Global Slowdown And Plunging Profits Have "Big Oil" Companies Searching For Ways to Rebound

By Bob Blandeburgo
Associate Editor
Money Morning

In late January, Exxon Mobil Corp. (NYSE: XOM), the world’s most ubiquitous oil giant, capped off a whipsaw year in the global oil markets by reporting net income of $45.2 billion, an all-time record for corporate profits that shattered the former record it had set a year before.

The number was so big and the results beat Wall Street estimates by so much at a time when the credit crisis was wreaking havoc on so many other sectors that Oppenheimer & Sons (NYSE: OPY) oil analyst Fadel Gheit couldn’t help but quip that he didn’t think Exxon “will be lining up for any TARP money or government handout anytime soon.”

Exxon wasn’t the only heavyweight reaping the benefit of a zooming energy market that had seen crude oil climb to an all-time record of $147 a barrel in July. The combined revenue for Exxon and Chevron Corp. (NYSE: CVX) for all of last year actually exceeded the gross domestic product (GDP) of all but 16 of the world's nations, Bloomberg News reported.

What a difference a few months can make.

If the name of the game is corporate profits, the global economic slowdown has transformed some of the world’s biggest oil companies from leaders to laggards.

Global-energy heavyweights Exxon and Royal Dutch Shell PLC (NYSE ADR: RDS.A, RDS.B) yesterday (Thursday) became the latest players to feel the one-two punch of dwindling demand and rising supplies, reporting profit drops of 66% and 67%, respectively.

Exxon’s net income fell to $3.95 billion, or 81 cents a share, compared to $11.68 billion, or $2.22 a share, in the same quarter a year ago. The results were well below Wall Street estimates for earnings of $1.02 a share. Shell’s bottom line fell to $3.82 billion, or 62 cents a share for the second quarter, compared to $1.87 per share in the same period last year.

“Global economic conditions continue to impact the energy industry both in the volatility of commodity prices and reduced demand for products,” said Exxon Chairman and Chief Executive Officer Rex Tillerson.

With consumers and companies alike slashing costs in any way possible in an environment of spiraling unemployment and the looming possibility of inflation as a result of government stimulus efforts around the world, Exxon, Shell and other Big Oil companies are feeling the squeeze and are cutting back in almost every way possible.

“Our second quarter results were affected by the weak global economy,” Shell CEO Peter Voser when the results were released. “This weakness is creating a difficult environment both in upstream and downstream” oil production.

Shell, for instance, said it’s embarked on a cost-cutting program that will pare billions of dollars in operating expenses. In one bright spot, however, The Netherlands-based oil giant did say that it had increased its second-quarter dividend 5% to 42 cents a share, and Chief Financial Officer Simon Henry said Shell will be able to keep raising the dividend to keep pace with inflation.

Exxon’s shares fell about 1% yesterday to close at $70.72 each. They’re down about 14% from their 12-month high of $84.76. Royal Dutch Shell’s “A” shares edged up 0.13% to close at $52.53; they’re down 29% from their 52-week high of $73.97.

"There's a lack of follow-through on production" at Exxon, Macquarie Research analyst Jason Gammel told Barron’s in an interview. "The Street rewards companies that grow production, not those who are flat."

Exxon’s combined oil and gas production dropped 3% in the quarter, and the company blamed the year-over-year decline on restrictions imposed by the Organization of the Petroleum Exporting Countries (OPEC). Shell’s production suffered more, falling 5.3%, placing part of the blame on a politically unstable Nigeria.

The heft that gave Big Oil companies the huge advantage of global scale last year is now working against them; with their large size, and against the backdrop of a global economic downturn, finding new revenue to bump up profits – and, ultimately, their share prices – will be a major challenge, analysts say.

“I think it’s generally going to be difficult for the Big Oils to move the needle,” Howard Weil analyst Doug Leggate told Bloomberg News. “Those companies that can move the needle in terms of adding value through exploration or other methods of improving their portfolios, they’re the ones who are going to win out.”

