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Financial Times: International companies: Big profits and big troubles

By Thomas Catan
Published: May 29 2006 13:34 | Last updated: May 29 2006 13:34

Amid soaring energy prices, international oil companies are making unprecedented profits.
 
ExxonMobil posted the largest annual profit in corporate history this year. BP, Royal Dutch Shell and the other “supermajors” are having a difficult time working out what to do with the money.

Over the past two years, the largest oil companies have returned well over $120bn to shareholders through dividends and share buybacks. Exxon alone is returning more than $2bn to investors each month.

But beneath the surface, these are uncertain times for the international oil companies. The first, and perhaps largest, problem they face is getting access to new resources. About three-quarters of the world’s oil and gas reserves are off limits to them because governments such as Saudi Arabia do not allow them to participate.

Meanwhile, many assets in places such as the Gulf of Mexico and the North Sea are past their peak, requiring billions of dollars of investment to extend their lives. Costs in the industry are skyrocketing amid a global squeeze on skilled labour and materials.

More problems come from such conspicuous success. Governments are increasing taxes on oil companies and politicians have turned them into scapegoats for rising energy costs. Even the oil-friendly Bush administration in the US has announced investigations into alleged “price gouging” by oil companies despite an almost total lack of evidence.

“The sharp rise in oil and gas prices is a double-edged sword,” says Fadel Gheit, oil analyst at Oppenheimer & Co. “On the one hand it gives oil companies record profits, on the other hand it made doing business much more difficult.”

Countries from Russia to Venezuela have been tightening their grip on their oil industries, pushing to get a greater share of export earnings. Venezuela unilaterally imposed tough contracts on the companies operating in the country this year and increased taxes on them. The populist government of Hugo Chavez is threatening to increase those taxes still further.

Bolivia nationalised its gas industry on May 1, surrounding key installations with soldiers and using fiery rhetoric against the oil companies. They have been given 180 days to renegotiate their contracts or leave the country. Even the UK has repeatedly raised taxes on companies operating in the North Sea.

“Despite the growing opinion that the integrated [oil companies] can only benefit from the current momentum behind global commodity prices, history would suggest otherwise,” wrote Bernstein Research in a recent report, Evolve or Face Extinction.

Even in sustained periods of high oil prices, returns have been eroded by cost inflation, windfall taxes and increased nationalisation, Bernstein notes. It believes returns in the industry will peak this year and decline thereafter, regardless of whether prices remain high.

Bernstein outlines a number of significant challenges faced by the oil majors.

“The integrated oil company operating environment is in a state of transition at the moment, and the strategic directions taken by the majors over the next few years will be critical for the longer-term survival of the players,” it notes.

What is the outlook for the oil industry? And how can individual companies succeed?

Countries such as Saudi Arabia no longer need the oil majors to extract easily-accessible reserves of “conventional” oil. They can get much of what they need direct from oil services companies such as Halliburton, Baker Hughes or Schlumberger. That means the majors must offer services those companies cannot.

That is driving the majors into more difficult areas such as “unconventional” in Venezuela and Canada, into liquefied natural gas and newer markets such as synthetic fuels created using “gas-to-liquids” (GTL) technology. It is also forcing them to go to “frontier” parts of the world – such as the Arctic or very deep water – that national oil companies cannot access themselves.

That move brings its own difficulties. Shell’s giant LNG project in Sakhalin has been plagued by construction delays and cost over-runs. The price has risen from $10bn to $20bn, and some say it could rise further.

The companies that perform best will be those able to bring such giant projects into existence on budget and on time.

Of the largest oil companies, ExxonMobil has the most impressive record in this regard. Smaller companies such as BG have also managed new projects well.

They must also be the canniest dealmakers, adept at negotiating with host governments that control resources.

BP has recently had the most success, gaining access to highly sought Russian oil by buying into TNK.

The company is also pursuing innovative deals with national oil companies in places such as China and India.

Shell has performed badly on both fronts of late. But it has managed to carve out leading positions in many of the potential growth areas of the future: LNG, GTL and Canadian oil sands.

With several decades of development behind it, few would dispute LNG is an attractive market, and Shell’s position is the envy of its competitors.

Whether oil sands and GTL can become as established will be central to the company’s fortunes in coming years.
 

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