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THE SUNDAY TELEGRAPH: Money to burn: “If BP and Shell were to gear up to about 30 per cent of capital employed, Citigroup reckons their yields would be pushed well into double digits, from around 7 per cent now. That prospect is another good reason to own oil.”: Sunday 24 July 2005

 

Huge! that's the only word to describe the mountain of money being generated by oil and gas firms. Last year the overseas profits of British oil and gas firms were almost enough to finance the UK current account deficit, according to HSBC. This year profits from BP, Shell and BG will be bigger still.

 

High oil prices are behind this bonanza. No one in the industry is complaining, but it gives companies a problem: what should they do with all this cash?

 

Some is being ploughed into new exploration. But oil is getting harder to discover, so it's not easy to find viable projects. Furthermore, state-owned oil firms have even more cash to spend. And since they don't have to worry about investors, they can edge quoted companies out of deals.

 

As a result, cash is burning a hole in the oil and gas companies' pockets. Some is being returned to shareholders via higher dividends; payouts are rising by about 18 per cent a year in the sector. More is being spent on buybacks, which have grown by about 60 per cent since 2002.

 

But even this is not enough to absorb the bounty, so the remainder is being used to pay down debt. By the end of this year, Shell will probably have net cash on its balance sheet. Even BP, which is making greater efforts than most to return cash to shareholders, looks undergeared.

 

So what's the solution? One possibility is to leverage up again, using cheap debt to retire expensive equity via yet more buybacks. One advantage is that it would shrink the oil firms. BP and Shell together account for almost a fifth of the FTSE100, so arguably they need to get smaller anyway.

 

It would also raise cash yields, which include dividends and buybacks. If BP and Shell were to gear up to about 30 per cent of capital employed, Citigroup reckons their yields would be pushed well into double digits, from around 7 per cent now. That prospect is another good reason to own oil.

 

By John Paul Rathbone

 

http://www.telegraph.co.uk/money/main.jhtml?xml=/money/2005/07/24/ccbreak24.xml

 

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