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Reuters: Shell posts record profits but clouds loom: ‘tie up between Shell and BP, could be on the horizon’

By Tom Bergin

LONDON (Reuters) – Royal Dutch Shell posted record annual profits, beating forecasts, but analysts warned rising costs, lower oil prices and refining margins and reduced growth targets could curb future earnings.

Shell said its fourth-quarter current cost of supply (CCS) net profit, which strips out changes in the value of inventory, rose 11 percent to $6 billion (3 billion pounds), thanks to higher output, strong oil prices and profit from disposals.

For 2006 as a whole, CCS profit was up 12 percent at $25.4 billion, a UK corporate record, analysts said.

Shell’s London-listed A shares closed 1.9 percent higher at 1,746 pence on Thursday, outperforming a 1.4 percent rise in the DJ Stoxx European oil and gas sector index.

“Overall Q4 results were resilient but annual earnings of $25.4 billion could be the peak in this earnings cycle,” Tony Shepard at brokerage Charles Stanley said.

The second-largest Western oil company by market value after Exxon Mobil, which posted a record $40 billion 2006 profit on Thursday, Shell said fourth-quarter production rose 4.1 percent to 3.645 million barrels of oil equivalent per day (boepd).

Full-year output was down 1.3 percent at 3.47 million boepd, largely due to strife in Nigeria which has shut in fields.

Chief Executive Jeroen van der Veer said the problems in Nigeria, intense competition in accessing resources and the planned sale of half of Shell’s stake in the Sakhalin-2 project in Russia, forced the company to drop a 2009 output target of 3.8-4 million boepd and a 2014 goal of 4.5-5.0 million boepd.

Shell now expects production growth of 1-2 percent to the end of the decade and 2-3 percent in the next, with much growth coming from oil sands and natural gas projects, which some analysts believe offer lower margins than oil.

Shell’s goals are below the growth levels targeted by rivals such as London-based BP Plc and France’s Total SA, although many companies have struggled to meet their output targets in the past two years.


Van der Veer said despite the anaemic growth projections, Shell was still focussed on growing organically rather than through acquisitions.

The industry is buzzing with talk about consolidation, with some analysts saying mega-mergers, such as a tie up between Shell and BP, could be on the horizon.

Shell said the planned sale of a controlling stake in Sakhalin-2 to Gazprom, after Kremlin pressure on the project, would slice 400 million barrels off its reserves base, and hit production levels after the deal closed in 2007.

Nonetheless, Shell’s reserves replacement ratio (RRR), the rate at which it matches production with new finds, was 150 percent in 2006, including oil-sands projects, after years of failing to hit the desired minimum 100 percent target.

“What is especially important is that the reserve replacement ratio is higher than 100 percent,” said FBS Bankiers analyst Jaap Barendregt.

However, other analysts were concerned that Shell was relying on low margin projects to boost reserves.

Chief Financial Officer Peter Voser said over half the reserves additions were related to oil sands projects, which involve extracting bitumen from tarry sands and then processing this into crude, and a project in Qatar which converts natural gas into diesel.


Voser said capital expenditure would rise 10 percent in 2007 due to double-digit inflation in the oil services industry and that costs were likely to continue rising.

Tim Whittaker, oil analyst at Lehman Brothers, said given the scaled back output targets, Shell was “spending a lot of capital for very little growth”.

Excluding non-operating items like asset sales, underlying fourth-quarter profit was $5.5 billion, above an average forecast of $5.216 billion in a Reuters poll of 10 analysts.

Investors consider the pre-exceptional CCS result as the best measure of Shell’s underlying performance.

Environmentalists criticised the bumper earnings. Global Community Monitor said Shell should spend the profits mitigating ecological damage from its operations.

The fourth-quarter earnings rise was powered by the upstream division, which in addition to higher output, benefited from higher oil prices.

Oil prices were up around 5 percent in the fourth quarter compared with the same period of 2005 but analysts forecast average oil prices will be lower in 2007 than 2006.

Refining profits dropped, as margins narrowed, and refining boss Rob Routs said he expected these to narrow further in coming years. In response, Shell is shifting its refining focus to high growth markets in Asia.

Shell announced a fourth-quarter dividend of 25 euro cents per share, up 9 percent. Voser hinted buybacks would be lower in 2007 as the company favoured raising dividends.

Thu Feb 1, 2007 7:43 PM GMT
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