Higher prices a boon for upstream, a bust for downstream

Higher commodity prices, more production, and increased drilling activity improved third-quarter profits for many upstream companies. But increased costs for oil and gas reduced margins for some downstream operations, analysts said.


Higher commodity prices, more production, and increased drilling activity improved third quarter profits for many upstream companies. But increased costs for oil and gas reduced margins for some downstream operations, analysts said.

"It was an outstanding third quarter for E&P results, with oil prices up about 10% and gas prices up about 20% from the second quarter of this year," said Stephen A. Smith, who tracks both independent and major integrated companies for Dain Rauscher Wessels, a division of Dain Rausher Inc.

It generally was a good quarter, too, for refining and marketing, Smith said. "Domestic refining and marketing pulled back some, while overseas operations picked up a little," he said. "The overall result may have been down a little from a strong second quarter."

Smith expects better or comparable results for energy companies as commodity prices continue to climb during the final quarter of 2000. He predicts another 10% increase in natural gas prices, "averaging closer to $5/Mcf" over the fourth quarter, with the average oil price up about $1/bbl from the third quarter.

Many independents reported record earnings during the latest quarter, with higher commodity prices generating a fountain of cash flow that they are using to pay down debt and to step up drilling.

"But they're not going to want to step up drilling too high or too fast," Smith said.

Lack of rigs, equipment, and workers will curb any sudden urge for wild spending among producers, as oil field service companies across the board begin collecting their share of the tightening market.

However, petrochemical operations were squeezed by higher prices for both oil and gas during the latest quarter. "They took probably a 30% hit from second-quarter levels," said Smith.

That means no fourth-quarter improvements for that segment as commodity prices continue to rise through the rest of the year, he said.

Major companies
Major exploration and production companies noted record earnings and revenues during the third quarter, thanks to higher commodity prices, increased drilling activity, and improvements in cost efficiencies and refining margins.

ExxonMobil Corp. said it set a third consecutive quarterly record for earnings and revenue, with third quarter net income rising more than $2 billion to $4.49 billion from $2.18 billion for third quarter 1999.

"As was the case last quarter, the majority of the improvement in profits came from outside the US and from our upstream business due to higher crude oil and natural gas prices," said ExxonMobil Chairman Lee R. Raymond.

The company's efforts to improve its operating efficiency also helped boost net income and revenues. ExxonMobil reported increases in oil and gas production from new production in the North Sea and Venezuela and increased production from existing operations in eastern Canada and Alaska.

Chevron Corp. also achieved record earnings during this year's third quarter, recording net income of $1.5 billion for third quarter versus $582 million for third quarter 1999.

"Higher profits as our US refining and marketing business this quarter complemented the very strong performance we've seen all year from our exploration and producing regions," said Chevron Chairman and CEO Dave O'Reilly. "Our oil and gas production results continue to reflect the financial benefit of not only higher commodity prices but also increased production�the direct result of our continued strategic focus on growing the upstream side of our business."

Texaco Inc. also posted record third quarter net income, which rose to $798 million from $387 million recorded for third quarter 1999. Aside from higher oil and gas prices, Texaco's net income was lifted by the production results from its Petronius field in the Gulf of Mexico, which started in July.

But Texaco's marketing margins in its downstream business, especially in its Caltex unit, "remained under pressure as higher crude oil costs could not be fully recovered in the marketplace," said Texaco Chairman and CEO Peter I. Bijur. Texaco's capital and exploratory spending rose $600 million during 2000 as Texaco continued investing in major upstream development projects and in alternate energy and power projects.

Royal Dutch/Shell Group reported a 29% increase for its third quarter net income to $3.06 billion from $2.4 billion this time last year. Shell said higher oil and gas prices gave Shell's earnings a major boost, while higher refining margins and cost improvements, partly offset by reduced marketing and chemicals margins, also caused income and revenues to surge.

Shell said the chemical cracker market outlook is mixed as chemicals' cracker margins for the third quarter fell from stronger levels seen during the second quarter as feedstock costs continued rising and downstream margins remained under pressure.

BP reported third quarter 2000 net income of $3.7 billion, up from $1.9 billion for third quarter 1999. BP Chief Executive John Browne said the company's improved returns have allowed it to buy back shares and increase its dividend. Reductions in the combined cost structure of BP and Atlantic Richfield Co., with which BP completed its merger earlier this year (Oil & Gas Journal, April 24, 2000, p. 26), are proceeding according to plan. About 75% of the $2 billion year-on-year cost reduction target had been achieved at the end of this year's third quarter, a statement said.

