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The Wall Street Journal: How Big Oil Is Forced To Share the Wealth

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As Crude Prices Rise,
Contracts Give Nations
More of the Output Pie
By GUY CHAZAN
November 9, 2007; Page A12

LONDON — Oil at $100 a barrel is a bane for fuel consumers. But it isn’t entirely a boon for major oil companies, either.

The rub: The economics of the production deals governing some of the world’s biggest oil fields stipulate that the higher the oil price, the less production and reserves oil companies get. Host countries such as Nigeria, Angola and Azerbaijan gain a bigger share.

Investors and analysts judge oil giants in part by their ability to pump more crude and find new reserves. So a decline can have an impact on the way markets perceive Exxon Mobil Corp., BP PLC, Total SA and others.

What these major companies lose in terms of volume they can make up for in profitability. “Any fall in volumes is going to be more than offset by the $30” rise in crude prices over recent months, said Fadel Gheit, an analyst with Oppenheimer. Oil companies “will make much more money in the fourth quarter than in the third.”

The production loss comes amid other headaches, such as rising costs, volatility and margin pressure in refining partly because of high oil prices. Also, the higher oil climbs, the more countries are encouraged to renegotiate contracts to get a bigger cut.

“In general, it is the governments who are the big winners when prices reach new heights,” Bob Dudley, chief executive of BP’s TNK-BP Russian joint venture, said last week.

Exxon last week reported third-quarter net profit of $9.41 billion. But that was lower than a year ago. BP and ConocoPhillips also said profits fell, and output for most majors declined.
 
The companies cite the advantages of high crude prices. In the early phases of an expensive project, “a higher price means you accelerate your cost recovery, which is a good thing,” said one BP executive, adding that price fluctuations balance out over the life of a contract. They also have little choice — the richest deposits in nations with fewer constraints have already been found.

State oil companies directly controlled 37% of global reserves at the end of 2005 and will account for nearly three-quarters of total oil production by 2030, according to the International Energy Agency. With oil revenue swelling their treasuries, oil-producing countries have less need to draw more foreign capital.

“The majors are like dinosaurs,” said Stephen Thornber, global equity fund manager at Threadneedle in London. “Their production is flat or falling, and their returns are under pressure.” He has shifted to state oil companies where production is on the rise, and also likes oil-service companies, which provide equipment and services and benefit from higher prices.

One of the biggest hits companies are taking is on production-sharing contracts. Investors bear costs but can recover them from production before having to share much revenue with the host government. High oil prices mean investors recover costs more quickly and have to start sharing what is known as “profit oil” with the host country earlier than planned.

Citigroup found that 31% of the production from major European oil companies is based on production-sharing deals and that percentage is expected to rise to 46% by 2012. With oil at $100 a barrel, Citigroup said, the participants in one BP-led project in Azerbaijan would receive 50% less than they would have with oil at $25 a barrel. BP declined to discuss terms.

Exxon, Chevron Corp. and ConocoPhillips all said recent production declines were partly because of contracts giving governments more oil when prices rise. Total, which has one of the highest levels of exposure to such contracts, this week trimmed its 2007 target for output growth to 1% from 2%.

•  The Trend: As crude prices rise, Western oil companies get a smaller share of production at some of their most important oil fields, especially under what are known as production-sharing agreements.

•  Who’s Hurt: With less production and fewer bookable reserves, Western oil companies may become less attractive to investors, who may seek value elsewhere.

•  Who Benefits: Large state-controlled companies could see their shares rise as investors looking for alternatives consider their greater access to untapped reserves within restricted borders.

Write to Guy Chazan at [email protected]

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