The Truth About Big Oil

For the record, Big Oil ISN'T suffering because of $96-a-barrel oil. Its bottom-line ISN'T worse off than at $25-a-barrel oil. The companies are profiting, and doing so handsomely.

This is important because, if one listens these days to Big Oil, such as in a piece yesterday in The Wall Street Journal, one might be led to get out the Kleenex.

In it, my former WSJ colleague Guy Chazan quotes a BP man, Bob Dudley, who runs the company's TNK operations in Russia, saying the following: "In general, it is the governments who are the big winners when prices reach new heights."

That statement is wholly misleading. It's rooted in a couple of facts about oil contracts abroad: when oil prices are low, the host country suffers the most, because regardless of the price, the companies get to use the same portion to pay off the bills for developing the field.

But when oil prices are high, a sliding scale is triggered that allows the country to earn a higher percentage of the price. The companies earn much more, but not as high a percentage as they do at $25 oil.

Alice-in-Wonderland Big Oil is arguing that somehow its current profit slide is partly attributable to high prices -- that those dastardly contracts they signed earn them lower absolute profit per barrel at $90 a barrel than at $25.

I think we can say with some confidence that if any oil lawyer did negotiate such a contract, one giving the company fewer absolute dollars at $90 than $25, he or she would not only be fired on the spot, but would quite possibly be liable for violation of fiduciary duty to shareholders.

A subtext involves how Wall Street values the companies, and what happens at the actual oilfield under high oil prices. Under all these contracts, the companies commit a lot of the barrels produced at the field -- say 100,000 barrels a day -- just to pay off the bills first. They call that "booking" the barrels. And, Wall Street -- understanding that one day those bills will be paid and the barrels turn to profit -- runs up the companies' share price based on those "booked reserves."

Now, since the bills are being paid off at Ferrari speed, the companies are "unbooking" reserves. So with fewer reserves, say the companies, Wall Street is valuing them less.

Again, the argument is muddled -- Wall Street is not so stupid as to be blind to Big Oil's historically unprecedented profit.

Instead, what Wall Street may in fact be seeing is Big Oil's low horizon. As Chazan quotes Stephen Thornber, global equity fund manager at Threadneedle in London (who Chazan says is now buying the shares of state-owned oil companies and oil services companies, which in my view is a forward-looking strategy that understands the industry's dismal future): "The majors are like dinosaurs. Their production is flat or falling, and their returns are under pressure."

Photo: Jan Tik
Rights: Creative Commons