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Financial Times: How Shell is taking the long view

By Ed Crooks
Published: February 2 2007 02:00 | Last updated: February 2 2007 02:00

Even by the standards of the energy industry, Jeroen van der Veer, Shell’s chief executive, is taking the long view. The question is whether even the most far-sighted investors are prepared to wait for the pay-off.

What he is doing, he said yesterday, is “building anew energy infrastructure” that will reward the company for the next three decades and more.

The context, as Mr Van der Veer set it out yesterday, is the increasingly ferocious competition round the world for oil and gas. To get access to resources, Shell, like other international oil companies, is being driven further into more challenging projects.

For example, Shell is persisting with a multi-billion-dollar investment in Iran to develop a vast gas field and build a liquefied naturalgas plant to export to Asia and Europe.

Mr Van der Veer stressed that, although preliminary agreements had been signed, the final investment decision would not be made until early next year. He likened the process to designing a house before deciding whether to build it.

But he gave a clear indication that the US would not necessarily stop him making the investment in Iran.

Describing the decision as “quite a dilemma”, Mr Van der Veer pointed out that Iran had the world’s second largest oil and gas reserves. Developing these reserves would be good for energy-importing countries for decades to come, he said. Against that were what he described as “short-term political concerns” – which is not exactly how the US would characterise the current behaviour of Iran.

He said, too, that Shell would be “very interested” in working in Iraq, although safety problems would have to be overcome first.

Above all, Shell’s response to the scarcity of resources is heavy capital spending.

The company invested $21bn (£10.7bn) last year, more than ExxonMobil, the world’s biggest oil company, whose profits were 50 per cent greater last year.

This year Shell expects investment to rise to$22bn-$23bn. And that is in spite of the sale of half ofits stake in the capital-intensive $20bn Sakhalin-2 project in Russia to Gazprom.

Much of the increased investment will be innew and “unconventional” sources of oil and gas, such as Canadian oil sands and in gas to liquids – the converting of natural gas into a liquid for road fuel.

It is offering more than $7bn for the 22 per cent minority interest in Shell Canada, to consolidate its grip on oil sands business.

Shell is also a world leader in LNG, which is not anew technology but hasbeen expanding rapidly in recent years.

Booking reserves from its Pearl GTL project in Qatar and its Athabasca oil sands project in Canada was the main reason that Shell’s reserve replacement ratio looked so good last year. It was able to book about 2bn barrels of oil equivalent, while producing about 1.3bn – a replacement ratio of about 150 per cent.

LNG was also very important to the 2006 results,with sales volumes rising14 per cent.

The problem with all of these businesses is that they are relatively high-cost ways of producing oil and gas. In many markets, LNG is usually a higher-cost source of supply than gas that is delivered by a pipeline.

Converting natural gas to a liquid road fuel is more expensive than refining crude oil to produce diesel.

And processing two tonnes of sand to get each barrel of oil is much more expansive than drilling a well and letting the crude flow out of the ground.

Shell has calculated that its Canadian oil sands business can be profitable with oil at $30 a barrel. The profits will be healthier if the oil price is higher.

On top of that, shortages of raw materials, equipment and above all skilled personnel will drive up the cost of capital projects by about 10 per cent this year. And that will put further pressure on the returns from all investment projects.

What Shell has done is take a bold long-term position on the price of oil and gas. In the next decade, it promises that the investment will pay off, with production growth accelerating from 1-2 per cent a year to 2-3 per cent.

By the time that happens, there is a risk that much of that production will be unprofitable.

But if the struggle for resources continues to grow fiercer, then investors who are still around may be very grateful for the investments Shell is making now.

Copyright The Financial Times Limited 2007

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