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The Business Online: Oil boom masks Shell's poor record

By Graeme Davies
29 January 2006
Plan to ramp up CapEx gets mixed response
THE boom in the oil sector over the past three years has helped Anglo-Dutch giant Royal Dutch Shell mask a poor reserves replacement record which could otherwise have sunk its share price.
Fuelled by hefty cash generation, Shell has decided to ramp up its capital expenditure plans for 2006 by $4bn to $19bn in an attempt to correct its falling reserves replacement record, a move which was greeted with a mixed response by analysts.
Oil prices are predicted to remain around $60 a barrel for much of 2006 and this should allow Shell to produce an acceptable performance while returning significant amounts of cash to shareholders. The amalgamation of the UK and Dutch businesses in the middle of last year also helped to significantly boost Shell’s share price. FTSE100 tracker funds were compelled to buy shares in the company as its weighting in the index increased.
Shell shares have been as high as £18.75 since the amalgamation and are currently steady around the £18.35 level. Thursday’s fourth-quarter and full-year results should demonstrate strong performance but will also highlight Shell’s continuing battle on reserve replacement.
Merrill Lynch recently downgraded Shell to neutral and said: “In particular watch for another year of sub-100% reserve replacement (we forecast 70%-80%) and another flat year of exploration and production revenues.” Merrill thinks BP represents better value than Shell because of its superior portfolio mix and better shareholder returns.
The Merrill team is also concerned shareholder returns could disappoint, particularly in contrast to BP’s hefty returns. It said: “The group has the financial clout to release some $30bn and still enjoy gearing below 20%. However, we doubt it will announce a special dividend.” It believes share repurchases will be restricted to $10bn as Shell reserves some firepower for a possible acquisition, which in itself carries risks.
Numis Securities also recently reduced its recommendation on Shell from add to hold following the increase in capital expenditure plans. It said: “The higher level of investment has not been accompanied by higher production or activity levels. It simply reflects a higher cost base.”
Other analysts are more positive, Credit Suisse First Boston’s team has an outperform rating on Shell with a price target of £21.70. It believes reserves replacement levels will witness a “steep rise” from 2006 onwards as the recent investment programme begins to kick in.
JP Morgan’s Gordon Gray is overweight on Shell with a price target of £19.75. Gray believes the increase in capital expenditure will relieve a key overhang on Shell’s share price and “long term volumes are likely to be more stable than most of its peers”.
Goldman Sachs is also overweight on Shell but has cut its price target by 3% to £21. It feels the recent upgrade to spending will not have a significant effect on the shares.
Graeme Davies writes for Investors Chronicle
NOTE: The authors on these pages have been selected for their expertise in various areas of investment. They or the funds they manage may or may not hold positions in the stocks discussed.

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