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FOCUS: 2Q Is Time For U.K. Oil Bosses To Prove Their Mettle

THE WALL STREET JOURNAL

JULY 27, 2009

By James Herron

Of DOW JONES NEWSWIRES

LONDON (Dow Jones)–For the bosses of U.K. oil giants BP PLC (BP) and Royal Dutch Shell PLC (RDSB.LN), the announcement this week of their performance in a tough second quarter will be the time to prove they have the right ideas to overcome problems afflicting the entire industry.

BP Chief Executive Tony Hayward needs to demonstrate that the reorganization he launched when he took the job just over two years ago really has made the company leaner, quicker on its feet and able to squeeze more profit out of each barrel of oil, say analysts and investors.

Shell boss Peter Voser has been in the job less than a month, but is likely to be defending his company’s worst quarterly profits for many years. People want to hear exactly how his reorganization plan will change Shell for the better and help it close the profitability gap with rivals.

“Restructuring is a marathon, not a sprint,” said Evolution Securities analyst Richard Griffith. However, the collapse in the oil price last year has increased the urgency in the industry to make every dollar count, he said, and investors want to be shown the path out of the woods.

Getting Fit For Testing Times

Major oil companies have seen their profits tumble along with the oil price, so the pressure is on for them to earn more from each barrel they pump if they want to keep paying generous dividends and investing for the future.

Opportunities to acquire cheap and easily worked reserves are few and far between these days, so oil bosses have been forced to turn inwards and pursue efficiency gains in order to boost profitability.

“I think the economic recession will have a lasting effect,” said Voser in an interview posted this month on Shell’s Web site. “That makes cost and efficiency key to Shell’s success. We’re not competitive enough. We need to readjust.”

Those words may sound familiar to shareholders of BP. When Hayward took the reins as chief executive in 2007, he made similar promises to streamline the company and improve basic performance after a string of operational failures that cost 15 lives, millions of dollars, and serious damaged the company’s reputation.

“Our problem is not about the strategy itself, but about our execution of it. BP’s performance has materially lagged our peer group in the last three years,” Hayward wrote in an e-mail to BP staff a few months after taking charge in 2007. BP’s management structure had become so complex that making a decision was like “running through treacle”, he said.

Hayward cut the number of business units from three to two, created a smaller division for alternative energy and cut 5,000 jobs out of around 100,000 total staff in an effort to cut overheads by 15-20% and improve operational performance.

Progress was slow, but the benefits of these changes have started to come through, say analysts and investors.

“The good news about BP in the last two quarters is that their operational strategy is starting to get them back onside,” said Colin Morton, a fund manager at Rensburg Fund Management, which holds a stake in BP.

“They are one of the very few large integrated companies talking about growing production…They’ve been telling a story of much better costs lately,” he said. BP has recently indicated to investors they are seeing costs fall by 5-10% across the business and in some cases 50-60%, he said.

If, as many analysts expect, BP does better than rival Shell in the second quarter, its “self help” program will be a big part of that, Morton said.

But there is still room for improvement, he said. BP needs to show that operational statistics and profit margins are in the top quartile of the industry, Morton said. He’s also hoping to see BP trim its 2009 capital expenditure in its results Tuesday due to efficiency savings.

“But generally speaking [Hayward] has delivered on everything. He’s done a good job,” Morton said.

Filling In The Blanks

Shell is not in as deep a hole as BP in 2007. It has had no safety failings of the scale or severity of BP’s fatal Texas City refinery explosion in 2005 and its most important projects appear to be on track.

However, the company could clearly do better when it comes to profitability. This month Shell topped the Fortune 500 list of the world’s largest companies, edging out rival ExxonMobil Corp. (XOM) on revenues, but coming up well short on profits.

“In some areas…we’re more expensive than our competitors and are second or even third-quartile in performance. That needs addressing,” Voser said.

Voser’s reorganization strategy announced last month follows a similar path to Shell’s competitors. Like BP, he is eliminating Shell’s gas and power division and giving responsibility for all hydrocarbon production to the upstream division. He is also creating a separate division to oversee technology and project design on a company-wide basis, a model that has proved successful for ExxonMobil.

But while major changes apparently proceed behind the scenes, with press reports this week that Shell may cut 600 senior management positions, details have yet to be filled in in public.

There was little clarity to Shell’s promise earlier this year to make savings of several billions of dollars in operating costs and capital expenditure, said Citigroup analysts Mark Bloomfield and David Thomas in a research note. “The question is whether management will be bold enough to make any internal cost targets public,” they said.

At some stage Voser needs to set out clearer targets that can be used to judge his performance, said Ivor Pether, a fund manager at Royal London Asset Management. “I’m hoping Shell will demonstrate they are weeding out low-return assets…I’m also hoping for insights into the thinking behind his management restructuring,” he said.

Voser has hinted at the approach he will take. “Rather than aiming exclusively for the highest production levels, we are also looking to achieve the best production quality to generate the best total profits and cash flow,” he said. “Shell still works in a rather complex way, so we need to streamline our processes and eliminate activities that don’t generate value.”

Radical change to the company’s culture seems unlikely. “I don’t like the word revolution,” Voser said. “I see myself as a calm leader…I am focused and disciplined and want to see things delivered.”

The Bigger Picture

The focus this week will be on internal changes, but investors and analysts are still concerned about BP and Shell’s long-term prospects. On this front, it seems again that Shell has rather more to prove than BP.

“BP has tried to put more visibility on its production growth targets. Shell’s outlook is rather more difficult to decipher,” said Pether.

BP’s guidance of 1-2% growth per year to 2020 is realistic, given its current asset portfolio, said UBS analyst Jon Rigby.

Shell, on the other hand, “muddied the waters” at its March strategy update by saying it may defer some projects to rework their costs, Pether said. It has also pulled back from a previous production growth target of 2-3% per year over the next decade. “Yes, they’ve got big projects coming onstream, but they’ve also got declines in mature areas and problems in regions such as Nigeria,” he said.

But targets will mean little if the companies can’t maintain their current focus on improving day-to-day operations in key areas, such as the Gulf of Mexico for BP, said Evolution’s Griffith. “Failure to deliver, or delays, would almost certainly see group growth targets missed,” he said.

-By James Herron, Dow Jones Newswires; +44 (0)20 7842 9317; [email protected]

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