A Weakening Oil Gusher?

As energy outfits notch another strong quarter, moderating crude prices and rising costs could weigh down future earnings

By Christopher Palmeri

These days, it's good to be in oil. The world's largest oil companies have begun reporting gushers of profit for another quarter. BP (BP ) hit first on Oct. 26, revealing that its earnings for the quarter ending Sept. 30 had surged 43%, to $3.9 billion, from $2.7 billion the prior year.

The following day, ConocoPhillips (COP ) reported earnings of $2 billion, up 54% from the third quarter of 2003. And on Oct. 28, ExxonMobil (XOM ) and the Royal Dutch/Shell Group reported earnings gains of 55% and 120%, respectively. Shell, seeking to simplify its structure after a reserves-related scandal early this year, also announced that it hoped to end a long-standing policy of trading as two separate stocks. Royal Dutch Petroleum (RD ), based in the Netherlands, and Shell Transport & Trading (SC ), its London affiliate, will merge, pending shareholder approval.


  Those strong results are largely a reflection of energy prices' climb. Oil has risen more than 70% in the past year. Natural gas, too, has exploded, up 70% since this time last year, to $7.70 per million BTUs. Gasoline sells for over $2 a gallon nationally, an increase of 50 cents a gallon, or 33%.

Strong worldwide demand remains the main culprit for those high prices. It's up about 3.4% this year, driven largely by a booming Chinese economy. Although uncertainty about oil supply from places like Iraq and Russia remains a problem, September's pounding from Hurricane Ivan in the Gulf of Mexico also dealt a severe blow to the region that supplies about 9% of U.S. oil consumption. Production there is down nearly 20%.

But the good times for oil producers may not last. For one, crude prices may have peaked, at least for the near term. The U.S. Energy Information Administration reports that crude oil inventories in the U.S. jumped by 4 million barrels for the week ending Oct. 22. That was more than twice the increase Wall Street had been expecting. The news sent crude prices tumbling nearly 5%, to $52 a barrel.


  And BP Chairman and Chief Executive John Browne says the rising cost of oil-field services like drilling rigs and the steel used in production platforms is forcing him to increase his capital spending. BP is expected to spend $14 billion next year, 12% more than originally forecasted, according to Deutsche Bank oil analyst J.J. Traynor. Whether oil companies can pass along such costs in in the form of continued higher commodity prices remains to be seen. Traynor expects BP's profits to fall about 16% overall, to $13.6 billion, next year.

While year-over-year earning growth has been strong, the changes from the second quarter have been far less dramatic. ExxonMobil saw its earnings decline nearly 2% from June to September, including the effect of special items and an accounting change. One big drag: Lower profits in the U.S. refining business, where crude's cost has risen far faster than prices at the pump.

This may be the high-water mark for oil prices and company earnings. But no one expects them to fall back to the $18 a barrel they averaged in the 1990s any time soon.

Palmeri is a senior correspondent in BusinessWeek's Los Angeles bureau

Edited by Beth Belton

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