Oil price pumps profits at Shell and BP

AN INVESTOR'S VIEW: CROESUSPressure could come on Irish banks to raise new equity capital over the next 12-18 months

THE PRICE of oil finally retreated from the $120 barrel level this week. However, the price remains elevated and bumper first-quarter profits from Royal Dutch Shell and BP released on Tuesday shows that the oil majors are beginning to benefit from the persistently high oil price. First-quarter earnings at BP rose to $7.62 billion from $4.66 billion a year ago and earnings were well ahead of analysts' estimates. Shell's net profit rose to $9.08 billion from $7.28 billion last year.

Not surprisingly, the share prices of both companies rose in the aftermath of these results.

However, the share price performance of the oil majors has not been particularly good in recent years. They have easily been eclipsed by the specialist exploration and production companies, some of whom have enjoyed spectacular price rises.

For example, Tullow Oil has risen by 76 per cent over the past year. Both BP and Shell have had production difficulties in recent years and their success rate at adding new reserves has been disappointing. Also, some of their earlier estimates of reserves at their existing fields have had to be adjusted downwards. The net result is that production of oil at both Shell and BP showed virtually no growth in the quarter. At BP, production was unchanged at 3.91 million barrels of oil equivalent, while Shell saw only a 1 per cent rise to 3.44 million barrels of oil equivalent.

Shareholders were rewarded with higher dividends, which leaves Shell trading on a dividend yield of 3.5 per cent and BP on a yield of 4 per cent.

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Initial estimates of first-quarter GDP growth in the US showed the economy growing at an annual rate of 0.6 per cent. This figure is a little deceptive as a build up in inventories added 0.8 of a percentage point to growth.

Excluding this build-up in inventories, GDP would have contracted. Consumer spending, which accounts for about 70 per cent of GDP, rose at a 1 per cent annual pace, compared with 2.3 per cent in the previous quarter and was the slowest gain since the second quarter of 2001.

Business fixed investment dropped at a 2.5 per cent annual rate, while the construction sector continued to contract.

International trade boosted growth by 0.2 of a percentage point as the trade deficit narrowed modestly. There was some good news on the inflation front with the GDP report's price index coming in at 2.4 per cent, which was lower than the 2.6 per cent rate of the previous quarter.

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Capital-raising exercises have become the prevailing theme in the banking sector. On Tuesday, investors were surprised by Citigroup's announcement that it is to sell an additional $3 billion of stock in a public offering, to add to the $30 billion already raised.

This announcement came only two weeks after the new chief executive indicated that the US
banking giant didn't have to raise any additional funds.

This event is likely to raise further concerns that the recapitalisation of the banking sector may take much longer than currently expected.

On this side of the Atlantic Halifax Bank of Scotland (HBOS) announced a fully underwritten rights issue to raise £4 billion on the basis of two new shares for every five existing shares. The issue price of 275p represents a 36 per cent discount to the theoretical ex-rights price and a 45 per cent discount to the previous night's closing price.

These discounts are similar to those in RBS's mammoth £12 billion issue last week. Market analysts had long been expected rights issues from both RBS and HBOS, and the only surprise is that the issues have occurred so close together. HBOS is setting much higher targets for its capital ratios, with its core tier 1 ratio now targeted at between 6 per cent and 7 per cent. This compares with the new RBS target of 6 per cent and AIB's estimated ratio of 5.5 per cent.

The HBOS higher target capital ratio could reflect a view that the downturn in the British economy could be more severe than anticipated. Irrespective of the rationale, the fact that the UK banks are increasing their capital ratios could have implications for the Irish quoted banks.

International investors in particular are likely to compare the capital strength of the Irish banks with their UK peers.

Most stockbroking analysts take the view that the Irish banks are adequately capitalised to cope with the type of downturn that is currently forecast for the Irish and British economies. However, if British banks continue to raise the bar in terms of capital ratios, pressure could come on the Irish banks to raise new equity capital over the next 12 to 18 months.