Comparative Operational & Financial Analysis

by Sarika Agarwala Dawn Pruitt Kenya Sanders Lei Wang (Group # 2) DISCUSSION TOPICS

„ Peer Group Introduction (RD/Shell, BP, and Chevron Texaco) „ Overview of Shell „ Operational Analysis „ Shell’s Recent Reserve Reclassification „ Financial Analysis „ Opportunities and Challenges Ahead SHELL OVERVIEW OVERVIEW OF SHELL STRUCTURE OF ROYAL DUTCH/SHELL OPERATIONAL ANALYSIS FINDING & DEVELOPMENT COSTS – W/O PURCHASES & REVISIONS

12 „ Shell incurred the highest F&D costs, due to poor 10 reserve additions from E&D. Shell’s main reserve additions were from acquisition of 8 Enterprise in 2002 for $5.3 Billion cash and increased 6 stake in the Norwegian Draugen field. 4

„ BP spent the maximum 2 amount of capital on an average basis for years 0 ending 2002 among the three 1998 1999 2000 2001 2002 firms and succeeded in Shell Chev BP plc Poly. (Shell) Poly. (Chev) Poly. (BP plc) having the lowest Finding Cost because of highest reserve additions especially 1998- 2002 Results of Finding Costs : 3 yr. Wt. Avg. ($/Boe) Gas, in areas classified as Companies 1998 1999 2000 2001 2002 “Rest of the World” in its 20-F. Shell 8.19 7.46 7.22 6.58 11.29 „ BP derives more reserve Chevron 5.97 6.28 6.01 6.31 6.18 additions from Improved BP 4.73 4.79 5.04 4.42 4.70 Recovery than the other two. FINDING & DEVELOPMENT COSTS – W/ PURCHASES & REVISIONS

„ F&D costs decreased for all three companies when purchases and revisions are included. „ Shell has 51% of its reserve additions from purchases and positive revisions with purchases of reserves playing a bigger role. „ Shell has been successful in purchasing reserves. F&D costs are substantially lower when purchases are included. Shell Reserve add „ BP’s ratios have slightly decreased, but have not been (3 yr. avg.) affected much with this variation. 1998- 2002 Results of Finding Costs : 3 yr. Wt. Avg. ($/Boe) Companies 1998 1999 2000 2001 2002 Shell 2.75 3.04 3.13 4.34 7.19 Chevron 3.94 4.23 4.17 4.67 4.56 BP 3.70 3.53 4.89 4.57 4.48

Chevron Reserve add BP Reserve add (3 yr. avg.) (3 yr. avg.) LIFTING COST „ F&D costs do not take into account the quality of the reserve additions. 14.0 Low F&D Cost is meaningless if the newly developed or purchased 12.0 reserves require high Lifting Costs. Lifting Costs can be viewed as a 10.0 measure for the quality of reserve additions. 8.0

6.0 „ Shell’s Lifting Costs are significantly lower than its competition every 4.0 year in the past five years.

2.0 „ This is a result of Shell’s operational efficiency and disciplined approach - towards divestments. 1998 1999 2000 2001 2002

Shell Chevron BP Poly. (Shell) Poly. (Chevron) Poly. (BP) „ While BP is much more aggressive in acquisitions, Shell is more focused on increasing profitability 1998- 2002 Lifting Costs ($/BOE) through divesting low-return assets. Companies 1998 1999 2000 2001 2002 The results are evident in this ratio. Shell 6.18 5.60 5.61 6.74 6.77 „ Shell much larger Production Per Chevron 7.72 7.89 8.25 10.56 11.44 Well (308 BOE/day in 2002, BP 8.00 8.66 11.39 11.43 11.57 compared to Chevron’s 52 BOE/day and BP’s 152 BOE/day) also contributed to its lower Lifting Costs. RESERVE VALUE ADDED TO SPENDING

„ Shell’s Reserve Value 180% Added to Spending Ratio

160% declined rapidly in 2001 and 2002. 140%

120% „ However, this is a very 100% volatile statistic, and may not be a good indication of 80% future trends. 60%

40% „ Shell’s poor performance was mainly due to huge 20% costs incurred on 0% exploration and 1998 1999 2000 2001 2002 development, and not so Shell Chev BP plc Poly. (Shell) Poly. (Chev) Poly. (BP plc) successful reserve additions due to „ Chevron has been quite successful with its E&D program, and discoveries. added 600 MM Boe through discoveries and extensions in Africa, Australia, Europe, and China and 500 MM Bbls through improved „ Shell’s performance recovery and expansion projects, primarily in Africa, Eurasia, and improves if acquisitions are . included in the calculation. „ BP incurred huge costs on acquisitions, and has been very successful in adding reserves. SHELL RECENT RESERVE RECATEGORIZATION FACTS AND ANALYSIS

„ Over 95% of the recategorization of the proved reserves is a reduction in the proved undeveloped category; the remainder is a reduction in the proved developed category. The recategorization of proved developed reserves resulted in an increased after tax depreciation charge in Quarter 4 2003 earnings of $86 million. The restatement has little impact on Shell’s historical financial statements or near term cash flows.

„ Most of the recategorized reserves will be rebooked over time as developments move forward. Over 85% of the recategorized resources are expected to mature within the next decade.

