Record oil price to boost oil majors' profits
April 25, 2008

LONDON (Reuters) - Exxon Mobil (XOM.N: Quote, Profile, Research), Royal Dutch Shell (RDSa.L: Quote, Profile, Research) (RDSa.L: Quote, Profile, Research) and BP (BP.L: Quote, Profile, Research) are expected to report bumper first-quarter profits next week, thanks to record crude prices, but $110 per barrel oil will also squeeze refining profits and delay a return to oil production growth.

Brent and benchmark U.S. crude prices rose around 70 percent in the first quarter compared with the same period last year, to average almost $97/bbl and $98/bbl, respectively, while gas prices also rose.

Earnings growth, though generally strong, is lagging behind.

"The profitability of the industry is clearly not as robust as the headline oil price might at first imply," Lucas Herrmann, analyst at said Deutsche Bank said.

London-based BP, which is undergoing a restructuring under Chief Executive Tony Hayward who took over a year ago, is expected to be the strongest gainer in the industry's top tier.

Nine analysts polled by Reuters said, on average, they expect BP to report a 31 percent rise in net replacement cost profit, which is comparable to U.S. net income, to $5.3 billion, excluding one-off items.

The world's largest non-government-controlled oil company by market value, Exxon, is expected to see net income rise around 22 percent to over $11 billion in the first quarter.

Industry number 2, Shell, is expected to report only a 4 percent rise to $6.8 billion in current cost of supply net profit, its measure, which is also comparable to U.S. net income as it strips out gains in the value of inventories, excluding one-offs.

One reason that profit growth lags oil price rises is taxes, and higher prices have encouraged governments from Russia to Venezuela to hike these.


Another reason for the relatively muted profit growth is the increasing use of production sharing contracts (PSCs) with host governments, under which companies receive a return based on the value of their investment, and so have limited exposure to oil prices.

Under traditional royalty schemes, which still dominate in OECD countries, companies own the oil or gas field and reap the gains when prices rise.

Under PSCs, companies are paid in crude, but they receive less oil if prices rise. Hence, the big jump in crude prices in the first quarter also means investors will have to wait for the sector to deliver a long-awaited return to output growth.

Analysts predict Shell's oil and gas production will have fallen over 3 percent to 3.2 million barrels of oil equivalent per day (boepd), compared with the same period in 2007.

Analysts said Exxon's first-quarter output may also fall from last year, when it was 4.12 million boepd, while BP's is forecast to be flat at 3.9 million boepd.

After three years of falling production as mature fields decline and new finds are harder to locate, partly because resource holders reserve the richest prospects for their state oil companies, investors had hoped 2008 would be a year of growth for the industry.

Analysts predict a drop of up to 1 percent in production, on average, across the sector in the quarter but remain optimistic growth may return later this year.

High oil prices are also putting pressure on refining margins, which halved on average across the globe in the first quarter compared to 2007, according to data from BP.

Refiners found it hard to pass on crude rises to customers in full, especially in North America.

BP's largely U.S.-focused refining division is expected to report a loss for the quarter despite facilities previously shut-in coming back on line.

Across the major oil companies' businesses, costs are expected to have continued rising.

A tight market for oilfield services, equipment and facilities construction -- partly because high crude prices are driving increased drilling and development -- has led to input inflation which some executives said is running at an annual rate of 20 percent.

Analysts at Dresdner Kleinwort said rising capital costs would likely mean Shell had net cash outflow for the quarter, after paying dividends and buying back shares.

Such an outflow despite the oil and gas price environment would add to investors' concerns that high oil prices may mask an industry failure to contain costs, implement projects effectively and make businesses grow.

"The sector has "form" in eroding macro upside with operational under-delivery," analysts at Citigroup said in a research note.

(Additional reporting by Michael Erman in New York; Editing by Quentin Bryar)

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