Shell shapes $32bn production boost

Of the five “supermajor” international oil companies, Royal Dutch Shell has the worst production profile of the decade, with 2009 marking its sixth successive year of decline.

Malcolm Brinded, who as head of exploration and production is responsible for that production, says at least part of the reason is Shell’s under-investment when oil prices were low, in the late 1990s and early 2000s.

It failed to build the foundations for growth, a strategic mis-step that was reflected – although Mr Brinded did not refer to it – in the reserves mis-reporting scandal that broke in 2004.

It is not a mistake the company will make again. Shell plans to invest more than any other listed company, about $32bn this year, to build projects that are intended to pay off for decades to come.

However, the short term has an unfortunate habit of intruding on the best-laid long-term plans.

The fall in the price of oil from an average of more than $100 last year to an expected average of $40-$50 this year, which has been combined with a squeeze on profit margins from refining and manufacturing petrochemicals, is hammering the cash flows of oil companies.

Several times in his presentation of Shell’s strategy yesterday, Jeroen van der Veer, chief executive, lauded the virtues of a “flexible” balance sheet. This year that flexibility will be tested.

Shell’s dividend, unlike BP’s, is set to rise this year: the company indicated an increase of 5 per cent was likely, in line with the already announced rise for the first quarter.

The cost of that dividend and Shell’s capital spending programme, which is $11bn bigger than BP’s, will not be covered by Shell’s cash flow from operations, so borrowing will have to take the strain.

Peter Voser, Shell’s chief financial officer who succeeds Mr van der Veer in July, expects the company’s gearing – net debt as a proportion of capital employed – to rise from 6 per cent at the start of the year to the “low 20s” by the end of it.

As he points out, for a company of Shell’s size, that level of debt will still be “very comfortable”. The big international oil companies are still able to raise finance in the bond markets, at rates that are lower than last year, in spite of the financial crisis.

Nevertheless, such a steep increase in Shell’s borrowing raises concerns about how long it is likely to last. Mr Voser refused to indicate at what level of gearing he will stop feeling so comfortable.

He predicts that next year the company’s cash position will improve, as costs in the industry fall and new production comes on stream.

Shell is also taking steps to curb its spending. It revealed yesterday that it had decided not to invest any further resources in wind or solar power. Its solar business was already very small but wind power had been seen as a growing business, at least in the US onshore market.

Mr van der Veer says that he expects the research and development budget, which rose again to $1.3bn (£926m) last year, by far the highest of any of the oil majors’, to fall in the future.

Shell is close to the point where some of its huge investments, such as the Pearl plant to convert gas to liquid fuels, and the QatarGas 4 liquefied natural gas project, both in Qatar, are near completion. Construction is expected to be finished around the end of 2010.

Those projects give Shell the confidence to predict that, after a probable seventh consecutive year of decline in 2009, its production will begin to rise by 2-3 per cent a year to 2012.

As the projects come on stream, investors should at last be able to see the benefits of all that spending.

If oil stays at current levels for another year or two, or even falls further, it could yet be a rough ride along the way.

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