„ As a result of the recategorization, historic reserve replacement ratios are decreased by between 20 and 30% depending on which period of analysis is chosen.

„ Shell still delivers industry-leading profitability and will be able to generate competitive earnings and cash flows whether or not today’s $30+/BOE oil price would last.

„ However, the recategorization could potentially affect reserve based leverage and asset protection metrics, and calls into question long-term profitability if RRR does not improve. A possible credit rating downgrade could increase future borrowing cost. Impact on past Reserves Replacement Ratios (RRR)*

RRR Including acquisitions & divestments Organic RRR % %

120 120

100 100

80 80

60 60

40 40

20 20

0 0 10-Year (94-03) 5-Year (99-03) 10-Year (94-03) 5-Year (99-03) 2003 Reserve Replacement Ratio: 98% 117% excluding acquisitions and divestments

Includes Minority Interest, excludes

* Taken directly from Shell’s website RESERVE REPLACEMENT RATIO

250 „ Shell was not able to increase its total proved 200 reserve base in 2002 and 2001 as compared 150 to the other two firms.

„ Shell had lowest proved 100 reserves added with maximum production, 50 explaining the lowest reserve replacement ratio. 0 1998 1999 2000 2001 2002 „ BP had the maximum Shell Chev BP plc Poly. (Shell) Poly. (Chev) Poly. (BP plc) positive change in the total proved reserve quantities. 1998- 2002 Results of Reserve Replacement ratios : 3 yr. Avg. Companies 1998 1999 2000 2001 2002 Shell 186% 150% 117% 82% 88% Chevron 140% 144% 133% 128% 126% BP 130% 104% 126% 162% 205% FINANCIAL ANALYSIS „ Current Ratio was less than CURRENT RATIO 100% for all 3 firms in this study, except in Year 2000.

„ Liquidity ratios don't take credit worthiness and borrowing capacity into consideration.

„ All 3 firms are integrated oil and gas companies with strong earnings, diversified portfolios and as a result, low cost of borrowing and substantial amounts of undrawn borrowing facilities available, therefore QUICK RATIO contrary to what liquidity ratios might suggest, they all have 1.00 sufficient working capital for 0.90 foreseeable requirements. 0.80 0.70 „ Current ratio is affected by the 0.60 inventory method used. Quick 0.50 Ratio presents a more 0.40 comparable picture by 0.30 excluding inventory. (At the 0.20 end of 2002, Chevron's 0.10 inventory value is lower than 0.00 replacement cost by $1.6 1998 1999 2000 2001 2002 billion, due to the use of LIFO Shell Chev BP plc Poly. (Shell) Poly. (Chev) Poly. (BP plc) accounting. „ Overall low debt leverage for INTEREST COVERAGE all three companies – no liquidity concerns! „ Shell's debt is substantially lower than its competitors due to its less ambitious M&A activities, and its focus on maintaining AAA credit rating. „ Shell was criticized for missing the opportunity to acquire asset cheaply in 1999, but Shell also has the strongest balance sheet and the largest borrowing capacity due to its LT DEBT TO EQUITY low debt level. „ In 2002, we witnessed an increase in Shell's borrowing mainly due to the acquisition of in the UK and -Quaker in the US. This reflected a shift in Shell’s Treasury focus to target a gearing ratio in the 20 – 30% region. „ This could herald an era of heavy E&P investment for Shell. „ Off-balance sheet items. (SFAS 47 and FIN 46) „ Net income aligns closely with industry price levels for crude oil and , due to PROFITABILITY - ROA the focus on E&P by all three firms. 12% „ Shell's higher profitability is a reflection of its 10% management philosophy to aggressively

8% divest low-return assets in order to better compete in a low-price environment. Its 6% lowest Unit Operating Cost in the industry

4% also contributes to its profitability.

2% „ It’s worth noting that Shell delivers higher 0% ROE despite its lower debt-to-equity ratios, 1998 1999 2000 2001 2002 which means Shell’s profitability comes from Shell Chev BP plc Poly. (Shell) Poly. (Chev) Poly. (BP plc) its operational efficiency more than financial leverage. 30% ROE „ BP’s aggressive M&A program enabled it to 25% deliver strong RRR & earnings growth in a

20% high-oil-price environment, but also diluted its profitability. The problem was further 15% highlighted by the use of purchase method of accounting. 10%

5% „ In 1998 Shell’s earnings suffered due to 0% impairment write-downs in the US assets,

1998 1999 2000 2001 2002 including Altura, and Aera.

RD/Shell ChevronTexaco BP plc Poly. (RD/Shell) Poly. (ChevronTexaco) Poly. (BP plc) „ Chevron’s earnings took a nosedive in 2001 and 2002 due to the booking of special-item charges (asset impairment in 2001 and loss on equity investment in in 2002). ASSET TURNOVER „ Shell delivers the highest Asset Turnover, an indication of its efficiency at using assets.

„ Normally, the companies' pricing strategy has a big impact on Asset Turnover - - those with low profit margins (or ROS) tend to have high asset turnover, and those with high profit margins have low asset ROS turnover. 8% „ However, Shell delivers 7% 6% the strongest ROS and 5% Asset Turnover among the 4% three companies in most 3% years -- a rare 2% combination. 1% 0% 1998 1999 2000 2001 2002

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