Shell follows BP in reporting significant declines in yearly profits, but a better-than-expected performance in the quarter:
1ST QUARTER 2009 UNAUDITED RESULTS
* Royal Dutch Shell’s first quarter 2009 earnings, on a current cost of supplies (CCS) basis, were $3.3 billion compared to $7.8 billion a year ago. Basic CCS earnings per share decreased by 57% versus the same quarter a year ago.
* Cash flow from operating activities for the first quarter 2009 was $7.6 billion. Net capital investment for the quarter was $6.9 billion. Total cash returned to shareholders in the form of dividends was $2.4 billion.
* A first quarter 2009 dividend has been announced of $0.42 per share, an increase of 5% over the US dollar dividend for the same period in 2008.
And the headline on the results from the financial press is that all things considered, both BP and Shell have put in a good run. Of course, the headline comparatives used by different media vary. Bloomberg, for example always opts to focus on the net income figure while Reuters leads with the industry’s preferred measure, profits adjusted for current cost of supply in Shell’s case. Here is how the two readings vary for Shell’s latest results:
Bloomberg (our emphasis):April 29 (Bloomberg) — Royal Dutch Shell Plc, Europe’s largest oil company, said first-quarter profit fell 62 percent as a slump in crude prices reduced earnings from exploration and production. Net income declined to $3.49 billion, or 57 cents a share, from $9.08 billion, or $1.46, a year earlier, The Hague-based company said today in a statement. Excluding inventory changes and one-time items, earnings beat analysts’ estimates.
Reuters (our emphasis):
LONDON, April 28 (Reuters) – Royal Dutch Shell Plc followed an oil industry trend of reporting sharply lower first-quarter profit due to lower crude prices, while outperforming analysts’ forecasts. Shell said its current cost of supply (CCS) net income, which strips out unrealised profits or losses related to changes in the value of inventories, fell 58 percent compared to the same period in 2008, to $3.30 billion. Europe’s largest oil company by market value said production of oil and gas fell 3.6 percent to average 3.40 million barrels of oil equivalent per day in the quarter, as new field startups failed to match natural field declines.
The difference mostly comes down to the way inventories are accounted for. For example, the net income figure is calculated according to IFRS standards in Europe which demand “first-in first-out” (FIFO) methodology for accounting inventory. Most US energy companies like Exxon however produce a top line figure based on “last-in first-out” (LIFO) accounting, a measure recognisable in the US but not under IFRS.
Both BP’s replacement cost profit and Shell’s current cost of supply, however, are neither FIFO nor LIFO compliant — one reason why comparing Exxon profits to BP and Shell profits is a little bit like comparing apples and pears. This is also why neither BP’s RC or Shell’s CCS figure are recognised by US GAAP or IFRS. They are an industry measure only provided for in quarterly results for the benefit of investors and out of the benevolent goodwill of the oil majors.
Very generally, both are compiled using a weighted cost pricing methodology for the reporting period, and do not reflect drawdown effects the same way LIFO methodology would. They also account for tax adjustments based on the new inventory value and one-time provisions. As Shell explains (our emphasis):
On this basis, Oil Products and Chemicals segment cost of sales of the volumes sold during the period is based on the cost of supplies during the same period after making allowance for the estimated tax effect, instead of the first-in, first-out (FIFO) method of inventory accounting. Earnings calculated on this basis do not represent an application of the last-in, first-out (LIFO) inventory basis and do not reflect any inventory drawdown effects.
Broadly though CCS and RC are best compared to LIFO, especially in a quarterly periods when inventories do not change much.
But it’s worth remembering that EPS is actually calculated on the basis of the net-income figure arrived at via FIFO inventory accounting. And while there is a lot to be said for the RC and CCS figures providing a much steadier performance record — investors should be aware of one thing. The impact of deflation/inflation varies greatly on the two measures.
As this note from FTN Midwest highlighted a while back, (emphasis FT Alphaville’s):
Inflationary Periods – During periods of inflation, companies on LIFO report lower gross margins and EPS than companies on FIFO since more costs impact the income statement. Overall inventory on the balance sheet is also lower for a company on LIFO than a company on FIFO in inflationary periods.
Deflationary Periods – During periods of deflation, companies on LIFO report higher gross margins and EPS than companies on FIFO since fewer costs impact the income statement. Overall inventory on the balance sheet is also higher for a company on LIFO than a company on FIFO in deflationary periods.
Consequently, in an environment where prices are declining RC and CCS figures outperform their historical records.
Which brings us to the case of inventories at hand and actual volumes sold this quarter. After all, it’s all very well reporting that CCS and RC figures fell in the first quarter because of oil price weakness, but we should also consider how the majors were impacted by declining sales volumes and corresponding build up, if any, in inventory at freshly booked “beginning-inventory” prices (the remainder being carried forward at historical prices).
Remember, we have seen some major inventory building across the entire products and crude complex on a global level. So is the case the same at BP and Shell? Well, the figures reflect very contrasting positions.
If we look at Shell’s balance sheet it shows a significant rise in the value of inventories alongside a likely rise in actual volumes held. This comes in the context of falling volumes sold across the board at the company:
Oil products (marketing and trading) sales volumes decreased by 12% compared to the same quarter last year mainly as a result of reduced global demand. Marketing sales volumes were 6% lower than in the first quarter 2008. Excluding the impact of divestments, marketing sales volumes decreased by 3%.
Chemical sales volumes decreased by 21% compared to the first quarter 2008, mainly as a result of reduced global demand.
Liquefied Natural Gas (LNG) sales volumes of 3.06 million tonnes were 13% lower than in the same quarter a year ago. Excluding the impacts from the security situation in Nigeria, LNG sales volumes were broadly similar compared to the same quarter last year.
Overall, Shell’s total oil-product sales fell in the period to 6,029 (thousand b/d) vs 6,400 the previous quarter, in part reflecting lower production levels out of Nigeria no doubt. As for actual crude volumes sales achieved, however, we don’t know as Shell doesn’t provide an exact figure.
BP, meanwhile, does. All in all BP saw product and chemical volumes fall, with crude volumes going up in the period to 1,844 mb/d vs 1,540 m/bd (partly reflecting higher production from the Gulf coast.) Overall, total oil-product volumes sold were 7,562 mb/d vs 6,985 mb/d. So BP managed to sell more barrels in the first quarter than Shell.
As for the inventory picture, Shell’s inventory values rose while BP’s fell. A quick back of an envelope calculation, however — using total inventory value divided by the firm’s average realised price — infers that in volumes both saw inventory gains. (*we do realise that that is not a strictly accurate way of valuing the inventories, but it gives us a clue.)
Anyway, such builds will have a future direct impact on RC/CCS figures because under FIFO accounting criteria, any new builds create a fresh “beginning-inventory figure”. In the current price environment that would be about $50 per barrel. So is it a surprise Tony Hayward, usually tight-lipped about price movements, made the following statement:
“We need rapidly to bring our costs to a level that is compatible with a $50 world,” Chief Executive Tony Hayward said in an email to staff seen by Reuters.
Point being, if both Shell and BP are forced to continue building inventory alongside the rest of the world as this quarter’s trend suggests they may be — under a FIFO accounting regime, the cost of inventory will eventually have to spill through ever more severely into future profits. That’s especially so if prices fall and inventory continues to grow.
Here are some charts for context (data source BP, Shell, created by FT Alphaville):
Related links:
Those ‘big four’ oil major results again - FT Alphaville
Just how big a problem is falling capacity utilisation? – FT Alphaville
The crude inventory problem, pictorial edition – FT Alphaville
Crude inventories still a problem – FT Alphaville