05 Feb 2010
Oil majors: Performance and outlook

Hello. Welcome to Company Focus, my name is Aamer Nawid, I'm an analyst at Fat Prophets and this week we're going to be taking a look at the oil majors, most notably BP and Royal Dutch Shell.

Regular viewers will recall that late last year I did look at BP and Royal Dutch Shell and our focus at that point was on cost cutting initiatives which needed to be implemented in the light of weaker refining margins. Today this week, the situation remains the same. The weak refining margins don't seem to be going away, but it seems as though BP is coping with this current situation slightly better than Shell.

Let's focus on results released this week and it's clear to see that BP has the edge. The company reported replacement cost profits of around about $3.45bn, 33 per cent higher than the fourth quarter last year. Shell, on the other hand, their profit for the same period for the same quarter was 75 per cent lower. It came in around about $1.2bn.

Having said that, looking at the share price reactions in the immediate aftermath of the earnings announcements it seems as though BP's results were interpreted as being a little bit worse by the market. Immediately after Tuesday's announcement that BP hadn't met market expectations, shares fell by around about 4 per cent whereas yesterday Shell released their results, the shares opened at around about 2 per cent lower than the previous close.

Both results failed to meet market expectations, so negative share price moves are to be expected. The only reason why BP's share price move was more pronounced was probably because over the last 12 months the shares have actually outperformed that of Shell by quite some distance.

Comparing the two, it would seem as though BP's momentum which has seen it usurp the position at the top of Europe from Shell is likely to continue. Upstream, the company reported an increase in production of around about 3 per cent during the quarter, over 4m barrels of oil per day equivalent. That was mainly due to new finds in the Gulf of Mexico and a relatively mild hurricane season.

For Shell, the production output came in 2.4 percent lower to around about 3.3m barrels of oil per day.

Now if you take a step back and look at a broader perspective, the result, the gulf between the two actually widens. Over the last 12 months, for example, BP has boosted production by 4 per cent while Shell's output has dropped by 3 per cent.

It's also important to note that in terms of replacing reserves, BP has excelled here as well. I mean it's the seventeenth consecutive year in which they've discovered more resources than they have taken out of the ground. Replacing reserves by 129 per cent of 2009 production is no mean feat.

As expected, relatively high crude oil prices and low demand for fuel have produced poor downstream performances and refining margins have come under considerable pressure.

Refining has hammered the performance of all the major players. Chevron was the first to report in late January. The company's refining arm posted a loss of $613m. Exxon, the world's largest publicly traded oil company, also posted a loss of $189m for the fourth quarter of last year.

The key for BP and Shell is to offset these losses, this poor performance, via upstream activities and cost savings. 2009 saw BP drop $4bn off their cost base compared to Shell's $2bn. BP is a couple of years into their cost cutting programme while Shell has just basically started theirs with most of their cost cutting initiatives basically going to yield benefits in 2011/2012 this will provide the long-term earnings outlook for Shell with a significant boost in its battle for pre-eminence with BP.

Shell will also be looking towards natural gas to underpin future earnings. As you can see from the chart, natural gas and crude oil have taken different paths during the year, during the recovery. I believe as economic recovery gains traction, I can see natural gas prices recovering from the lows that they're currently at.

Now, 47 per cent of Shell's production is natural gas while for BP the figure is lower at 36 per cent. So whilst this lower exposure for BP has benefited during 2009, in the year ahead in 2010 I think that Shell's 47 per cent of production, its higher exposure, will yield benefits.

As regular viewers will be aware, I do believe that high dividend yielding large-cap stocks will find increasing favour during 2010 and a flight to quality will be one of the main features for the year ahead. Both BP and Shell tick the boxes. They're both companies with robust balance sheets, so dividends are secure even though management do have an uncertain outlook for the year ahead.

Share price reaction to this result may have been negative but I believe the reaction is knee-jerk and I do expect the prices to recover relatively swiftly.

Thanks for watching. Make sure you tune in again next week.