The Independent: Outlook: BP puts Shell to shame as oil price gushes

By Jeremy Warner

30 March 2004

It's payback time for investors in BP. While Shell flounders, BP was yesterday able to announce "significant extra cash" to shareholders over the next three years, both through share buybacks and increased dividends. The contrast with Shell could scarcely be greater. BP is utterly confident of its proven reserves, which have been hugely expanded over the last five years, so much so that the company has been replacing its annual production at an average rate of 153 per cent a year. As we now know, the equivalent figure at Shell is rather less than 100 per cent.

Lord Browne, BP's chief executive, wouldn't have wanted to rub Shell's nose in it, but that was the effect of yesterday's strategy statement. Alongside the svelte, thorough bred form of BP, Shell looks like a clumsy old cart horse mired in a muddy lane. For all the effort Shell is making to extract itself, it's not a contrast that looks like changing anytime soon. Missed production forecasts caused BP to stumble a couple of years back, but now it's back in supremely self confident form. Yesterday's statement was the most upbeat in years.

The extra ingredient is the oil price, which has remained much stronger than anyone anticipated. Soaring demand from China makes Lord Browne's forecast that "there appears, at present, to be overwhelmingly more chance of the oil price being above $20 a barrel for the next few years than not" seem almost laughably cautious. None the less, it allows for a new benchmark which will enable BP to distribute all its free cash flow to shareholders in excess of operating investment as long as the price remains above $20 a barrel. It will also allow BP to look at developing more fields which have up until now looked commercially marginal.

If the oil price remains above $30 over the next three years, which doesn't seem impossible, the new policy would allow for roughly $15bn of share buybacks, or approaching 10 per cent of the company's present market capitalisation. On present form, Shell will struggle even to pay the dividend.

Can the oil price possibly maintain its present lofty elevation? In the past, a high oil price has always ultimately proved self correcting. Too much demand equals too high a price, which raises business costs. In the subsequent inflation, interest rates are jacked up, demand falls, and the price comes back to earth with a bump. The ups and downs of the oil price correspond almost exactly with those of the economic cycle.

This time it might be a bit different. For a start, there's the added factor of China. What's more, the world economy is no longer as dependent on oil as it was, so the effect of a rising price isn't as great. The upshot is that the world economy might be able to sustain a permanently higher oil price without undue damage to its health. Last month, Opec bizarrely ordered a cut back in quotas in anticipation of a seasonal fall off in demand in the second quarter. The new quotas have been largely ignored and still the price has continued to rise. The way things are going, a new Opec target range cannot be long in coming.

For BP everything looks set fair. That's assuming, of course, that the company's multi-billion dollar investment in Russia doesn't suddenly turn bear shaped.

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