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Higher oil prices rescue beleaguered Shell

By the time you've finished reading this sentence, Shell will have made another £2,000 of profit. Shock, anger, scandal. How dare these profiteering, monopolistic good-for-nothings make so much money at the poor old motorist's expense? Time for a crack-down. Slap on a windfall profit tax, regulate prices and throw the entire board in jail.

Yes indeed, it's Big Oil bashing time again and there's no denying the cause. Shell is gushing cash in such abundance that not withstanding the continuing débâcle of its overstated reserves - another 10 per cent was slashed yesterday, bringing to a third the downward revision since the scandal first emerged - it is able to raise dividends from $7bn to $10bn and announce a $5bn share buy-back on top.

Yet despite the headline grabbing demands of the chairman of the Commons Trade and Industry Select Committee, the Government is not going to impose a windfall profits tax. Even if ministers wanted to, it would be virtually impossible to do so. Only a small proportion of Shell and BP's profits come from the UK. The overseas earnings are taxed in the jurisdictions where they occur.

Of course, it would be possible further to increase petroleum revenue tax on North Sea production, but any such attempt would only be self-defeating. It's already hard enough, even with the oil price at $50 a barrel, to get the big oil companies to invest further in the declining acreage of the North Sea. There are plenty of other, more benign tax regimes for Big Oil to go prospecting in. The Government is in any case already getting a windfall from higher oil prices in the shape of enhanced VAT receipts.

Yet on one level, critics of the oil majors have got a point, even if the message conveyed is a somewhat confused one. Despite the higher price, no oil major has yet raised the benchmark at which it will invest in new oil development, which for most players remains stuck at $20 a barrel or less. This is one of the reasons why oil companies are so much more profitable than they used to be. In recent years they have become much more picky about what they invest in, conscious of past experience when the dash to invest while the oil price is high is punished as hopelessly uneconomic when it collapses back down again. The general approach to investment during the present upswing in oil prices has been much more disciplined.

Whether that's justified is open to question. The oil price may have settled on a permanently higher level. Moreover, if growing doubts about the size and sustainability of Saudi Arabian reserves prove well founded, it's headed in only one direction. In such circumstances, huge tracts of previously untapped reserves elsewhere in the world suddenly become commercial. Is this what the green lobby, which tends to go hand and hand with those who complain of profiteering by Big Oil, really wants?

High oil prices will eventually drive users to greater efficiency. The present inflated price of oil is certainly a boon for investors in the oil majors, but it may also be good for the planet, helping to stimulate the take-up of cleaner, more efficient technologies and generally encourage lower oil usage. By keeping their benchmarks artificially low, thus ensurng that supply always trails demand, the oil majors may even be doing us all a favour. Surprising but true, the pursuit of profit is not always such a bad thing.

As for Shell, it is indeed a curiosity to see a company which has so comprehensively mismanaged itself generating so much profit. Without the ever advancing oil price, Shell would be deep in crisis right now. As it is, things are bad enough when you take a look beneath the bonnet of record profitability.

Most worrying of all, there's been a further decline in the rate at which Shell is replacing its spent reserves since the company last updated us on these numbers in July. Projected at between 60 and 80 per cent back then, Shell is today replacing less than half the oil it sells with new reserves, which means that the company is progressively shrinking in size.

Jeroen van der Veer, the chief executive, hopes to be back to 100 per cent by 2008, but this is ventured as more of an aspiration than a target. When you take account of the fact that most of this progress will be accounted for by rebooking reserves Shell has been forced to unbook over the past year, it looks even less impressive. Anything less than 100 per cent would be regarded as wholly disastrous by either BP or Exxon Mobil, both of which have proved far more accomplished in choosing the right areas of the world to ensure their long term future.

So how come the Shell share price has been outperforming BP over the past few months? This is where the mysteries of the stock market take total leave of reality and enter the realm of Alice in Wonderland. As part of its response to the reserving fiasco, Shell is replacing its dual-listed structure with a unified company whose primary listing will be in London. The size of the share capital traded in London will consequentially double, which is triggering one of the biggest technical readjustments since Vodafone acquired Mannesmann. Big index tracking funds are being forced significantly to increase their weighting in Shell at the expense of BP. The better investment is being dumped for the poorer one, which is great for commissions, but very bad indeed for investors. It's hard to imagine a more bizarre investment rotation.

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jeremy.warne[email protected]

Editorial Notes: First published 4 February 2005 Original title: "Jeremy Warner's Outlook: Higher oil prices rescue beleaguered Shell".-LJ

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