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Reuters: $100 oil not such a boon for oil majors

Tue Nov 6, 2007 10:58am EST 
By Tom Bergin and Michael Erman – Analysis

LONDON/NEW YORK (Reuters) – If $100 dollars a barrel becomes a long term oil price, shares in top crude producing companies should benefit, but the dramatic boost implied by traditional financial models is unlikely.

Analysts’ existing assumptions indicate as much as a 50 percent uplift in profitability and as much as a 100 percent rise in asset values among companies such as Exxon Mobil (XOM.N: Quote, Profile, Research) and BP Plc (BP.L: Quote, Profile, Research), should prices settle at a new norm above the record $96/bbl seen last week.

However, at an oil conference in London last week oil executives, including Christophe de Margerie, Chief Executive of France’s Total (TOTF.PA: Quote, Profile, Research), warned that if crude does continue to rise, upward trends on taxes and production costs could worsen.

Coupled with an increasing reliance on lower-margin natural gas to meet production goals, and on new oilfield contracts that limit the upside from high oil prices, $100/bbl oil could prove a disappointment.

“Equity markets increasingly run the risk of misinterpreting the value impact of high oil prices,” said Citigroup in a research note.

Oil prices have more than quadrupled since 2004, but in the same period the FTSE Global Energy Index, which includes companies such those named above, Royal Dutch Shell Plc (RDSa.L: Quote, Profile, Research) and Chevron Corp (CVX.N: Quote, Profile, Research), has only doubled.

This is partly because analysts and investors do not expect oil prices to remain at current levels for the full life of the companies’ fields.

Shares in the oil majors currently factor in a long-term oil price of only $55-65 according to Jason Kenney, oil analyst at ING in Edinburgh.

However, even if analysts accepted oil will hit and stay at $100, few think share prices would jump by a commensurate amount, largely because profits would not keep pace.

PROFITS TO LAG

Exxon set a U.S. earnings record of $39.5 billion in 2006 thanks to strong oil prices, while Shell set a record for a UK-registered company.

BP has a “rule of thumb” that says a $1 rise in the Brent oil price boosts its full-year pre-tax operating profit by $500 million.

Given Brent averaged $65 in 2006 and BP’s average tax rate is about 35 percent, this would pile another $11 billion onto BP’s profits, which were $22 billion in 2006.

However, BP officials caution its rule may become less accurate as oil hits new highs and in any case depends on all other factors remaining equal — something few in the industry believe will happen if oil hits $100/bbl.

Profit growth will lag oil prices anyway because natural gas accounts for a large and growing part of output — around 30-40 percent for the companies named above — and gas prices have not risen as much as oil.

Governments have also become smarter at exploiting their oil, and record prices have spurred countries from Venezuela to Russia via Britain to redraw terms. There may be further tightening if prices continue to rise.

“The tax rates have generally risen so the majors don’t hold onto as much of it as they used to,” Brendan Wilders, oil analyst at Oriel Securities, said.

IMMUNE TO OIL PRICES

Analysts at Citigroup say the increasing use of Production Sharing Contracts (PSCs), rather than traditional tax and royalty schemes, further limits the upside for the top companies.

Under tax and royalty schemes, oil companies own the field and take on all the risks and benefits associated with oil prices.

Under PSCs, the government retains ownership of the field. Companies are compensated based on their investments, but receive relatively little benefit if prices rise.

Citigroup estimates that 46 percent of the big European companies’ production will be covered by PSCs by 2012.

Italy’s ENI will be the worst affected, with 60 percent of its production covered by PSCs in 2012, while BP will be the least exposed, with 37 percent, Citigroup said.

Exxon and Chevron also have significant chunks of production under PSCs, although, with only 16 percent of its reserves covered by PSCs at the end of 2006, Exxon is likely to be relatively less exposed than many rivals in future.

While pumping oil accounts for most of the oil majors’ profits, the biggest oil companies also refine millions of barrels of crude each day.

In the past three years refining has become very profitable, but Gene Pisasale, an analyst at PNC Wealth Management, said if oil stays above $80, refining margins may be slim for coming quarters, as it is proving hard to pass on higher prices to customers.

Exxon is the world’s biggest refiner. Total is Europe’s and BP and Italy’s ENI are less focused on refining than peers.

Cost inflation is another drag on earnings. Oil companies’ costs have risen more than 67 percent since 2000 on higher demand for steel, drilling rigs, and other materials, according to a Cambridge Energy Research Associates Study Released in February.

“High prices are not helping costs,” Bob Dudley, the Chief Executive of Anglo-Russian oil major TNK-BP, told a recent conference, and oil executives predict that if oil hits $100, contractors will want an even bigger cut.

Nonetheless, the surge in oil prices in recent months has forced analysts to boost their earnings forecasts for the next quarter. So the link between pricey oil and big profits, while weakening, is still intact.

“Companies that produce a lot of oil are going to make a lot of money,” said Gene Gillespie, at energy investment firm Howard Weil in New Orleans.

© Reuters2007All rights reserved

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