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THE WALL STREET JOURNAL: Big Oil’s Not-So-Big Growth Plans

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With New Reserves Harder to Snag,
Western Firms Could Opt for Smaller Role
January 31, 2008

Big oil companies, benefiting from oil’s recent rise toward $100 a barrel, are expected to report more flush earnings in coming weeks.

But fat results aren’t likely to impress investors, many of whom are focused on more worrying long-term trends. By several other key measures, Big Oil is shrinking.

Royal Dutch Shell PLC, the second-largest Western oil company by market capitalization, reports fourth-quarter results today, followed in coming days by No. 1 Exxon Mobil Corp., then No. 4 Chevron Corp., No. 3 BP PLC and No. 5 Total SA. Exxon Mobil could set another record for annual corporate profit. Investment bank Credit Suisse estimates last year’s earnings from producing oil and natural gas, the companies’ most profitable segment, rose 43% from a year earlier to a combined $106.7 billion.

Individual company results will depend on how much the oil-production business offsets a profit decline in their other operations, which have suffered from tough comparisons and declining margins. Profits for the business of refining and selling fuels are expected to have fallen 37% to a combined $28.4 billion, according to Credit Suisse.

Still, investors have their eyes on other figures. Beginning with Shell today, the oil companies’ results will provide a glimpse of how much their profitability is being blunted by rising costs for everything from drill bits to engineers.

And in coming weeks, the companies will disclose their capital-spending plans for this year. Those plans will show whether the companies will make a play to add to their supplies of oil and gas in the ground and keep their traditional industry heft, or whether they will wait on the sidelines and continue to shovel cash to their shareholders in the form of share buybacks and dividends.

At least one midsized U.S. company is ready to step up its spending to produce more oil and petroleum products. Marathon Oil Corp. said yesterday it would increase its capital budget by 67% to $8 billion this year.

For the most part, oil companies have been pouring their extra cash into dividends and share purchases.

While final 2007 figures aren’t yet available, the top five Western oil companies are expected to have spent $178.9 billion snapping up their own shares over the past four years, according to energy consultant John S. Herold Inc. That is more than the market capitalization of blue-chip U.S. stalwarts such as IBM or Coca-Cola. Amy Myers Jaffe, associate director of the Rice University energy program, argues that the large increases in dividends and share buybacks are beginning to look like “partial liquidation,” as the companies are “accepting a smaller role in the future energy world in return for larger cash payouts now,” she says.

Western oil majors are having trouble delivering on promises to raise production growth and find enough new sources of crude to replace what they are pumping out of the ground — a measure referred to as the reserve replacement rate. Credit Suisse estimates production volumes of oil and natural gas fell 2% in the fourth quarter from a year earlier. The companies face rising nationalism in oil-rich places like Russia and Venezuela, restrictions in the Middle East and growing competition rising from state-owned oil companies.

One company expected to report a decline in output is Shell, which was forced last year to shut in some of its Nigerian production due to unrest. Meanwhile, its reserve replacement rate, which it announces in the spring, will likely be hit hard by its loss of half of its stake in Russia’s huge Sakhalin II oil-and-gas venture.

Between 2004 and 2006, only Exxon Mobil has managed a better-than-100% replacement rate on its own. As a group, the companies managed a 75% rate outside of growth through acquisitions, meaning that for every four barrels they pumped out and sent to market they found only three new barrels in the ground.

“None of these companies are interested in shrinking, but that is effectively what they are doing,” says Charles Swanson, managing partner in the Houston office of accounting firm Ernst & Young. In the past, high oil prices translated into higher investment as the majors poured money into new exploration. Now, though, capital spending on new projects isn’t increasing as fast as some think it should.

“They simply don’t have enough lucrative opportunities to invest,” says Fatih Birol, chief economist of the Paris-based International Energy Agency. “They’re investing more to slow down the decline in their existing fields than in new production.”
Oil companies contend that chasing growth at the expense of profits is foolish. Exxon Mobil spokesman Gantt Walton says the company aims for consistency. “It goes back to using your cash wisely and not going crazy in the good times, but not cutting back during the bad times,” he says. “We consider capital discipline one of the hallmarks of the company.”

“We are not in the game of simply chasing volumes at the expense of profitability,” Shell’s chief finance officer, Peter Voser, told analysts in November.

Indeed, Exxon’s annual capital budget has barely budged, growing at a 1% annual rate since 2003. Other companies have seen double-digit annual growth in expenditures. Spending on exploration or production capabilities rose 10% to $270 billion in 2007, but most of that reflected inflation in the cost of rigs, labor and oil-field services, according to an estimate by HSBC. Spending in real terms was flat.

Some analysts expect the majors to spend more this year. Lehman Brothers forecasts the European majors like BP, Shell, Total and others will lift capital expenditures by an average of 14%, or by $17 billion, globally. BP, it predicts, will raise capital expenditure this year to $21.5 billion from $18 billion in 2007; Shell to $28.8 billion from roughly $25 billion; and Total to $20 billion from $16 billion.

Some of that increase represents greater confidence that oil prices will remain high and greater efforts to unlock resources. But BP Chief Executive Tony Hayward last year estimated oil-patch-cost inflation is running at a 10% rate, meaning generous portions of those increases are going merely toward higher expenses.

•  The Outlook: Oil companies are expected to report big 2007 profits, but investors will look at other measures.

•  The Trend: Most oil companies aren’t replacing reserves and are returning more cash to shareholders, reducing their heft in the oil patch.

•  The Price: The companies say they won’t spend money on projects at the expense of profitability.

Write to Guy Chazan at [email protected] and Russell Gold at [email protected] and its also non-profit sister websites,,,,, and are all owned by John Donovan. There is also a Wikipedia article.

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