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Investors May Be In for a Crude Correction

OCTOBER 27, 2009

THE WALL STREET JOURNAL

The recent surge in oil prices hasn’t benefited Big Oil much, and the moment may be passing.

BP reports third-quarter results Tuesday, kicking off a week of results from the world’s biggest integrated oil companies. ConocoPhillips reports Wednesday, Exxon Mobil and Royal Dutch Shell on Thursday and Chevron on Friday.

It is expected to be a tough quarter for the group, in part because year-ago comparisons will be brutal.

[oil stocks performance]

In the third quarter of 2008, crude-oil prices on the New York Mercantile Exchange averaged $118 a barrel, lifting revenue in exploration and production. Exxon’s $14.83 billion in net income then set a record for profit from recurring business by a U.S. company.

Fast forward to the third quarter just ended, when oil prices averaged $68 a barrel. Analysts expect Exxon’s income for the period to be less than half of the comparable quarter last year.

Oil has recently surged back to $80 a barrel, a 71% run-up since March 9 that outpaced the S&P 500-stock index, though oil dropped below $79 on Monday.

The burst would seem to be a boon to these companies. Yet, the Dow Jones U.S. Integrated Oil and Gas Total Stock Market index is up less than 21% for the same period.

Part of the problem for some of these companies is sheer scale, which makes it difficult to significantly add to reserves or production.

“Investors are leaning more toward smaller-cap companies because they can see more potential for growth,” said Oppenheimer analyst Fadel Gheit.

The group also is exposed to the dismal refining business, in which just 81% of capacity is in operation due to low demand.

There also is reason to doubt the sustainability of $80 oil, with global inventories still high and demand still weak.

U.S. oil supply at last count was 339 million barrels, higher than its long-term average and up nearly 28% from last year.

Under the circumstances, oil should be priced closer to $50 a barrel, said Mark Gilman, analyst at the Benchmark Co.

“We’re at these prices due entirely to excess global liquidity,” Mr. Gilman said. “When it corrects, it’s not going to be pretty.”

Write to Mark Gongloff at [email protected]

Printed in The Wall Street Journal, page C1

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