Be sure of Shell

We first recommended integrated oil major Shell (SHEL) at 368p in February (FAT23) because we believed the shares offered significant leverage to the rising price of oil. Recent events have served only to reinforce our belief that oil prices will remain high, and that Shell will continue to be a significant benefactor thereof.

The past month and a half has seen upward momentum build in Shell's share price following a short-lived correction in early August. Sustained strength in the oil price helped to propel SHEL to a fifteen month high of 421.5p. Although the oil price has dipped back under US$45 in the past four weeks we remain certain that prices will ultimately rise to US$50 a barrel and beyond in the not too distant future.

Oil prices rose this week on fears that Hurricane Ivan may disrupt oil and gas production in the Gulf of Mexico. Shell evacuated 750 workers in the area, closing down daily production totalling 420,000 barrels of oil equivalent while the hurricane passed over. We believe this may cause 10 days production disruption, or 3.8 million barrels of oil equivalent, which represents a minute 0.1 percent of Shell's annual output. However the sensitivity of the oil price to a localised event such as this underscores the tightness of current global supply in our opinion.

The world has recently experienced an increased level of terrorist activity. This includes the Beslan school massacre, the escalation of fighting in Iraq, and the bombing of the Australian Embassy in Jakarta. In our opinion heightented levels of geopolitical tension will also keep oil prices high for the foreseeable future.

OPEC announced this week it was increasing the official oil production quota by 1 million to 27 million barrels per day. This announcement had a muted effect on world oil prices as OPEC was already producing more than this official ceiling. Fat Prophets believe that with OPEC producing at near full capacity, the cartel's ability to manage prices through supply is breaking down.

Meanwhile Shell's share buy-back and cancellation programme has continued to gather pace. We estimate that over the last 3 months, Shell has brought back and cancelled approximately 0.4 percent of the company's issued share capital. We maintain that buybacks are an excellent way of returning value to shareholders and should continue to underpin Shell's share price.

Last week Shell announced the sale of minority positions in the Belgian gas wholesale company 'Distrigas' and the Belgian gas transmission company 'Fluxys'. Shell's respective 16.7 percent holdings in these utility companies were sold to controlling shareholder 'Suez Tractebel' for a total of £260 million. The rationale for exiting these positions is that the capital is better utilized elsewhere within Shell's investment portfolio. Shell is targeting upstream petroleum production assets, where higher returns across the investment cycle, have been identified. Fat Prophets are naturally supportive of Shell's portfolio rebalancing into capital assets that provide a superior return.

In the press, Europe's third-largest integrated oil company, 'Total' has been linked with a takeover bid for Shell. It is believed that Total is the only firm capable of gaining regulatory approval for such a merger. Total's chief executive 'Thierry Desmarest' dismissed the rumour saying such a move would prove too complex. Nevertheless there is no 'smoke without fire' as Shell well knows, and we expect bid speculation to further underpin the share price in the months ahead.

Last month the Financial Services Authority (FSA) publicly outlined why Shell was fined £17 million in relation to the reserves debacle. According to the FSA, Shell made false and misleading statements between 1998 and 2003, which despite warnings, were not corrected until 2004. The FSA quite rightly views timely and accurate disclosure to shareholders as fundamental to maintaining the integrity of UK financial markets. Shell has agreed to a combined settlement of US$120 million with the FSA and the Securities and Exchange Commission without admitting or denying the respective regulators findings and conclusions. With the relatively immaterial 'fine' paid, we are confident the negative regulatory news-flow is now slowly drawing to a close.

Given our belief that oil prices will remain high in the foreseeable future, we continue to regard Shell's valuation as compelling. SHEL trades on a 2005 price earnings of less than 14 times, and yields 4 percent. While financial institutions has been slow in ratcheting-up the long-term oil price used in forward looking forecasts, we believe the market will be more proactive as the oil majors begin to consistently report significant cash flow growth. As such we expect to witness further re-ratings of Shell's share price.

Adding to the positive fundamental picture is a solid base of support which SHEL has established between 350p and 330p. In our opinion this should support a higher share price over the medium to longer term. Accordingly, SHEL will remain firmly held within the Fat Prophets Portfolio.