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The Wall Street Journal: Oil Prices, Profits Set to Diverge

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Despite Crude at $86.13,
Producers’ Earnings Curbed
By Costs, Refinery Squeeze
By ANA CAMPOY and GUY CHAZAN
October 16, 2007; Page A3

Oil prices reached a new high of $86.13 a barrel yesterday. But that may not translate into higher profits for many oil companies.

Crude prices reached their record yesterday on supply concerns, continued interest from financial investors and tension in the Middle East — though oil still remains below the high of more than $101 a barrel reached in 1980 when adjusted for inflation. The rise continues oil’s third-quarter surge, when it moved above $80 a barrel for the first time.

Many major energy companies are expected to show third-quarter profit declines when they issue their financial results beginning next week. Profitability in the refining business fell for many of them, while rising oil-field costs are pinching profits and delaying new projects. Many oil companies increasingly rely on natural gas, which is volatile in price and fell during the quarter. Oil-rich countries are demanding tougher terms.

“Profitability is not keeping pace with crude-price increases,” said Paul Sankey, a Deutsche Bank analyst, in a note.

Future periods are expected to bring improvement as some companies put production snafus behind them and new projects and new drilling equipment come on-line. But the third-quarter also provides a glimpse of the future for the West’s publicly traded oil giants, which may have to be firing on all cylinders to enjoy higher energy prices as the operating environment toughens.

“In a high-dollar world, investments do become increasingly difficult,” said Kenneth Medlock, fellow in energy studies at the James A. Baker III Institute for Public Policy. “The earnings reports that you saw in 2005 — you’re not going to see that anytime soon.”

Still, high oil prices should allow oil companies to maintain “reasonable profits,” he added. The third-quarter profits of major oil producers like Exxon Mobil Corp., Royal Dutch Shell PLC and BP PLC are still expected to be measured in the billions of dollars. Many of the companies will suffer only in comparison to what was a flush third quarter a year earlier. In that quarter, companies with both production and refining operations in the Dow Jones U.S. Integrated Oil Index saw net income rise 16% to $21.53 billion, compared with the third quarter of 2005.

Shrinking profit margins in the business of refining crude oil into fuels like gasoline is expected to hit several companies, particularly in the U.S.

Exxon Mobil, the world’s largest publicly traded, nongovernment-controlled oil company by market capitalization, will likely post flat earnings in the third quarter, compared with a year ago and a 3% drop from the second quarter, estimates Doug Leggate, a Citigroup Inc. analyst. It is expected to weather the refining impact better than rivals because its business is spread out geographically and it has a diversified production mix.
 
Third-quarter results at Shell and BP will be weighed down by refining, analysts say. Citigroup forecasts Shell’s net income for the quarter at $5.36 billion, a 20% drop from a year earlier. For BP, Citigroup is predicting net income of $3.98 billion, down 19%. The three companies declined to comment.

Some European majors, such as France’s Total SA and Eni SpA of Italy, aren’t expected to see as sharp a drop in profits as Shell and BP because they are less exposed to the U.S. refining market, analysts said. European refiners haven’t had such an abrupt fall-off in margins as their U.S. peers.

Mr. Leggate at Citigroup expects average earnings for U.S. major oil companies to fall 12% in the third quarter from the same period last year. Among the hardest-hit will be those that derive most of their earnings from refining and from natural gas, while those that make the lion’s share of their profits from oil will do better.

Chevron Corp. last week said it sees third-quarter earnings “significantly below” the record $5.4 billion it earned in the second quarter. ConocoPhillips and Marathon Oil Corp. have warned that their refining business will be less profitable.

In the second quarter, unplanned refinery shutdowns and high demand pushed gasoline prices to records and fattened refining margins, or the difference between the price refiners pay for crude and the price of the products they make with it. However, as summer demand eased and oil prices shot up, third-quarter refining margins collapsed. The benchmark refining margin tumbled to $11.74 a barrel from $24.28 in the second quarter, according to market data compiled by ConocoPhillips.

Earnings will also be stunted by lower production volumes, said Fadel Gheit, an analyst at Oppenheimer & Co. in New York. Although a drop in production is normal in the third quarter, a time when the majors traditionally carry out maintenance work on refineries and production facilities, some companies are also producing less because of tougher terms imposed by governments of the countries where they operate.

•  The Issue: Despite record oil prices, many oil companies are expected to post a drop in their third-quarter results.

•  In a Pinch: Profits are being squeezed by higher costs and tougher terms from oil-rich nations. Also, a narrower difference between the price of oil and fuels like gasoline hurt refining results.

•  The Outlook: Oil companies will have to become more efficient to capture the benefits of higher oil prices amid a tougher operating environment.

Write to Ana Campoy at [email protected] and Guy Chazan at [email protected]

 

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