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

Where's My Cut?

What does $86 oil mean in the former Soviet Union? More muscular attitude from Russia's already swollen President Putin, and greater petro-assertiveness from Kazakhstan.

Putin is on his way to Tehran, where there will be much in the way of chest-beating from him and the leaders of the other Caspian Sea states with whom he is meeting tomorrow.

But Kazakhstan in particular will be in a fighting mood over the now 41% surge in crude oil prices this year (read New York Times account). Why, when it is earning more money than it ever expected from contracts negotiated years ago on the basis of $17-$20 a barrel oil?

Because it would be receiving much more money had its foreign partners -- Big Oil -- fulfilled their word and begun producing oil by now at the supergiant Kashagan oil field. The Italian-led consortium -- which includes most of the big names in Big Oil -- was supposed to produce the first barrel in 2005, but now says that won't happen before 2010.

Some people interpreted a recent public remark by Kazakhstan President Nazarbayev as proof of a calming ocean on the topic of Kashagan. If it was, the storm is back.

Over the weekend, Prime Minister Karim Massimov made that plain with a renewed demand for a higher state stake in Kashagan, according to a report in The Independent of London. If he was having sleepness nights over such assertiveness, it did not show, as he said there was "big line of potential investors" should anyone be excessively discomfitted.

Chevron is in the same stew. The California company cannot seem to close a deal with Russia over doubling the size of the dedicated export pipeline from Kashagan's sister oilfield, Kazakhstan's supergiant Tengiz, of which it has a 50% share. That is sure to slow down and complicate Chevron's plans to vastly increase Tengiz production next year, and to vex Kazakhstan over the relative stagnation of its bottom line.

Kazakhstan has already made it plain to Chevron that, as with the Kashagan partners, it means business. It recently levied a $609 million environmental fine for sulfur deposits from Tengiz, demonstrating that the country expects the companies to think of Kazakhstan, too, when they are counting their windfall profits.