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Pricey Crude Can Be Trouble for Big Oil

The Wall Street Journal Home Page
AHEAD OF THE TAPE

By MARK GONGLOFF

Pricey Crude Can Be Trouble for Big Oil

July 29, 2008; Page C1

Big Oil’s relationship with high crude prices is more complicated than one might think.

[AOT]

Thanks to pricey oil, the world’s big oil companies this week are set to unveil another round of record profits. BP‘s second-quarter haul is due to be posted Tuesday, with Exxon Mobil, Royal Dutch Shell and Chevron reporting later in the week. The four are expected to rake in a combined $35 billion in net income for the period, in which crude oil averaged $124 a barrel, up 91% from a year ago.

Exxon Mobil alone may report a record $12.2 billion profit and could make $48 billion this year, according to consensus estimates. That would top the 2007 gross domestic product of Luxembourg.

Yet Exxon Mobil also has lost some $64 billion in market value this year, as its stock price has sunk 14%. Odd as it sounds, expensive oil isn’t altogether good for integrated oil companies, which do everything along the crude-oil assembly line, from exploration to putting gasoline in your tank. It encourages consumers to look for alternatives, gets the political opposition’s blood flowing and encourages unfriendly foreign governments to grab production.

It also hurts a key profit driver. In the first quarter, unable to fully pass along rising oil prices to consumers at the pump, Exxon Mobil reported a 39% drop in refining and marketing profit that contributed to its lower-than-expected $10.9 billion net income. Last week, ConocoPhillips reported a 72% drop in so-called downstream earnings.

Cheaper crude could actually ease that and other big pains for the oil companies. The hitch is, pulling oil out of the ground is getting increasingly difficult and expensive, meaning prices mightn’t fall too far.

High-Yield Investments Retain Their Allure

In finance as in life, old habits die hard. Among investors, one such ingrained habit has been the search for extra “yield,” or investments that carry higher interest rates.

The credit crunch temporarily ended that obsession, as investors began focusing on matching risks to returns. Judging by the behavior of certain currencies, however, the allure of high-yielding investments remains potent.

Take the Turkish lira. Turkey, facing an imminent political crisis, must finance large deficits at a time of tightening borrowing conditions world-wide. Normally, that would cause investors to shun the currency. But the central bank’s key interest rate is 16.75%, one of the highest in the world, which provides an incentive to buy lira and hold them in very short-term deposits.

Indeed, an investor who took dollars and followed that strategy would have earned a return of nearly 7% this year as of Monday, said Win Thin, a currency strategist at Brown Brothers Harriman. Turkey’s high interest rates have rewarded investors while the currency has declined only modestly — about 3% — against the dollar. The lira, though, remains vulnerable to a continuing clash over laws separating religion and the state.

Of course, there are exceptions. Iceland, another country with high interest rates but a troubled financial system, has seen its currency tank.

–Joanna Slater

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