The Wall Street Journal: Conoco’s Downbeat Update

Softer Refining Margins
Are Hurting Oil Firms
As Crude Surge Persists
By BETH HEINSOHN
October 4, 2007; Page A12

ConocoPhillips’s third-quarter update offered the latest sign that the business of refining and selling gasoline and other fuels has become much less profitable.

The company, based in Houston, said refining margins narrowed significantly during the just-ended quarter compared with the second quarter. Refining margins, or the difference between the price of oil and the price of refined products, are an indicator of refining-industry profit margins.

The financial update issued yesterday followed increasing skepticism in recent weeks regarding refining companies’ prospects as refining margins have narrowed industrywide as a result of higher oil prices. ConooPhillips and other integrated oil companies are somewhat shielded because they also have exploration and production operations, which benefit from high oil prices.

But third-quarter results for the big oil companies still could be affected, depending on their operations’ mix and performance. Deutsche Bank AG Monday downgraded ConocoPhillips to “sell,” in part because of the slide in margins. The company is scheduled to report third-quarter results Oct. 24.

ConocoPhillips was down $1.41, or 1.7%, to $84.06 in 4 p.m. New York Stock Exchange composite trading.

Last year, ConocoPhillips’s refining and marketing operations contributed $4.48 billion to its full-year net income of $15.55 billion.

ConocoPhillips also disclosed an expected decline in production of oil and natural gas, citing its withdrawal from Venezuela over a dispute with the government. During the third quarter it pumped 180,000 fewer barrels of oil equivalent a day than the 1.9 million barrels a day produced in the second quarter. It also said its chemicals operations improved.

The profit to be had from purchasing crude oil, converting it into product and selling that product was narrowing. One reason is the rising price of oil, which leads to higher costs for refiners. Retail gasoline prices in the U.S. are about 50 cents a gallon higher from a year ago, and heating oil prices are at historic highs, but they continue to lag behind crude oil, which has risen 16% since late August and is hovering at about $80 a barrel.

Gasoline prices have been helped by refineries coming back online after longer-than-usual outages, and have received a lift from rising gasoline imports.

During the current “shoulder season” between peak summer gasoline consumption and the height of winter heating oil demand, “not a lot of refiners have the ability to aggressively push pricing increases to consumers,” said Ann Kohler, managing director of Caris & Co., an investment bank in Del Mar, Calif. “Continued oil-price strength would continue to be negative for refining margins,” she said.

On the upstream end of the business — exploration and production — ConocoPhillips said it spent about $240 million, down from $270 million in the second quarter. The company said third-quarter production was also hurt by unscheduled repairs to a third-party pipeline in Britain and maintenance shutdowns on fields in the Timor Sea and Alaska.

AT THE PUMP
 
•  The News: ConocoPhillips’s third-quarter update included lower production, as expected, and tighter refining margins.

•  The Hit: The combination of high oil prices and stable gasoline prices is expected to hurt refiners’ bottom lines.

•  The Outlook: Integrated companies like ConocoPhillips are less vulnerable, but results still could be affected.

–Jim Jelter contributed to this article.

Write to Beth Heinsohn at [email protected]

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