Published: November 7 2007 09:26 | Last updated: November 7 2007 11:16
In recent years, Europe’s two biggest oil companies by market capitalisation have embodied different bets on the oil price. With a much smaller refining base than its supermajor peers, and shunning costly, unconventional fuel sources like oil sands, BP has been counting on prices falling. Lord Browne, chief executive until this summer, was banking on $40 a barrel in the medium term, slackening to $25 or $30 further out. Shell, meanwhile, implicitly believes in prices being stronger for longer. Since late 2004 it has gone out on a limb, developing big, long-life upstream projects, complemented by a solid downstream business able to process complex fuels.
The stock market, however, continues to reward conservatism, leading to a valuation gap. As Shell has ploughed more cash back into its business – capital expenditure consumed over 70 per cent of post-tax cash flow from operations last year, compared to 54 per cent at BP – its valuation has consistently lagged its rival by around 10 per cent in terms of debt-adjusted cash flow multiples, and about five per cent on earnings multiples.
The trade-off between short term cash flow generation and production growth is a challenge for BP’s new chief executive Tony Hayward. He has yet to outline his view on oil prices or capex, but there are some hints that he could unpick the strategy of his predecessor. A recent stray aside from the company’s EMEA chief suggested BP was eyeing a return to Qatar, which sits on the world’s third-largest gas reserves, after a 15-year hiatus. Speculation is now mounting that Mr Hayward may look for a way back into Canadian oil sands – a business BP twice exited under Lord Browne, blaming insufficient returns.
If deals and capital spending follow, it would represent a U-turn by BP. It is also understandable why oil majors use cautious long term forecasts. Nonetheless with spot oil prices now almost four times BP’s current planning assumption, it looks likely that Mr Hayward will turn the capex tap on.
Copyright The Financial Times Limited 2007
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