Oil & Gas Majors

The U.S. DOE's Energy Information Administration (EIA) division recently released its report on the combined net income of the nineteen major oil companies for the third quarter of 2008 (Q308). The combined net income for this index of companies was $48 billion dollars, an 82% increase over the same period last year and a 102% increase over the average third quarter net income from 2003 to 2007. Revenue for Q308 was $428.8 billion, 43.4% higher than Q307 results. The report cited higher refining margins, crude oil and natural gas prices, and an abundant supply of natural gas which compensated for reduced crude oil supplies. According to the report, petroleum businesses faired well-almost doubling their net income from Q307 to Q308 (99.6%). The Oil and Natural Gas Production businesses did even better with a 110% increase over Q307's net income. Net income growth for the Refining/Marketing and Natural gas and Power businesses were lower but nevertheless impressive at 62% and 48.1% respectively. All sectors saw positive net income growth with the exception of the Chemical sector which saw a 20.1% decline in net income compared to Q307. Net income growth for domestics Oil and Natural Gas Production companies was better than that of their foreign counterparts. Compared to Q307, net income for domestic Oil and Natural Gas Production businesses increased by 107.8%, while net income for foreign businesses within the same sector grew by 72.2%. On the other hand, income growth for foreign Refining/Marketing businesses was better than that of their domestic cohorts. Net income for foreign Refining/Marketing businesses was 89.2% greater than that for Q307 while the domestic income growth was 49.3%. Domestic Oil and Natural Gas Production grew by 87.9% over the same period last year while foreign production only grew 14.5%. Overall, Q308 net income result for major oil companies, both foreign and domestic were spectacular and chatters the record net income results of the same quarter last year.

The nineteen oil companies used in this report include: Anadarko Petroleum Corp., Apache Corp., BP p.l.c. (U.S. operations), Chesapeake Energy Corp., Chevron Corp., ConocoPhillips, Devon Energy Corp., El Paso Corp., EnCana Corp. (U.S. operations), EOG Resources Inc., Equitable Resources Inc., Exxon Mobil Corp., Hess Corp., Marathon Oil Corp., Occidental Petroleum Corp., Royal Dutch Shell p.l.c. (U.S. operations), Sunoco Inc., Tesoro Corp., Valero Energy Corp., The Williams Companies Inc, and XTO Energy Inc.

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For now he is dead, but he shall re-incarnate and run again. And, even as he dies, he shall not visit the depths of hell for a long, long time. When demand for oil is perceived as rising and production is at existing capacity, a cut by OPEC puts a firm floor under prices. When demand for oil is perceived as falling and production is below existing capacity, a production cut will lead to quite the opposite; prices will fall because there is the comfort that future increase in demand can be met from existing capacity. Medium term, demand will rise but there are increases to existing production coming up from Angola, Brazil, GOM and Saudi; supply and demand is well balanced. In such situations, oil should trade at close to the demand led equilibrium (marginal cost of production) - approximately $60. Oil could get over-sold on recession fears, but I do not see it falling below $50. I would look for average prices of $100 over the course of the coming 5 years.

When the economic expansion starts (and this is inevitable - it is a question of when not if), oil will rally sharply from a higher base. While I do not expect it, I would not be surprised to see oil hit $200 when growth in perceived demand rises above existing production capacity. Basic materials and energy are in a very strong fundamental position because of Emerging Market demand and this will last several years. Oil prices are going to remain high for a while yet - the inflation adjusted historic price which is at over $100 is not an unreasonable estimate/price target. What can reduce oil price expectations? (a) Long term demand destruction - unlikely due to EM growth (b) Significant energy alternatives - unlikely until oil prices are at economically un-sustainable levels for a long period of time. A major and meaningful shift to nuclear, battery operated cars, improved solar technology, wind technology, hydro technology, will only occur in response to meaningful economic hardship caused by oil prices. Given that energy intensity {% of energy component in each $ of GDP} is low in the developed world, oil price does not matter as much as it has in the decades past. Price does matter, but it is unlikely to cripple the global economy at $100/$120 price levels. (c) New supplies coming from E&P activity including ultra deepwater exploration to exceed elevated demand from EM's. What is visible is likely to keep demand and supply in balance but we are certainly not yet at a point where there will be excess capacity anytime soon. (d) New drilling technologies to reduce producer costs. Again, there is nothing new on the horizon; dual drilling tables and dual stack technology on semi submersibles & drill-ships have already been in place several years. The sixth generation rigs now arriving on the market focus more on improving access to hitherto un-explorable areas - it will be possible to drill in deeper water; it is not an innovation aimed at reducing producer capex. Producer capex inflation is running at 12% and producer opex inflation is running at 6%; the latter will moderate very fast after oil prices fall. But the former will moderate only after 2012 when new drill rig availability to match demand is on-market. There is and has been heavy new build activity since 2003, once these rigs are available utilization ratios will come down from 100% and that is when you will see capex pressure on produces pull off because day rates on ultra deepwater assets will ease from historic highs we see today. This downturn in oil is economic cycle related. It does not mark the end of an era of fundamental strength for the sector.