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Europe’s Oil Firms Cook Up a Treat

JANUARY 12, 2012

By ALEXIS FLYNN

European energy companies are expected to return more money to shareholders in 2012 as stubbornly high oil prices swell their balance sheets.

With full-year results only weeks away, expectations are growing that heavyweights like Royal Dutch Shell will cap an extraordinary 12 months by raising dividends.

According to Deutsche Bank, the sector has “plenty of headroom” to support a forecast of 5% aggregate dividend growth in 2012. Already, it says, companies in the sector are expected to accumulate 50% more cash than they need to cover operating costs in 2012 and 2013.

Even BP PLC may raise its dividend.

The U.K. oil company, which for many years was known for bumper payouts, had to suspend its dividend in the wake of 2010’s Gulf of Mexico oil spill. Only last February did it resume payments, at a lower level.

As the company’s ultimate liabilities for the spill become clearer, management could be confident enough to increase the payouts, analysts from Credit Suisse say.

Investors in recent years have had to contend with major oil companies plowing their free cash into new sources of oil, and the technology to extract it, although the sector has remained a reliable source of dividends.

Still, Moody’s Investors Service points out, four energy companies—Shell, BP, Total SA and Statoil ASA—rank among the 20 European firms with the best cash positions. It also notes that the European energy sector as a whole ranks third, after utilities and automotive firms, in terms of its cash holdings.

Investors are still spooked by the memory of 2008. Crude prices were then rapidly dragged down by Lehman Brothers’ collapse and a sudden contraction in the global economy. Oil firms’ stock prices fell, but analysts say history is unlikely to repeat itself in 2012.

Oil and gas prices weathered last year’s uncertain macroeconomic environment because of supply issues, such as the civil war in Libya, while the earthquake and tsunami in Japan forced the government to temporarily shut down all nuclear power generation. Utilities had to scramble to buy liquefied natural gas, lending strength to LNG prices.

Growing tension between Iran and the West and threats to supply in Nigeria are likely to keep crude prices elevated for the foreseeable future.

Since higher energy prices are currently translating into superior cash generation, analysts say the sector’s top firms already feel confident enough to give money back to investors.

“Healthy cash flow should leave room to increase shareholder returns in the form of dividends or buybacks, for some select companies,” said Credit Suisse in a note.

It added that chief financial officers will also likely keep some cash on the books as insurance against economic risk and in case opportunities for mergers arise.

Continued high oil prices are the keystone upon which any largess rests, analysts argue. “The sector now requires an average $90 a barrel to achieve cash neutralityacross 2012/13,” said Deutsche Bank. If a company is cash-neutral, it is generating enough cash to cover its costs.

The firm most likely to deliver continued dividend increases in the medium term is Shell, according to analysts at Nomura. The bank says Shell will continue to see the benefit of its long-term investments in big-ticket projects in Canada and Qatar.

However, Goldman Sachs sounded a note of caution on Shell’s fortunes. It said that while the Anglo-Dutch giant could enjoy a bumper year, its fourth-quarter results could bring down its earnings per share.

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