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The Independent: Jeremy Warner’s Outlook: Attractions of undervalued oil majors

Friday 06 July 2007

My note the other day arguing that there is life in the oil majors yet has caused a stir among readers. As you might expect from an environmentally-conscious readership such as The Independent’s, many have argued that the low-carbon economy the world must adopt to deal with climate change means oil companies have little or no future.

At the other end of the spectrum comes the possibly more realistic if depressing view that Asian growth means that demand for hydrocarbons will continue to grow exponentially, making these companies extraordinarily valuable properties.

A recent circular from Morgan Stanley on Royal Dutch Shell lends some support to this argument. According to Morgan Stanley, the markets are profoundly mispricing the oil majors. The investment bank refers to “a massive gap” between Shell’s market value and the underlying value of the company which it calculates at perhaps as much as $120bn. The same argument could be made about BP, Total, and perhaps Exxon Mobil too.

How come? Morgan Stanley makes the case on a simple sum-of-the-parts argument. The focus on Shell’s declining upstream activities disguises a massive and highly valuable downstream business, including some of Europe’s biggest refining, marketing, gas and power and chemical businesses.

Yet the argument can as easily be made about the oil majors’ reserves of oil and gas, which, given the high oil price, seem to be hugely undervalued by present share prices. There is a big difference between the present price of oil and the value that markets attribute to some of its major producers. The chief reason for this mismatch is that markets are sceptical that the oil price can be sustained at these historically high levels. The general assumption is that, come the next downturn, it will slump back down again.

The really interesting thing is, however, that it needs to fall back an awfully long way to make current valuations look expensive. The great bulk of these reserves are in at assumed development and production costs of $25 a barrel or less.

If oil remains scarce and in demand, reserves at such prices look massively undervalued, so much so that you have to wonder whether the likes of BP and Shell might eventually become targets for the Chinese in what is already an extraordinarily aggressive search for assets with which to secure the country’s future energy needs. If it were thought politically acceptable, they would no doubt already have tried.

Were it not for their size, these companies would also be an absolute no-brainer for private equity. As I have argued, a BP/Shell merger continues to look implausible. The regulators would never allow it. But a bid by others for one or both these companies shouldn’t altogether be discounted. Likewise, they might soon find themselves the target of activist investors, determined to obtain a more aggressive extraction of value. and its sister websites,,,,, and are all owned by John Donovan. There is also a Wikipedia article.

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