Oil firms can weather the price storm

May 3 2008 by Peter McCusker, The Journal

OIL has remained in the headlines. The brief strike at the Grangemouth refinery raised the spectre of nationwide petrol shortages, and created queues at the pumps and an unwelcome sense of déjà vu.

The price of crude oil has gone close to $120 per barrel. Opec, the main producers’ organisation, has warned that prices could hit $200 per barrel.

Higher oil prices hurt, not just when you are filling up your car. They push up an enormous range of other prices, from chemicals to consumer staples. But the oil firms themselves seem one group that is well able to weather the storm.

Both BP and Shell released their first quarter results yesterday, and there were few nasty surprises.

BP’s first quarter results before non-operating items were a record US$6.6bn, up from US$4.4bn a year in the first quarter of 2007.

Shell’s results were also upbeat, with earnings up to $7.9bn, well ahead of expectations.

Despite the recent overall boost given by high oil prices, it still makes sense to take a more considered view of the two companies’ overall prospects.

Here we tend to favour BP.

After a whole string of problems, the company’s fortunes should start to turn around in 2008. In the short term, refineries will come back on stream. Longer term, new production from the Gulf of Mexico, West Africa and Azerbaijan will help boost the company’s prospects.

We remain rather more cautious on Shell, being worried by what we think is a continued negative medium-term fundamental outlook.

We think that the group’s capital management strategy is good but not as attractive as some. There remains the risk of higher capital expenditure.

In summary, we think that BP shares look good value on a 2008 price earnings ratio of around eight times and dividend yield of close to 5%, with share buy-backs running at around $1bn per quarter.

In contrast, Shell shares stand on a price earnings of less than 8.5 times and offer a yield of 4.2%. This does not appear expensive but recognises the unimpressive long-term earnings growth.

Andrew Miller is regional office director at Barclays Wealth