MARKET COMMENT
Shell Must Stop Cross-Subsidy

By David Kuo (TMFDragon)
February 9, 2001

Carburton Street, London – Shell Transport & Trading (LSE: SHEL), the Anglo-Dutch integrated oil titan, reported record fourth-quarter profits yesterday. Ahead of results, shares in the company have been on the bounce, up by almost 7% since the beginning of the month.

This is because investors who understand the workings of oil companies also know that higher crude oil prices can translate into better earnings for the upstream operations at these businesses. However, companies involved in downstream operations tend to fare less well since cost of crude oil for their refineries will be much higher. These increased costs are invariably passed on to consumers, like motorists, who face higher pump prices.

Therein lies the problem for integrated oil companies like Shell whose operation embraces both upstream and downstream businesses. Shell claimed profits in the final fiscal quarter were boosted by higher energy prices and cost saving schemes that came in ahead of plan. In the meantime consumers saw rising pump prices. In its defence, Shell claimed selling petrol in the UK has not been profitable for the last three years.

This begs the question of whether earnings from one part of a business should be used to subsidise those of another. In other words, should Shell be allowed to apportion profits from its upstream business to downstream operations? Clearly consumers would benefit but cross-subsidisation also has the nasty effect of reducing operational efficiency and, in so doing, shareholder value.

There is another UK company that is keen to see its business split into to separate operations. BAA (LSE: BAA) is at present compelled to use profits from its commercial businesses to subsidise airport charges. Releasing BAA from this stranglehold could be to the detriment of consumers but a boon to shareholders.

As consumers and also sometimes as investors, we need to differentiate between what may be good for us in the short term against what could be very damaging for businesses over the long haul. Cross-subsidisation is a curse to business efficiency and should never be allowed, even if it means higher prices.

Where Next?

Shell Transport & Trading discussion board 
BAA discussion board