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Financial Times: Easy pickings from ‘Big Oil’s ‘windfall’ are running out

By Andrew Hill
Published: February 1 2008 02:00 | Last updated: February 1 2008 02:00

“Obscene” profits and calls for “windfall taxes”: it’s oil company reporting season again. Royal Dutch Shell formally launched the 2007 full-year results festival in the UK yesterday by recording the largest profit ever reported by a listed European company – $27.6bn (£13.9bn) after tax, adjusted for changes in the value of fuel inventories.

If the chorus of complaint from unions and environmental groups at the “£1.6m-a-hour” profit was predictable, so was the reaction of analysts: disappointment. Fourth-quarter net income was slightly below the market consensus. If the company reaped a bonus from the higher oil prices last year, it had to use it to offset lower production.

That is one reason why Jeroen van der Veer, Shell’s chief executive, deemed the numbers merely “satisfactory”. The reality is that as fast as Shell pulls in profit, it is having to reinvest it to prepare for the future. The group’s capital expenditure for 2007, excluding acquisitions and disposals, was a staggering $25.5bn – itself almost certainly a record or near-record. That figure will rise again this year to $28bn-$29bn – in tabloid terms, £1.7m an hour.

As for “profitability” – rather than profit – analysts point out that cost inflation in the past two years of rising oil prices has curbed oil majors’ profitability, as measured by return on capital employed. Returns have been, at best, flat since 2005 and are projected to fall in the years ahead.

Production of “easy oil” and “easy gas” – reserves that are close to markets and relatively simple to extract – should peak by 2015. That will push Shell out into deep water, literally and metaphorically, in a search for what it calls “unconventionals”. Squeezing reserves out of inhospitable terrain is not cheap.

The fall in the share price yesterday put Shell on a forward multiple of about 9 times forecast earnings for 2008. Some analysts consider the stock a short-term bargain. But over a longer period, the destiny of Shell and its “supermajor” peers is to run as hard as they can – not to catch a windfall, but to avoid a downfall.

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