Fundamentals look strong for US-based, integrated oil and gas companies at the start of 2005, although the firms are unlikely to achieve the record earnings and refining margins of 2004.
"The likelihood of 2005 being a déjà vu experience is low unless world GDP [gross domestic product] growth remains on track, and OECD [Organization for Economic Cooperation and Development] and other nations get comfortable with the idea of a low US dollar," said Merrill Lynch & Co. analyst John Herrlin of New York.
In a Jan. 4 research note, Herrlin estimated the six integrated companies that he covers will generate $32 billion in free cash flow in 2005, compared with an estimated $38 billion in 2004.
Companies probably will use free cash flow to increase common stock dividends or repurchase shares, he said.
Most integrated companies have rationalized nonstrategic assets, and they are expected to increase upstream volumes by 3.5%/year through 2008.
"From the start of 1994 until 2003, these six companies returned $124 billion to shareholders with dividends and common stock buybacks, which was 71% of their market value in 1994," he said.
The six integrated companies that he covers are Amerada Hess Corp., ChevronTexaco Corp., ConocoPhillips, ExxonMobil Corp., Marathon Oil Corp., and Murphy Oil Corp.
Trends
"The focus, at least at the start of the year, will be on commodity prices, and warmer US weather could affect both oil and natural gas pricing," Herrlin said.
Last year, commodity and stock markets recognized the effects of shrunken spare production capacity and longer project lead-times. In addition, the effects of a weakened US dollar were recognized, and the lower dollar value mitigated higher oil prices abroad, he said.
"This isn't a just-in-time manufacturing business given the variety of oils produced and refining capacity limitations, and thus there is always potential for short-term supply and demand balance hiccups as witnessed in 2004," Herrlin said.
Integrated companies have learned that the industry needs to build more production and refining capacity. The additional capacity will take time and likely will cost more per unit than in past price cycles, he said.
Another 2004 trend likely to continue into 2005 is little oil demand sensitivity to high prices in OECD nations, Herrlin said.
For the last 10 years, the US-based integrated sector's worldwide oil and gas production has been static, but Herrlin believes that production growth is returning. Merrill Lynch said the integrated companies in its coverage universe produced 3.1 billion boe in 1990 and 3.4 billion boe in 2000.
Merrill Lynch estimates that the companies produced 3.28 billion boe in 2004 and forecasts that they will produce 3.37 billion boe in 2005 and 3.5 billion boe in 2006.
Downstream
Refining and marketing were very profitable during 2004. The downstream sector might not match that strength during 2005, but it still is expected to generate good earnings and cash flow, Herrlin said.
Merrill Lynch believes "a modest retracement in annual average margins is likely." The firm forecasts global refining margins of $6/bbl in 2005, down from more than $8/bbl in 2004 but still above the $4/bbl average during the 1990s.
Meanwhile, global refining capacity utilization remains tight, Herrlin said.
"Global capacity utilization jumped 2% to 87% in 2004, and the issue of the market's limited ability to process increasing volumes of heavy and sour crude oil gained wide recognition. There is no quick fix for these issues, and we expect tight utilization and wide discounts on heavy and sour crude oil to continue in 2005," he said.