What the Oil Majors’ Earnings Reveal

In a mixed quarter, refining clearly remains a sore point

   

When it comes to energy production, the integrated oil majors are truly in a league of their own. Among the world’s largest corporations, the group holds huge oil and gas reserves and is responsible for the bulk of the planet’s energy production. Their huge scale provides cost savings and other advantages many smaller firms could only dream of.

No wonder investors pay so much attention these giants’ earnings announcements. Generally, how the majors perform is a good indication for the rest of the sector and indicative of trends affecting the industry. With BP’s (NYSE:BP) latest quarterly numbers now in, most of the energy giants have reported.

And the more things change, the more they stay the same. Many of the same issues that plagued the sector last year and the previous quarter have continued. But there have also been plenty of exciting developments. This is a good time for investors to look back to get an idea of where we’re going. Here are some highlights from the oil patch’s latest quarter and some potential outcomes for the future.

Pain Keeps Flowing Downstream

BP’s recent lower-than-expected earnings announcement continues to highlight a growing trend for many of the integrated giants — terrible refining margins. While rising cost per barrel is great for exploration and production (E&P) revenues, it wrecks havoc on downstream refining profits. With crack spreads (the price difference between crude oil and refined products) under constant pressure, the refiners, especially those on the East Coast, are seriously hurting.

The British firm said the global benchmark, Brent crude, averaged around $118.45 a barrel in the first quarter, compared with $105.52 a year earlier. Profit in its refining and marketing division slipped to $2.3 billion from $4.4 billion a year earlier. While global margins have begun to improve since March, they still aren’t great. BP already has plans to dispose of its Texas City and Carson refineries by the end of this year.

That echoes similar moves by Chevron (NYSE:CVX), which sold all of its Spanish refining assets, as well as ConocoPhillips (NYSE:COP), which spun off its downstream unit into Phillips 66 (NYSE:PSX). Overall, refining continues to be a “goldilocks” situation, with firms needing nearly perfect conditions to produce a real profit — not too hot, not too cold. The majority of market strategists predict that 2012 will be a tough year for the sector, and Moody’s (NYSE:MCO) continues to keep its outlook on the global downstream industry at negative.

This is now the sector’s quarter of poor downstream results. With Brent forecast to remain high for the next few months, it’ll be interesting to see how many energy firms engage in sales or spin-offs of their refining assets in coming quarters. Even some smaller downstream-focused players are announcing spin-offs of their own. Marathon (NYSE:MPC) has plans to bundle some of its pipeline operations into a master limited partnership to separate itself even further.

Lower Production

The latest earnings announcements show another continuing another trend among the majors: Production continues to drift lower. The world’s biggest energy company, Exxon Mobil (NYSE:XOM) reported its biggest output drop since 2008. Likewise, Chevron, BP and Royal Dutch Shell (NYSE:RDS-A, RDS-B) all produced less oil than before.

Several factors are keeping the majors from pumping more oil and gas. Legacy fields continue to show their age and produce less as they get older. In addition, new wells and fields are tougher and more expensive to find and extract from. At the same time, many of the newest and biggest finds are located in nations that want to keep much of their oil revenue at home. Argentina’s recent nationalization of YPF (NYSE:YPF) is just one — albeit extreme — example.

This helps explain the recent high capital spending announcements this year. Overall, exploration efforts like Eni’s (NYSE:E) and Exxon’s forays into the Russian Arctic, and Shell’s Chinese shale gas ambitions will eventually bear fruit and become profitable. These moves will take time to realize their full potential, but are necessary for long-term survival. BP, on the other hand, continues to realize lower production based on its massive asset sales meant to help pay for its legal woes.

Despite the lowered production, the bulk of Big Oil saw higher earnings. Higher crude prices helped offset any difficulties with refining and production drops. Upstream operations continue to be the majors’ big money-maker. Even Exxon, which saw an 11% drop in profits managed to earn $9.45 billion. That’s mainly because it was able to sell oil for higher prices around the world and saw a 16% gain in international natural gas prices.

The end lesson for investors is that while production is dwindling, what’s produced is fetching a much higher price.

Returning More to Shareholders

More of the majors’ profits are also making their way back to shareholders. Buyback programs and dividends continue to expand. Exxon recently boosted its dividend by 21%, to $2.28 a year, the largest increase since it 1975. Not to be outdone, rival Chevron announced an 11.1% hike in its payout to $3.60 annualized.

Additionally, while Conoco has announced a post-spin-off slowing of its buyback program, it should yield a growing 4%. Shell also recently announced a slight increase to its interim dividend.

In the end, these dividend raises help underscore the fact the majors are cash-generating machines. Higher long-term profits will ultimately boost the firms’ bottom lines as well as investors.

A Mixed Quarter

All in all, it was an uneven period for the integrated energy firms. While all of them saw profits, the level varied dramatically, and some, like Exxon, reported less-than-stellar results. However, oil prices should remain high on both Mideast tensions and strengthening global demand. That’ll be bullish for E&P sector.

For investors, the majors often set the tone for the rest of energy world. Overall, lower production and issues with the refining and downstream segments remain the chief pressures on earnings. Look for similar results from smaller firms.

As of this writing, Aaron Levitt doesn’t own any shares mentioned here.


Article printed from InvestorPlace Media, http://investorplace.com/2012/05/what-the-oil-majors-earnings-reveal/.

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