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Shell to Boost Exploration Spending

January 31, 2013

Falling profits at Royal Dutch Shell last year could be explained by volatile oil and gas prices. But Heard on the Street’s Andrew Peaple reckons economies of scale may no longer be working for the oil behemoth.

LONDON—U.K.-listed oil and gas company Royal Dutch Shell RDSB.LN -2.73% PLC Thursday said it would increase capital expenditure this year, despite the uncertain global economic outlook, with the aim of finding and developing more resources and rejoining the ranks of the world’s top oil and gas producers by 2018.

The spending plans came as Shell missed expectations by posting a 13% rise in profit for the fourth quarter, with analysts expressing concern about the amount of money the company spent on exploration.

Shell isn’t the only company ramping up spending on exploration. The oil sector is in the midst of an exploration boom as major companies seek to replace declining reserves. Last year Shell only added enough new reserves to replace less than half the oil and gas it produced.

Shell said it expected $33 billion of net capital investment this year, up 10% from 2012, with a big chunk of that spending going to high-risk and costly ventures to grow production in areas such as the Arctic and Kazakhstan.

The company’s strategy is to look past short-term market volatility and focus on future projects that would help to deliver long-term returns shareholders, said Shell Chief Executive Peter Voser.

Exploration activity will step up in 2013 and 2014, with more than 40 high-potential exploration wells in 18 different locations around the world and tests to determine the prospects of 10 basins for shale oil and gas, including areas in China and Ukraine, Shell said.

But the strategy has its risks, as was seen by Shell’s failed attempts last year to complete two exploration wells offshore Alaska during the short ice-free summer season, and the further setback when its drilling rig ran aground after breaking free from tow ships in high seas.

The operation to recover the Kulluk cost around $40 million in the fourth quarter, Shell’s Chief Financial Officer Simon Henry said. This sum doesn’t include additional expenses incurred in the first quarter or the cost of repairing damage the vessel suffered during the grounding, he added.

Shell has already paid $2.2 billion for the leases to drill in offshore Alaska and around $2.8 billion for operations over the past six years, without making any new discoveries.

Some analysts fear that mounting exploration expenses could be a recurring theme. “People will be worried,” said Investec analyst Stuart Joyner. “They’re spending a lot more cash on exploration going forward.”

Exploration spending was $5 billion in 2011, $6 billion in 2012 and is expected to be $7 billion this year, said a company spokesman.

The Anglo-Dutch energy company said its current cost of supplies, a figure that excludes gains or losses from inventories and is therefore equivalent to the net profit figure reported by U.S. oil companies, was $7.29 billion in the three months ended Dec. 31, compared with $6.46 billion in the fourth quarter of 2011.

Excluding the impact of exceptional gains or losses from things such as asset sales, the company’s profit was $5.58 billion, below average expectations of $6.16 billion in a Wall Street Journal poll of 11 analysts.

Total oil and gas production was 3.41 million barrels of oil equivalent per day in the fourth quarter, a 3% increase on the year because of a ramp up of Pearl gas-to-liquids plant in Qatar, which converts natural gas into liquid fuels such as diesel. Production was in line with analyst expectations.

Around 30 new projects under construction will increase Shell’s oil and gas production to around 4 million barrels of oil equivalent a day by 2017 or 2018, the company said. Hitting that target would put Shell among only a handful of listed companies that produce more than 4 million barrels of oil equivalent a day, including U.S. giant Exxon Mobil Corp. XOM -0.46% and Russia’s state champion OAO Rosneft, once it completes the acquisition of TNK-BP Ltd.

Shell’s oil and gas production hasn’t exceeded four million barrels a day since the first quarter of 2004, according to earnings reports, when the company surprised investors by unexpectedly cutting its oil and gas reserve estimates.

Write to Selina Williams at [email protected]

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