Earnings Quadruple at Shell But Markets Remain Unimpressed

Strong Earnings and a Favorable Outlook

Yesterday Shell announced a 375% increase in their 2010 fourth quarter earnings compared the same quarter in 2009 with a rise from $1.2 billion to $5.7 billion. This was on the back of a modest 5% increase in oil production, a 25% increase in sales volumes of Liquified Natural Gas, higher oil prices and another year of cost cutting than has yielded a $2 billion reduction in underlying costs. Costs have been cut by moving thousands of jobs offshore to cheaper locations, economies of scale through global procurement and some simplification and standardisation of processes,

Short Term Challenges in the DownStream Business

Despite this, the markets remain unimpressed and the share price dropped 3% before close of trading. This was mainly down to expectations of even higher earnings not being met: analysts had forecast around $6.4 billion profits. Also Shell is currently operating at reduced capacity in its downstream refining with its large aging Pernis refinery struggling to meet more stringent environment standards while operating competively. The lack of capacity is likely to restrict earnings in the first half of 2011 when there will be pressure to increase volumes due to rising prices and instability in the Middle East. In the short term, other players such as Exxon and perhaps BP are better positioned to benefit from the high oil prices that are likely to be with us for a few months.

By the end of 2012 Shell aims to be selling more gas than oil. This strategy has been aided by a 5 year program of selling off $30 billion of assets globally and reinvesting in new projects – the long term prospects for Shell remain good.

Novice Investor Note

The fall in Shell’s share price after seemingly excellent results is a great example of how, in the short term, the share price is more a measure of expectations than of the value or the earnings potential of the company. As far as the markets were concerned, Shell posted a result that was $750 million less than expectations and hence the price was marked down.

For a small investor, who is not close to the market, it is very difficult to be successful in short term trading by following market trends as by the time their trade is executed the price has already moved up or down. The small investor will typically buy at a much higher price than a dealer and sell at a much lower price. If a small investor wishes to trade short term then a contrarian approach will yield much better results from a timing standpoint since the market has time to move in the direction he or she wants before their trade is executed. (In this case the delay in executing the trade plays for the investor rather than against). The problem of course, that while the contrarian approach offers timing benefits, it does not always yield good results as sometimes the price actually does move the way the markets expects.

A small investor is therefore often best to take a medium to long term (5 to 10 year) view on the great majority of their shares and avoid doing much trading on that part of their portfolio other than for tax mitigation reasons.

Of course the actual percentage to trade actively depends on the investor’s growth and income objectives, their capacity and appetite for risk and their liquidity needs, amongst other factors defined in their Investment Policy Statement.