Why Royal Dutch Shell Plc Will Continue To Beat BP plc

royal dutch shellThe world’s oil resources are finite. Much of the planet’s most easily accessible oil has already been consumed. Of what remains, much of this resides in the Arabian peninsula, where only State-owned companies such as Saudi Aramco have access.

Then there is oil in the far reaches of the Earth: in the depths of the Gulf of Mexico, in the frozen wastes of the Arctic, and off the coast of Brazil. To obtain this oil, companies are having to invest more and more in complex and expensive oil extraction technologies.

Oil is increasingly expensive to extract

If you need proof of this, a review of 127 oil companies around the world by the US Energy Information Administration has found that they have increased net debt by $106bn in the past year.

In short, oil is becoming increasingly expensive to extract. So even if oil prices remain high, the increasing capital expenditure that oil companies are having to fork out mean that profits will fall.

That’s why I have recently been negative about investing in oil companies. So how does this explain the title of this article?

 Well, Shell (LSE: RDSB) and BP (LSE: BP) have long been seen as the UK’s oil company stalwarts. But, to me, Shell isn’t really an oil company any more. Already half of Shell’s production is gas rather than oil. And, over the next few years, I expect Shell’s gas production to pull ahead of its oil production.

Shell’s investments in liquefied natural gas (LNG) are coming to fruition, and it now leads the world in this field. By cooling gas to form a liquid, storage and shipment costs are dramatically reduced.

While gas is still plentiful

Gas is still plentiful, and more and more gas reserves are being discovered. Shell clearly sees natural gas playing a key role in its future. Admittedly, this means Shell’s profits are prey to the ups and downs of the gas price, but we still have a long way to run before we reach ‘peak gas’.

Shell is still a major oil producer, but the increased investment required has already had an impact on its free cash flow, and it is gradually throttling down the scale of its investments in oil exploration and extraction.

bpIn contrast, BP has based its future firmly on oil. So it is seeking out oil in the Gulf of Mexico, the Arctic and, through its joint venture with Rosneft, Russia. At the same time, after the Deepwater Horizon oil spill, it is still working through its programme of asset sales.

As far as I can see, it is sifting through its oil reserves, keeping its most profitable assets, and selling the rest of its portfolio. This strategy seems, to me, the harder and bumpier path than the one Shell has chosen.

This is why BP’s share price has been trading in a range since Deepwater Horizon, while Shell’s share price has been pushing higher and why, over the long term, I expect Shell to be a better investment than BP.

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Prabhat Sakya has no position in any shares mentioned. The Motley Fool has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.