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European oil and gas companies reaping fruits of investments
By Benoit Faucon
Last update: 7:38 a.m. EDT April 30, 2008

LONDON (MarketWatch) -- First-quarter reports show that large European oil and gas companies are finally capturing higher crude prices as past investments begin to bear fruit on their production.

Anglo-Dutch major Royal Dutch Shell PLC (RDSB.LN) and U.K. oil giant BP PLC said Thursday that first-quarter net profit rose 28%, lifted by high crude oil prices and stronger hydrocarbon output.

And BG Group PLC (BG.LN) is expected to post a 59% rise in quarterly profits Wednesday, taking the figure to GBP685 million.
Overall, the European oil and gas sector was expected to record a 21% rise in earnings per share, Deutsche Bank said.

The significant profits are a break from a recent trend that has seen oil and gas companies struggling to capitalize on a rise in oil prices.

According to Citigroup, the U.K. North Sea Brent crude contract was up 66% on average in the quarter and U.K. natural gas contracts were up 128.6%. Also, U.S. oil prices peaked close to $120 a barrel Monday.

On paper, higher oil and gas should automatically boost profits. But in recent years, rocketing hydrocarbon prices have triggered negative side effects such as cost inflation and pressure to distribute more revenue to host countries.

According to BP and Shell, a rush to build new projects to satisfy the world's energy demand has triggered an annual industrywide cost inflation of 20%. But both majors say they are now better able to negotiate and rein in the rise to 10% a year.
But other factors also contribute to reduce output, potentially hurting corporate profits every time prices rise. Under production-sharing agreements, which represent 80% of production at Shell, governments are entitled to a greater portion of the oil pumped when prices are higher. As a result, international oil companies get fewer barrels.

In addition, soaring oil prices have led governments to demand a greater share of revenue. That's particularly the case in countries to which European oil majors are strongly exposed, such as Kazakhstan, Nigeria, Russia and Venezuela.

And it's not just the governments that want more. The newfound oil wealth has led local populations to demand a larger share of revenue, triggering attacks on and shutdowns of oil facilities operated by Shell and ENI in Nigeria.

As a result, Eni's average daily hydrocarbon production dropped by 1.9% for the full year 2007, BP's by 3% and Shell's by 6%. BP is not present in Nigeria but faced a series of delayed projects after operational mishaps.

But for the first quarter of 2008, both BP and Shell reported no change in oil and gas output, while Eni's production was up 3.6% from the first quarter of last year.

The rise or stabilization of oil and gas production - the sale of which provides the bulk of their earnings - now enables the companies to translate higher oil prices into profits. The improved output performance itself stems largely from a diversification into new projects or businesses or acquisitions, not legacy assets.

Eni's profit rise come after an acquisition spree in 2007 - in which it spent more than EUR9 billion - allowed it to bag assets in Russia, Congo and the Gulf of Mexico, among other places.
Shell, despite being hurt by unrest in Nigeria, benefited from a decision a few years ago to invest in liquefied natural gas, or LNG, for which quarterly volumes increased by 6% year-on-year. Similarly, BG is also expected to get a boosted from the ramp-up of an Equatorial Guinea LNG supply contract, according to Dresdner Kleinwort.

Citigroup said that a key profit factor for BP in the first quarter was the startup of large oil projects in the fourth-quarter, which included Greater Putonio in Angola and Atlantis in the U.S. Gulf of Mexico.

StatoilHydro ASA (STO), which reports on May 13, is also expected to benefit strongly from improved production thanks to the startup of new projects, according to Deutsche Bank.
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