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Financial Times: Lex Column: BP, Shell and oil prices

Published: November 8 2007 02:00 | Last updated: November 8 2007 02:00

In recent years, Europe’s two biggest oil companies by market capitalisation have embodied different bets on the oil price. BP, with a much smaller refining base than its supermajor peers and its avoidance of costly, unconventional fuel sources such as oil sands, has been counting on prices falling. Lord Browne, chief executive until this summer, was banking on $40 a barrel in the medium term, falling to $25 or $30 further out. Implicitly, Shell 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 that is able to process complex fuels.

The stock market, though, continues to reward conservatism, leading to a valuation gap. Shell has ploughed more cash back into its business – capital expenditure consumed more than 70 per cent of post-tax cash flow from operations last year compared with 54 per cent at BP. As a result, its valuation has consistently lagged behind by about 10 per cent in terms of debt-adjusted cash flow multiples.

Trade-off between short-term cash flow generation and production growth is a challenge for Tony Hayward, BP’s new chief executive. 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 a senior executive suggested that BP was eyeing a return to Qatar, which sits on the world’s third-largest gas reserves, after a 15-year hiatus. Speculation is 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.

The attraction of cautious long-term forecasts is understandable. But with spot oil prices almost four times BP’s current planning assumption, Mr Hayward looks likely to turn the capex tap back on.

Copyright The Financial Times Limited 2007

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