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Will Oil Profits Run Out of Fuel?

By Christopher Palmeri If oil company executives still acted like James Dean in the classic film Giant, this would be the week they grabbed their hats and screamed "Yee-hah!" amidst a gusher of crude. The reason: High energy prices are fueling record earnings at some of the industry's largest players.

Occidental Petroleum (OXY) got the ball rolling on July 19 when it announced an earnings increase of 55%, to a record $581 million, or $1.48 a share. On July 27, BP (BP) and Marathon Oil (MRO) followed with 23% and 42% second-quarter profit hikes, respectively.

On deck are Amerada Hess (AHC), ConocoPhillips (COP), and Murphy Oil (MUR), which report on July 28. ExxonMobil (XOM), Royal Dutch Shell (RD), and Apache (APA) are expected to announce their results on July 29, with ChevronTexaco (CVX) and Anadarko Petroleum (APC) releasing their earnings the following day.

DARK CLOUDS. Reuters Research expects profits for the 15 largest U.S.-based oil outfits to jump 44%, to $13.5 billion, for the quarter. Many analysts are expected to bump up their earnings estimates for the year and their price targets for energy stocks, based on the strong results. The average oil company stock is up 13% this year, while the benchmark Standard & Poor's 500-stock index has been flat.

However, these shares might be running out of room to rise much more. Even after a bang-up quarter, A.G. Edwards oil analyst L. Bruce Lanni has a price target of just $55 for BP, which is currently selling for $53.80.

Some dark clouds lurk on the horizon. World economic growth -- the big driver of increased energy demand -- has begun to slow. And gasoline refining margins are running at record levels. That has led to higher imports to the U.S., where gasoline inventory has begun to build up, even during this peak summer driving season. So, companies heavily dependent on refining earnings, such as ConocoPhillips and Marathon Oil, could see profit pressure in the second half of the year.

RESTRAINED PRODUCTION. Sadly for energy consumers, the current profit surges are almost entirely the result of increased commodity prices. At $41 a barrel, crude is 36% higher than this time last year. Although crude prices fell briefly in June after reports that OPEC planned to increase production in coming months, they've crept back in recent weeks and remained there. Meantime, retail gasoline prices are down about nine cents from their late-May peak of just over $2 a gallon. Still, at a national average of $1.91, regular unleaded remains 25% higher than it was last summer.

Despite the profit windfalls, few oil companies are dramatically increasing oil and gas production. Marathon lowered its 2004 production forecast to about 360,000 barrels of oil, from the previous estimate of 365,000 barrels. It attributed the reduction to delays in projects in Equatorial Guinea.

Although BP reported a huge jump in production of 18%, that was entirely due to a big investment in Russian oil company TNK International. Were it not for that, BP's production would have been lower in places such as the North Sea, the Gulf of Mexico, and Trinidad. Deutsche Bank oil analyst JJ Traynor figures that oil and gas production at the large companies he follows actually declined 2% in the quarter.

COOLING PRICES? That may not bode well for the long term, but investors are benefiting in the short term. Rather than spend more exploring for energy, oil companies are buying back their own stock and increasing dividends. BP, ChevronTexaco, and Shell have all announced big share repurchases, following similar strategies employed by ExxonMobil and Total. That has helped create record returns on capital for the major oil companies. Good news for shareholders, bad news for energy consumers.

Meanwhile, the cost of finding oil and gas is rising. Big new fields are harder to find. And high steel prices coupled with a falling U.S. dollar have made oilfield-equipment purchases more expensive.

Right now high energy prices are producing high-octane earnings on Wall Street. But those prices are likely to retreat in coming months. And if that happens, it'll be energy consumers, and not the oil executives or investors throwing their hats in the air. Palmeri is a senior correspondent in BusinessWeek's Los Angeles bureau

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