Investors Chronicle: Is shell willing to risk us sanctions?

An article we missed…

2 February 2007

Shell’s planned investment in a US$10bn (£5.1bn) Iranian liquefied natural gas (LNG) project could now lead to US sanctions. But, given historical reluctance to enforce sanctions against multinationals, Shell may reckon the risk is worthwhile as it scrambles to shore-up future production, after Russia seized control of Sakhalin Energy LNG.

Losing Sakhalin cost Shell both previously-touted production targets and roughly one-tenth of booked reserves – the Iranian deal would address the former, but not the latter. Under Iran’s ‘buyback’ contract, foreign hydrocarbon investors receive costs plus a pre-agreed margin through production at market prices, retaining no ongoing interest. Analysts therefore don’t recognise reserves on buy-backs when forecasting a company’s future reserves, but they do include the in-kind payment in a company’s production base.

Following its 2004 reserves debacle, Shell has sought to refocus attention on production and profits rather than reserves – particularly as its upstream efforts are skewing towards ‘unconventional’ energy sources that are inadmissible as reserves under industry-standard definitions. The vital plank of Shell’s unconventional upstream is its Canadian oil sands business vested in Shell Canada, from which Shell is seeking to buy out minority shareholders at C$45 a share, up from the previous price of C$40.

Canadian oil sands analysts say Shell Canada is worth approximately C$24 a share stand-alone, growing to the mid-thirties assuming synergies with Shell’s US refining business. Only by counting on significant future reserve additions could the valuation approach the low forties – and now some Shell Canada shareholders say they want C$50 per share.

Operating costs per oil sands barrel are approximately US$20-$30, but sizeable upfront investment pushes break-even higher. Oil sands extraction is also extremely environmentally costly, which may cause future trouble for the sector.

Shell obviously thinks that its activities in Canada and Iran are the best way to grow in the next few years, even if long-term returns in each case look relatively poor. The company was conspicuously silent in 2006 on its conventional upstream exploration efforts, indicating that last year’s search for ‘big cats’ – fields holding more than 100m barrels – proved disappointing.

Daniel O’Sullivan

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