Higher Crude Prices Boost Eni's Profits But Gas Sales Disappoint

High Crude Prices Drive Profits

Eni SpA produced another impressive spurt of growth in the final three months of 2010, registering a 40% leap in fourth-quarter profits to EUR4.7 billion, thanks to higher crude oil prices and increased levels of output. Oil and gas production grew 1.1% to a record 1.815 million barrels of oil equivalent per day (boe/d), while proved reserves increased 2.5% from 6.677 billion boe/d in 2009, to 6.843 billion in 2010, implying an organic reserve replacement ratio of 127%. This higher output pushed adjusted year-end profits to EUR6.7 billion, up 31.9% from 2009, despite a 39% drop in revenues from gas and power operations. Adjusted operating profit in the Italian firm's utilities branch declined 31.1% from EUR1.127 billion in the fourth quarter of 2009 to EUR777 million. Equally, refining activities sank back into the red, recording a EUR39-million loss in the fourth quarter, having briefly turned positive in the previous three months.

As with Eni's previous quarter, the growth in profits is in large part thanks to external factors as opposed to internal measures or strategy. Average oil prices grew from USD56.9/b in the first three quarters of 2009 to USD75.9/b over the same period in 2010, and soared to USD87.45/b during the final quarter, a 16% increase from a year earlier.

Outlook and Implications

The majority of Eni's production growth originated from North Africa. Whereas production from here grew by 565,000 boe/d in 2009, the rate quickened to 688,000 boe/d in 2010. Africa as a whole accounts for over one third of Eni's output, with a further quarter coming from the former Soviet Union (see Kazakhstan:11 February 2011: TCO Reports Increase in 2010 Crude Production in Kazakhstan; KPO Output Down). The costs associated with extracting oil from the regions are relatively low—USD3–4/boe, which positions Eni with an unusually strong PV-10 (the estimated future gross revenue to be generated from the production of proved reserves): around USD7.1/boe compared with ExxonMobil's USD5.0/boe and USD4.0/boe for Shell.

This augurs well for the future although two clouds remain over Eni's upstream oil and gas exploration and production operations. First, its PV-10 is likely to decline in the near future as it comes to rely increasingly on output from geopolitically sensitive locations. In particular, the unstable fiscal regime in Iraq remains a cause for concern. The Iraqi Zubair redevelopment project will account for around 22% of new growth in 2015, yet the contract Eni has agreed with the Iraqi government allows for just USD2 per incremental barrel—a tiny margin, rendered even more fragile by the bottlenecks and skilled labour shortages the project will likely encounter (see Iraq: 10 June 2010: Eni Firms Up Zubair Development Plan, Promises 12 New Iraqi Oil Wells This Year). Second, IHS remains sceptical that Eni will reach its five-year compound annual output growth target of 2.5% per year. Eni will need to increase output by nearly 3.5% per year to 2015 in order to reach its goal—an unrealistic figure, even after this quarter's production improvements. Eni also appears to be placing a lot of faith in its Polish operations, acquired alongside Minsk Energy in mid-December (see Poland: 13 December 2010: Eni Enters Polish Shale Gas Fray with Minsk Energy Resources Acquisition). While European unconventional resources may well yield significant results in the longer term, it seems risky to assume that any firm will produce significant volumes within the next four years.

Further downstream the picture is also mixed. Natural gas sales in Europe dipped slightly from 55.4 bcm to 54.5 bcm, despite the cold winter. This decline was driven mainly by a 14.4% slump in Italian sales: increased competition in Italian markets (anti-monopoly regulations require Eni to limit its hold on Italian gas markets), oversupply arising from the new Adriatic LNG regasification facility, and subdued economic recovery, limiting demand, all served to put pressure on Eni's Italian gas revenues (see Italy: 11 February 2011: Enel Pushes Sicily LNG Deadline back to 2015). Outside of Italy, Eni claimed that the unfavourable differentials between oil-linked gas purchase costs and natural gas spot prices brought results down, although this situation appears to have been reconciled in the past few days (see Italy: 15 February 2011: Gazprom Agrees Further Price Concessions for European Energy Firms).

Power production increased 16.4% from 34TWh/y to 39TWh/y in 2010, as a result of installed capacity additions at Ferrera Erbognone. Italian power prices were higher than those in neighbouring countries through most of 2010 because of limited effective plant capacity, limited transmission connections between areas within Italy, higher domestic gas prices, and past market concentration in power and gas. Growth in combined-cycle gas turbine (CCGT) capacity, investments in transmission within and into Italy, and a more active approach by the Italian energy regulator are pressures that should reduce the Italian price differential with other countries, in turn weakening Eni's bottom line.