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US News & World Report: Big Oil Faces a Tougher Drill

By Marianne Lavelle
Posted Sunday, January 7, 2007

Crude oil’s surge to more than $77 a barrel last summer, followed by a precipitous fall below $56 by November, produced a rude awakening for investors in the energy sector. Although oil rebounded to finish 2006 where it began-in the low 60s per barrel-the energy-heavy Goldman Sachs Commodity Index was down 15 percent after four straight years of huge gains.

So, mutual funds with direct exposure to commodity prices, often by tracking the Goldman Sachs index, had a rough 2006; the Oppenheimer Real Asset Fund (QRAAX), for example, was down 13 percent. But it was a different picture for many of those who put money into Big Oil stocks. Their fortunes are only partly tied to the price of oil and depend also on success in exploration operations and healthy margins in refining.

Shares of Exxon Mobil swelled 34 percent to more than $76. Chevron (up 29 percent) and Conoco-Phillips (22 percent) also had strong showings. The Vanguard Energy Fund (VGENX), which counts those three companies among its top holdings, along with French oil giant Total and oil services company Schlumberger, was up 19.7 percent last year.

But a key question for 2007 is whether these big multi-nationals will be able to repeat their performance. “I really think the easy money has been made,” says Oppenheimer oil company analyst Fadel Gheit. “There will be growth but at a lesser pace.”

Signs of trouble already were apparent in 2006. Royal Dutch Shell performed just even with the market, while BP-with environmental, safety, and infrastructure woes-fared poorly. All industry players face a tough time replacing resources, driven into difficult terrain-both geologically and politically-and hampered by labor shortages and escalating expenses. “They’re all under a lot of cost pressure,” and profit margins could shrink, says Philip Weiss, Argus Research analyst.

Several analysts see ConocoPhillips as the most undervalued of the large oil companies. Wall Street didn’t like its $36.5 billion acquisition of natural gas company Burlington Resources as natural gas prices fell last year. But in the long run, the deal provides the company with valuable assets.

Democrats’ agenda. The tide isn’t in Big Oil’s favor on Capitol Hill. Democrats want to act quickly to strip away industry tax breaks, a move that shouldn’t cause too much harm-as long as oil prices stay high. Climate-change legislation, also a top agenda item, poses more risk, but few analysts expect quick action. Still, Democrats might be able to push through smaller policy changes that shave U.S. oil demand, such as greater use of alternatives.

That prospect, along with its predicted weakening of the economy, prompted Friedman Billings Ramsey to lower its earnings estimates for most large oil companies. Analyst Jacques Rousseau instead is talking about ethanol companies like VeraSun Energy, which went public last June at $30 per share but has since slid below $20. Although the price of ethanol has faltered, he predicts huge demand ahead, because of an alliance between the Farm Belt GOP and environmentalists in the new Congress. “A lot of people don’t like to bet on Washington-and that’s understandable-but the thing we’ve liked about ethanol is both Republicans and Democrats are in favor of it,” he says.

royaldutchshellplc.com and its sister websites royaldutchshellgroup.com, shellenergy.website, shellnazihistory.com, royaldutchshell.website, johndonovan.website, shellnews.net and shell2004.com are all owned by John Donovan. There is also a Wikipedia article.

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