Despite the recent decline in the price of crude, I remain quite bullish on oil companies over the next couple of years, because of -- among many other things -- continued demand growth, limited spare production capacity, declining production rates in key regions such as the North Sea, and the uncertain political environment in many oil-producing nations.
On the other hand, to steal a quote from George Orwell's immortal Animal Farm, "All animals are created equal . but some are more equal than others." That sentiment certainly applies to the oil industry. While I believe that most major oils -- ExxonMobil
In simple terms, Royal Dutch Shell faces a number of troubling issues that include a relatively weak production profile, one of the lowest reserve replacement ratios among the majors, and problems with regard to its operations in both Russia (political pressure) and Nigeria (escalating violence).
Let's drill into these issues, shall we?
Royal Dutch Shell
Originally formed in 1907 through a tie-up between Britain's Shell Transport and Trading and Netherlands-based Royal Dutch Petroleum, Royal Dutch Shell is one of the largest integrated oil and natural-gas companies in the world. In 2005, the company produced approximately 3.5 million barrels of oil and equivalents (BOE) per day, with proven reserves of roughly 11.5 billion BOE, 58% of which was natural gas.
Given the company's long history of operations, you'd think that Royal Dutch Shell would have a better grasp of production issues. Simply put, the company has not had any production growth since 2002. In fact, production has declined in each and every year, and 2006 looks to be no different. Royal Dutch Shell recently cut its production forecast for 2006 to 3.4 million BOE/day, down from its previous prediction of 3.5 million to 3.8 million BOE/day . which will represent yet another annual decline in production.
Call me crazy, but to continually reduce forecasts isn't the best tonic for a company that is still trying to regain investor confidence after having to restate its reserve base by a massive 20% (or 3.9 billion barrels) back in January of 2004.
Is there light at the end of the tunnel for long-suffering investors? It doesn't seem so, if Royal Dutch Shell isn't somehow able to get its reserve replacement ratio increased.
When the company reported that it had replaced just 75% of its reserves in 2005, it marked the fifth consecutive year that its reserve replacement ratio fell below 100%. In fact, that number was actually an improvement -- it brought the company's five-year average reserve replacement ratio up to an anemic 70%. That means that at current rates of production, Royal Dutch Shell's reserves will last only 8.8 years, one of the lowest rates among the major oils.
And investors shouldn't look for any quick fixes coming out of the company's operations in either Russia or Nigeria.
Royal Dutch Shell has had a bit of bad luck with regard to its Sakhalin-2 project in Russia. Just as this $22 billion project is nearing completion, Royal Dutch Shell has been coming under pressure from the Russian government in the form of environmental lawsuits seeking the revocation of the project's approval -- a bald-faced attempt to allow Russian energy giant Gazprom to grab a slice of the pie. This tactic seems to have worked; recent reports indicate that Royal Dutch Shell has offered to cede control of the project to Gazprom while retaining a blocking stake of at least 25%, in exchange for a stake in one of Gazprom's natural-gas fields and some cash.
While political pressure has been the problem in Russia, escalating violence over control of the oil-rich Delta region has been the issue in Nigeria. In the past quarter alone, Royal Dutch Shell's production in the region was 185,000 barrels per day lower than last year's total, as a result of security concerns. The situation looks to be worsening, as the recent kidnapping of yet more foreign oil workers indicates.
Given the issues I've reviewed here, I believe that shares of Royal Dutch Shell are expensive trading at roughly 12 times forward earnings, a 10% premium to peers such as BP
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Fool contributor Will Frankenhoff is enjoying his time writing for The Fool more than playing golf, reading The Financial Times, or rooting for the Jints. He welcomes your feedback at firstname.lastname@example.org. He does not own shares in any of the companies mentioned above. The Fool has a disclosure policy.