Profit at Exxon’s production and exploration unit fell to $3.81 billion in the second quarter, down $6.2 billion compared with a year earlier. In its refining business, its profit fell to $512 million, down $1.05 billion from a year ago. Profit in the same category at Shell dropped 77%, to $1.33 billion, from $5.9 billion a year ago, mostly on lower oil prices.

The grim oil earnings news yesterday followed Wednesday’s report from the Energy Information Administration (EIA) that U.S. crude stocks rose by 5.1 million barrels to 347.8 million barrels for the week ended July 24. Estimates by market research firm Platts were calling for a gain of just 1.1 million barrels, reported.

U.S. crude stocks are 29.8 million barrels above the five-year average and 52.6 million barrels above year-ago levels, according to Platts.

"The data has been bearish for most of the year, and the market may be ready to acknowledge that we are awash in crude oil and products, and demand is lower than last year despite the fact that oil and product prices are much lower," WTRG Economics analyst James L. Williams told MarketWatch. "We will be well into the recovery from the recession before there is any appreciable increase in demand.”

As of yesterday afternoon, crude oil for September delivery was trading at $66.80, up $3.45 a barrel. But that’s down $55 a barrel from this time last year – a 45.16% decrease.

Those hoping for a rally may find that they’ve only engaged in a bit of wishful thinking, since a number of analysts say there aren’t any catalysts for higher prices in sight.

Take James Cordier, president of Liberty Trading Group, who says that the rally to prices in excess of $70 earlier this year was “well overpriced.” He expects prices to continue to fall in the weeks and months to come, Cordier said in an interview with Yahoo Inc.’s (Nasdaq: YHOO) Tech Ticker.

Cordier points to the speculative demand driven by government stimulus packages, notably the liquid commodities in China, a nation whose economy looks “a little bit like a bubble to us.”

Cordier’s firm, which trades commodity-based options, is “selling calls with both hands.”

If there’s an upside to any of this, Cordier says it will be lower gas prices, which he expects to fall 15-to-20 cents per gallon around August or September, a welcome relief for consumers.

The low demand and rising supply of oil is catching the eye of regulators worldwide, who are applying the heat to speculators who are believed to be behind the main force behind wild swings in the futures markets over the past two years.

Here in the United States, the Commodity Futures Trading Commission (CFTC) this week held the second of three hearings on energy trading. In the United Kingdom, the Financial Services Authority (FSA) will hold a special meeting on Aug. 5 with oil companies, banks, hedge funds and oil brokers to review regulation in the market.

A lot of what we’ve seen in recent years has nothing to do with the underlying fundamentals of the market,” Tom Bentz, a senior energy analyst at BNP Paribas Commodity Futures Inc. (OTC ADR: BNPQY), told Bloomberg. “Something has to be done to reduce some of the speculation, no doubt about it.”

Indeed, the supply-and-demand fundamentals taught in high school and college have actually come under fire just because of how speculators have allegedly distorted the oil-price market in recent years.

This year’s volatility in the market defy the “accepted rules of economics,” French President Nicolas Sarkozy and U.K. Prime Minister Gordon Brown said in an opinion column published earlier this month in The Wall Street Journal.

“The surge in prices last year gravely damaged the global economy and contributed to the downturn,” the two statesmen said. “The risk now is that a new period of instability could undermine confidence just as we are pushing for recovery. Governments can no longer stand idle. Volatility damages both consumers and producers.”

Big Oil executives said it is doubtful the looming U.K.-based meeting would result in any substantial new initiatives, but added that it would discuss “whether the current arrangements [in the oil market] remain appropriate,” The Financial Times reported. “The question of position limits does not seem to have the same level of priority (in Europe) as it does in the United States,” Deutsche Bank AG (NYSE: DB) Chief Energy Economist Adam Sieminski told the FT.

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