COLUMN-Shell's fall from grace: Kemp

Tue Feb 4, 2014 11:03am EST

By John Kemp

LONDON Feb 4 (Reuters) - "All political lives, unless they are cut off in midstream at a happy juncture, end in failure," wrote Enoch Powell, a former member of Britain's parliament who held controversial views on immigration and national identity.

Much the same could be said of business careers, as Shell's former chief executive Peter Voser has learned the hard way. His strategy of continuing to invest in complex megaprojects through the oil industry cycle is now blamed for the company's recent profit warning and underperformance.

In May 2013, when Voser's retirement was announced, he was described by Reuters as having been Shell's "renaissance CEO". According to my colleague Andy Callus, "his exit from a role he is seen to have excelled in surprised investors, analysts and people inside Europe's biggest oil company" .

Fast-forward eight months and Voser's successor stunned the market with a profits warning. "Our 2013 performance was not what I expect from Shell," Chief Executive Ben van Beurden told investors and promised a more disciplined approach to investment as well as better operational performance and project delivery.

It was a remarkably quick fall from grace for both the former chief and the company, though no swifter than many other chief executives and businesses have endured.

FROM HERO TO FAILURE

Speaking to Reuters in May 2013, Voser warned: "You spend capex through the cycle. Don't try to read it, don't slow down. It will cost you more when you want to grow afterwards.

"I know a lot of investors and analysts. They all think they can read the market ... but one thing in our industry is very clear; it takes you five to seven years to recover (from) a strategic slowdown," Voser explained.

"The market changes its views in three to six months, and you can't change that fast in our industry."

Just a few weeks after Voser stepped down, Shell has finally succumbed to cyclical pressure. Van Beurden insists the company's overall strategy is sound, but has promised to cut investment and enhance returns by making hard choices about new projects.

Shell's abrupt turnaround has prompted questions about whether the company's strategy was mistaken, poorly executed, or if the company was the victim of changed circumstances beyond its control.

It has also prompted unflattering comparisons with BP , which emphasised spending discipline much earlier, and is now the darling of analysts and investors.

SIBLING RIVALRY

Contrasting the strategy, leadership, culture and performance of the two London-listed oil majors is a favourite pastime of writers about both companies.

In the standard caricature, Shell is more conservative, bureaucratic, technology-driven and controlled by engineers. BP is reputedly more entrepreneurial, innovative, risk-taking and controlled by financially focused managers.

The two have regularly swapped places as the favourite of the media and investors over the last two decades depending on which set of characteristics is in fashion.

Legendary Chief Executive John Browne, who played a leading role consolidating the oil industry, pushing into post-communist Russia and building up a formidable oil trading division, made BP the favourite in the late 1990s.

But in the wake of accidents like the Texas City refinery explosion and Macondo well blowout in the Gulf of Mexico, BP's alleged lack of engineering expertise, reliance on external contractors, obsession with short-term financial results, and criticism of its safety procedures, drew adverse comparisons with Shell's boring but predictably safe operations.

BP suffered a near-death experience following the 2010 Gulf oil spill, and is still paying out tens of billions of dollars in fines and compensation.

But Shell too has had its ups and downs. The company's Pearl gas-to-liquids project in Qatar has proved to be enormously profitable. Shell's advanced engineering is admired across the industry. And Shell was the first of the major oil companies to exploit the shift from oil to gas.

But the company's misstatement of its proven reserves early in the century landed it with a multi-million dollar fine from stock market regulators and forced the departure of its chairman as well as shocking investors. Shell has had its own environmental problems in Nigeria. Now it is being severely criticised for overspending.

SIMILAR RETURNS

In practice, the long-term performance of the two companies has been remarkably similar. The attached chart shows the share price performances of Shell and BP since 1994 ().

At times, BP has outperformed its more staid rival, but its shares have also been much more volatile, and the two companies' performance over the whole period has ended up remarkably similar.

If reinvested dividends are taken into account, the total return on Shell's shares has averaged 8.64 percent per year since 1994, only marginally less than the 8.96 percent return on BP shares. Which company comes out ahead is sensitive to the period chosen for analysis, suggesting underlying performance is basically indistinguishable.

That is not really surprising. Both companies face the same fundamental forces - including exploration and development costs, political risks, price risks, and technology challenges.

The fact the two companies' financial performances have been similar over the long term suggests the fundamentals they have in common are more important than the cultural, strategic and leadership factors that differentiate them.

Journalists, financial analysts and investors tend to focus on human factors like strategy, leadership and culture because they make for a more interesting story. But the fundamental factors the two rivals have in common are probably more important in explaining medium and long-term performance.

FICKLE FASHIONS

Voser was right to observe that in a capital-intensive industry like oil and gas it makes no sense to keep changing spending and investment plans in response to short-term demands from investors and analysts. But he was most definitely wrong to think the market would reward Shell for taking a rational long-term view.

Nearly all political, business and financial careers end in failure and recriminations because as they mature leaders become more rigid, less adaptable, and less open to new thinking, and they must live with the consequences of past decisions when circumstances change.

The only leaders to escape with their heroism intact tend to be those who leave early before the external environment shifts. Voser retired early but he was unlucky to do so just as the industry's investment climate was turning.

Shell's strategy was not wrong, and it certainly was not worse than BP's, however it was not well aligned to the prevailing phase of the cycle, and the company did not adapt quickly enough to keep investors and commentators happy.

But the cycle will keep on turning. In a few years BP will be out of favour again, and everyone will be writing about how Shell is a much more solid and reliable performer, with a good long-term investment portfolio, and crediting its lucky CEO.

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