Independent E&P firms
Independents are cashing in on higher prices for natural gas in the expanding US market, although many companies had earlier hedged much of that production at lower prices. "But hedging is about to get a lot lighter as those contracts expire," Smith reported.

EOG Resources Inc. reported its "best ever" operational results during the third quarter, which marked its first anniversary of independence from its previous parent, Enron Corp.

"The key drivers for the quarter were volume growth, combined with our unhedged natural gas position," said Mark G. Papa, chairman and CEO. "Most importantly, EOG's increase in North American production has been from the drill bit, an increasingly difficult challenge for our industry." The Houston-based independent reported net income of $113.7 million for the quarter, up from $32.5 million a year ago.

Other third quarter net income comparisons among independents, in millions of dollars, included: Kerr-McGee Corp., 264.6 vs. 97.7; Apache Corp., 201.3 vs. 67.8; Burlington Resources Inc., 200 vs. 61; Mitchell Energy & Development Corp., 74.4 vs. 25.9; Vintage Petroleum Inc., 57.4 vs. 27.3; Cross Timbers Oil Co., 31.8 vs. 13.5; Pogo Producing Co., 26.9 vs. 2.7; Meridian Resource Corp., 25.4 vs. 6.4; McMoRan Exploration Co., 25.4 vs. (1.3); Triton Energy Ltd., 10.3 vs. 4.4; Frontier Oil Corp., 10.1 vs. 8.4; Carrizo Oil and Gas Inc., 4.9 vs. 0.3; and Harken Energy Corp., (1.7) vs. 4.

Diversified energy companies
Diversified energy firms continue consolidation to achieve critical mass, as the industry expands into telecommunication and bandwidth trading. The market is rewarding the most innovative companies, analysts said.

Dynegy Inc.'s third quarter earnings jumped to $235 million, up sharply from $50.7 million a year ago, with its April acquisition of Illinova, a utility holding company.

"This is the most successful quarter in Dynegy's history," said Charles L. "Chuck" Watson, chairman and CEO. He said the Houston-based company is "poised to benefit from one of the most dynamic energy markets in recent years, both domestically and internationally, through strong internal growth opportunities and continued strategic asset acquisitions and development."

Enron Corp.'s earnings edged up to $292 million in the latest quarter from $290 million a year ago. The 1999 earnings included a gain of $345 million from sale of its Enron Oil & Gas Co. stock, which was partially offset by a $292 million charge reflecting the impairment of Enron's methyl tertiary butyl ether asset.

Nevertheless, the firm's wholesale and retail energy businesses "achieved record-setting levels of physical deliveries, contract originations and profitability" in the latest quarter, said Kenneth L. Lay, Enron chairman and CEO.

Similar comparisons of third quarter net income, in millions, among integrated energy companies include: El Paso Energy Corp., 137 vs. 39; Williams, 121.1 vs. 28.1; LG&E Energy Corp., 85.7 vs. 87.2; SEMCO Energy Inc., (4.7) vs. (2.2); and Columbia Energy Group, (63.8) vs. (22.7).

Upstream service-supply
Increased drilling activity worldwide produced a profitable quarter for many service and supply companies.

"Our financial results have begun to reflect the improving market conditions that began in late 1999. We expect our results to continue improving through the coming year as the rig market recovery, which initially began in the US Gulf of Mexico, continues to strengthen and expand internationally," said Bob Rose, chairman of Global Marine Inc.

The Houston-based marine drilling contractor's earnings jumped to 32.3 million in the quarter from $13.8 million last year.

Quarter-to-quarter comparisons, in millions, among other service companies, included: Santa Fe International Corp., 27.8 vs. 27.2; Petroleum Geo-Services ASA, 17.3 vs. 20.1; Grant Prideco Inc., 7.3 vs. (10.4); and Parker Drilling Co., (1) vs. 1.3.

Refining
"Refining margins in the western US were very high, reflecting the tightness of supply and refining capacity in that region. We capitalized on these conditions by operating our refineries at historically high rates, even with a turnaround in Hawaii in September," said Bruce A. Smith, chairman and CEO of Tesoro Petroleum Corp. in San Antonio, Tex.

But the company's improved margins were partially offset by a decline of $18.8 million in non-refinery profits from product and crude marketing. As a result, Tesoro's quarterly earnings dipped to $23 million from $23.3 million a year ago.

Giant Industries Inc. in Scottsdale, Ariz., reported earnings of $5 million during the quarter, up from $3.5 million a year ago.

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