Royal Dutch Shell Group .com Rotating Header Image

Financial Times: Pumping cash rather than oil and gas

Pumping cash rather than oil and gasPublished: May 8 2006 03:00 | Last updated: May 8 2006 03:00

The oil majors are suffering an embarrassment of riches. Last year Exxon/­Mobil enjoyed the largest profit in US corporate history, while Shell, BP and Total all broke their own earnings records. Investors and customers would like to know whether the money will go towards finding more oil.


The question was given particularly sharp focus by Royal Dutch Shell on Thursday, as it warned that it was unlikely to meet a medium-term target for replacing the oil and gas it was pumping. Shell's reserve replacement has been disappointing but many oil majors have struggled to find new oil, in spite of lucrative rewards for success.

Shell emphasised a reserve replacement target in a bid to restore some credibility after the misreporting of reserves led to the departure of top executives in 2004. The company has slightly embarrassed itself by retreating from that target but did the right thing. Shell discovered the business school rule: projects should be rejected unless they improve discounted future cash flows, target or no target.

The reserves issue is further clouded by the fact that the official Securities and Exchange Commission definition of proven reserves is nearly 30 years old and increasingly obsolete. Nevertheless, oil majors are failing to develop enough of a commodity that has rarely been as valuable as today.

Yet it is not obvious what the oil majors should do now. They could buy up smaller companies as a way of embellishing their reserve figures but that would be of dubious value to their shareholders and no value to their customers. They could attempt to find more oil and gas themselves but they now face formidable constraints. National oil companies and governments are understandably reluctant to grant production licences cheaply.

In addition, only so many geologists and drilling rigs exist and fierce competition has vastly raised the costs of using them. Eventually those constraints will ease but in the short term this is almost a zero-sum game.

The majors must now be ruing their lack of vision when, in the late 1990s, they slashed investment and sacked large numbers of expert workers. Hindsight is a wonderful thing but in a business where investments take several years to begin production and may then operate for decades, it was unforgivably foolish to respond so conservatively to a brief crash in the price of oil, albeit after several years of modest prices: 1998 was the time to invest, economically, in building new reserves.

Those with long memories will recall what happened the last time oil companies had too much cash. BP diversified into animal feed. Mobil bought a catalogue retailer. For now, investors should be relieved to see dividends and buybacks have exceeded $100bn (£53bn) in the last two years. The majors are signalling they are less competent than shareholders to find a good use for the money. One can only agree.

This website and sisters,,,, and, are owned by John Donovan. There is also a Wikipedia segment.

Comments are closed.