007 14:14

It used to be said that “you can be sure of Shell”.

That was, of course, before a large chunk of the oil major’s reserves went missing. Since that low point in 2004, the group has struggled to rebuild its image of reliability. Its fourth-quarter results will help – up to a point. Shell beat expectations on profits and upstream production, and has now pleasantly surprised investors for four quarters in a row.

Further evidence of a stronger grip on Shell’s operations is welcome. The other element of Shell’s recovery, however – rebuilding the reserves portfolio – is bittersweet for investors. When you are this big, fixing the upstream business takes time and money. Hence, Shell was forced on Thursday to raise its 2007 capital expenditure budget by 14-19 per cent.

This year, oil prices and refining margins are unlikely to match the elevated levels of 2006, and Shell has cut its upstream production target. Therefore it faces a potential squeeze in terms of lower operating cash flow and higher capex. Merrill Lynch estimates that, discounting the effect of acquisitions and disposals, Shell needs an average oil price of $55 a barrel in 2007 to cover its dividend, compared with $40 at ExxonMobil and $46 at BP. Crude has averaged $54 so far this year.

Shell’s negligible net debt leaves it plenty of room for manoeuvre. The problem is that its strategy is, of necessity, slow-burning. Headline reserves replacement last year of 150 per cent was strong, but heavily dependent on higher cost, non-conventional projects like the Pearl gas-to-liquids plant in Qatar. These assets have long life-spans and mean that, after 2010, Shell’s production growth should pick up after years of stagnation. Over the long term they will provide steady cash flows. That provides a solid, if somewhat utility-like underpinning for Shell’s long-term outlook. In that context, Shell’s increase in the dividend – putting it on a sector-beating yield of 4.2 per cent – can be seen as a sweetener to shareholders who might otherwise look for near-term growth elsewhere. Investors can be more sure of Shell these days, but there is little to get excited about in the immediate future.

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