Shell Q4 Earnings Up 11% Despite Falling Production

Higher Oil Prices, Higher Profits

Shell, the second-largest of the international supermajors, today released its financial results for the fourth quarter of 2007. The company posted earnings (on a current-cost-of-supply basis) of US$6.68 billion, a solid 11% increase over the same period in 2006. Strong performance during the quarter drove home a successful year overall for the company; total 2007 earnings reached US$27.56 billion, a 9% increase over 2006.

The company's solid fourth quarter was driven by its upstream performance. Earnings from its exploration and production division totalled US$4.87 billion, a commendable 38% increase over the fourth quarter of 2006. Shell said its upstream performance was buoyed by higher energy prices during the period, with Brent and WTI crude prices averaging 48% and 51% higher than in the same period in 2006. Shell's global gas realisations were also up 19% on a year ago. However, given the highly favourable price environment, the company may feel the quarter represented a missed opportunity to achieve a truly notable performance, as lower oil and gas production during the period mitigated its overall upstream results. Total hydrocarbon production reached 3.38 million barrels of oil equivalent per day (boe/d) during the quarter, 4% less than in 2006. Shell indicated its output during the period was affected by a reduction of 53,000 boe/d due to the "resolution of contractual issues"—a seeming reference to the divestment of half of its stake in the Sakhalin-2 project in Russia in the second quarter of 2007. The company indicated upstream profits have also been hit by higher taxes and royalty charges and climbing costs.

Downstream Underperforms

Shell's oil products segment posted earnings of US$876 million in the fourth quarter, a 40% decline over its 2006 figures. The drop-off was primarily caused by lower realised refining margins during the period. In particular, margins were lower in the United States' Gulf Coast and West Coast regions. Downtime at refineries also had an impact on the segment's performance. Higher marketing margins partly offset the overall negative trend.

Shell's gas and power division earned US$631 million during the quarter, 9% up on the previous year. The improvement reflected higher realised LNG prices during the period. Its chemicals division also saw healthy growth, notching up earnings of US$348 million on improved margins and lower fixed costs.

Outlook and Implications

Overall, Shell chief executive Jeroen van der Veer noted the company had achieved "satisfactory" results during the fourth quarter of 2007, and indeed the 11% growth in earnings presents an overall positive picture of the company's performance over the three months. Standing out from the company's results, however, is the 4% reduction in oil and gas production. In isolation, the production decrease is relatively small but for Shell, incremental losses in production have become part of an overall trend of decline. The company's oil and gas output has now been in retreat for several years, reflecting the increasing challenges the industry is facing in securing new reserves amid growing nationalisation of oil and gas resources. These challenges were evident for Shell in its fourth-quarter results, with its reduced stake in the Sakhalin-2 project—triggered by pressure from Russian authorities—having a notable impact on output, as did the ongoing security problems posed at its operations in Nigeria's troubled Niger Delta region, where 189,000 boe/d of the company's production remains shut in.

The company has a clear strategy to overcome these challenges: it has been undertaking a process of consolidating its existing operations in a bid to refocus its resources on high growth upstream opportunities and new legacy assets. The completion in December 2007 of the development of Norway's massive Ormen Lange gas field—in which Shell holds a 17% stake—is one such example of this strategy coming to fruition. However, even as Shell executes its rejuvenation strategy, it is continuing to lose ground. The company's oil and gas output averaged 3.23 million boe/d in 2007, 5% down on 2006 production. While such production is likely to be sufficient for now for Shell to retain its place as the second-largest supermajor, investors will be all too aware that this trend cannot be sustained over the longer term. Shell's announcement this week that it will not release its revised reserve figures until the publication of its annual report in May could be a further sign that the company is struggling to face up to these longer-term challenges. This year is shaping up to be a pivotal one for Shell, and indeed may be indicative of the likely direction of the broader battle among the supermajors to secure new reserves and sustain their performance amid the global trend of resource nationalisation.

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