Financial Times: Petrol pumps at dawn over strategy

By Ed Crooks
Published: February 5 2008 19:46 | Last updated: February 5 2008 19:46

Tony Hayward at BP and Jeroen van der Veer at Royal Dutch Shell have a great deal in common.

Both chief executives took over when their companies were in crisis; Shell after the reserves misreporting scandal that emerged in 2004 and BP after the fatal explosion at the Texas City refinery in 2005 and other problems that drew attention to deep operational weaknesses.

Both face the same challenge of how big international oil companies – challenged by ever more assertive governments and national oil companies – can gain access to the resources they need to survive. They have found some of the same answers, in terms of trying to restrain cost inflation and making it a priority to secure access to resources.

Yet in this difficult terrain, they remain on divergent paths.

Their differences can be traced in part to the companies’ origins. Shell Transport and Trading, the British parent of today’s Shell, was originally a shipping company, the pioneer of oil tankers. Its alliance with Royal Dutch Petroleum built a strong marketing business before the first world war.

BP’s roots lie in oil exploration, with a big find a hundred years ago in what is now Iran.

That differing corporate DNA has shaped the companies fortunes’ ever since.

It is not that BP cannot do refining; its refineries outside the US perform as well as anyone’s.

However, its US refineries have been a persistent problem: not just in the deaths at Texas City in 2005, but in the slow pace at which the refinery has been brought back on stream following Hurricane Katrina later that year and in the fire at Whiting in Indiana in March last year, which has kept it working below full capacity ever since.

Those troubles meant that much of BP’s capacity was unavailable during one of the best periods on record for US refiners. The US refineries lost more than $800m (£408m) last year.

Worldwide, BP made a $2.62bn profit from its refining and marketing segment; a performance described by Mr Hayward as “very disappointing”. Shell, by contrast, made $6.95bn from its refining and marketing business.

Upstream, on the other hand, BP seems to have the edge. It is not that Shell is incapable of conventional exploration. It said last week it had found about 1bn barrels of oil equivalent to add to its resource base last year, although that figure is different from the definition of proved reserves accepted by the US Securities and Exchange Commission.

However, Shell has not yet given any guidance on what its reserve replacement would have been, according to those SEC rules. The number, due out in a few weeks, is likely to look bad.

BP, meanwhile, was able to say on Tuesday that it had replaced all of the oil and gas it produced last year: the 14th consecutive year its reserve replacement ratio has been more than 100 per cent. It reported significant exploration successes in Azerbaijan, Egypt and Angola and has secured important deals in Libya and Oman.

There is a similar contrast in the two companies’ near-term production outlook.

BP has new projects such as ACG3 in Azerbaijan, Thunder Horse in the US and Tangguh in Indonesia coming on stream this year. If oil prices average about the same as last year, BP could expect 1 or 2 per cent growth in production, while Shell would expect a fall – for a sixth successive year.

Looking into the next decade, however, Shell expects to come into its own. Rather than putting all its effort into finding oil and gas, its strategy has been to make massive investments in “unconventional” sources.

That spending is going into projects such as the oil sands of Alberta, liquefied natural gas at Sakhalin 2 and converting gas to liquid fuels in Qatar, which are expected to have very long productive lives. In the 2010s, Shell expects its production to be expanding by 2-3 per cent a year, thanks to those investments.

Neil McMahon of Sanford Bernstein, compares the companies with wines: “BP will drink well over the next few years, whereas Shell will be better after 2010.” In investing in these unconventionals, Shell is well ahead. BP has only just entered oil sands, with the joint venture with Husky Energy announced late last year.

Shell already gains 5 per cent of its production from unconventionals and expects that proportion to rise to 15 per cent by 2015.

Shell’s strategy is favoured by a higher oil price. BP said on Tuesday it expected oil to be in a range of $60-$90 a barrel over the next few years, and it would be happier than Shell at the bottom end of that range.

However, if Mr van der Veer is right that conventional and easy to extract oil will be unable to meet demand after about 2015, his decision to invest so heavily now should be vindicated.

Copyright The Financial Times Limited 2008