THE SUNDAY TELEGRAPH (UK): Investors play the Shell game: “The historic unification to create one company, to be called Royal Dutch Shell, is expected to be given the green light by investors at annual meetings in London and the Netherlands this Tuesday. The restructuring, introduced by Jeroen van der Veer, the chief executive, in the wake of shareholder pressure after the oil group's shocking overstatement of its oil and gas reserves last year, will herald a new chapter in Shell's century-long history.”: Sunday 26 June 2005

(Filed: 26/06/2005)

Shares in the oil giant have seen stronger rises than BP's for a technical reason relating to its unification with Royal Dutch. Can the outperformance last? Sylvia Pfeifer reports

A deceptively simple new investment idea has been doing the rounds of the trading floors in the City in recent weeks: "Sell BP, buy Shell". The idea has little to do with the fundamentals of the respective businesses of the two oil giants but a lot to do with the upcoming merger of Shell's two operating companies, Shell Transport & Trading, its UK arm, and Royal Dutch Petroleum of the Netherlands.

The historic unification to create one company, to be called Royal Dutch Shell, is expected to be given the green light by investors at annual meetings in London and the Netherlands this Tuesday. The restructuring, introduced by Jeroen van der Veer, the chief executive, in the wake of shareholder pressure after the oil group's shocking overstatement of its oil and gas reserves last year, will herald a new chapter in Shell's century-long history.

At the same time, however, it will pave the way for a shake-up of the UK's stock market indices.

From July 20, the day shares in Royal Dutch Shell start trading on the London Stock Exchange, the company's weighting within the FTSE All-Share will rise from 3.4 per cent to nearly 8 per cent. The re-weighting will make the company the second-largest stock in the index after BP.

The shake-up has already prompted a wave of buying by UK fund managers of Shell shares and there is more to come - with some analysts forecasting that purchases could top £20bn. At the same time, fund managers have been selling shares in other companies, including BP, to raise funds.

The point is that funds that aim to perform in line with relevant UK indices are obliged to buy shares in Shell, regardless of what they believe is the fundamental worth of the company.

Many fund managers have already started to position themselves ahead of July 20. According to analysts, this technical buying, coupled with record oil prices of $60 a barrel, has helped underpin Shell's share price in recent months: since October, when Shell announced its plans for unification, its shares have outperformed those of BP by around 7.4 per cent.

Lord Browne, the chief executive of BP, has said privately that Shell's move to a full weighting in London is helping its shares outperform those of BP.

Nevertheless, there is some debate as to how much buying of Shell shares has already taken place. Some investors believe the bulk of the buying will only take place in the next three to four weeks in the run-up to July 20.

Most say this will be the biggest technical adjustment to the market since Vodafone's £113bn takeover of Mannesmann, the German telecommunications group, five years ago. That deal forced investors, especially those who track benchmark indices such as tracker funds, to buy shares in Vodafone simply because of its increased size. Today, fund managers face a similar pressure with Shell.

"It's a focal point for institutional investors," says Jim Stride, the managing director of Axa Investment Managers, which holds just under 2 per cent of Shell's UK arm. "I don't think investors have bought enough shares yet [to make up for the re-weighting] and the volume of shares that will be traded in Shell in July will be phenomenal."

Shell's re-weighting has already raised concerns among fund managers. About 10 years ago, the top 10 stocks represented just over 20 per cent of the FTSE All-Share index. After Shell's merger, the weighting of the top 10 will be more than 40 per cent.

The top five stocks in the index will be BP, Shell, HSBC, the bank, GlaxoSmithKline, the pharmaceuticals group, and Vodafone.

In a clear sign of the City's concern, FTSE Group - which runs the indices - last week launched new versions of the FTSE100 and All-Share indices. These limit the weighting in any one stock to 5 per cent of the market's value. BP, HSBC, GSK and Vodafone have been capped at that proportion, as will Shell, once its merger goes through.

Legal & General, which operates the biggest index-tracking business in the UK, says it is already in the process of constructing a FTSE All-Share index that does not include the five biggest stocks. It will be offered to institutional clients. Pooled funds of the five biggest stocks are also being set up.

A spokesman for L&G adds that despite the concerns about the impact on the market of the newly combined Shell, managing trading volumes is "what we do for a living". We try to minimise the market impact all the time. There is liquidity in all sorts of places and there are all sorts of things you can do," he says.

At some point, though, investors will have to look at Shell as a business again, and not simply as a statistic in the index.

"In terms of the fundamentals, BP is clearly a better company than Shell. But that is not the point," says Jonathan Copus, an analyst at Investec Securities who has Shell on a "buy" rating. According to Copus, the question for investors is "how much of BP's fundamentals are already in its share price and is Shell really a turnaround story?"

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