Saturday, August 1, 2009

Big Oil's Profits

I read with great interest articles on the profit reports from the major oil companies. Chevron's in particular intrigued me. The company's profits are down 71%, which is no big surprise given the swings in oil and gas prices. What was interesting is that one of the cost cutting measures the company is undertaking is the cessation of North American natural gas drilling. "By the end of the year, we will not have a single gas land-rig running," said George Kirkland Chevron's EVP for global upstream oil and gas. It almost sounds like he's proud to say it.

Clearly Chevron's assets are in fields that are not economical at these low prices. Being a Big Boy, they don't have to submit to drilling at unprofitable levels. But it got me thinking about something that Chesapeake Energy likes to say. They contend that the companies that participate in the major North American shale plays are the "haves" and those who don't have a meaningful presence there are the "have nots." I'm sure Chesapeake started making that statement before the reality of this extended period of depressed gas prices, but it is starting to look like a prescient statement. Rig counts in the U.S. have more or less stabilized, but given Chevron's sentiment, there is still some downward pressure. But look at this week's rig count. Rigs are stable in the Haynesville Shale region and have grown in recent weeks. The producers say they are making money and the newest wells are showing some really impressive flow rates. Because most of them have a time constraint to hold these expensive leases by production, many don't have any choice but to drill. Still, if prices remain low it will be telling where companies continue to drill.

It also got me thinking of a time five years ago. I was involved with a company that served producers in the Gulf of Mexico. The chairman of the company called me excitedly when oil hit $50 and said, "it's going to $60!" Those were heady days but nothing like oil at $130, which seemed to reset companies' expectations for profits. Another friend calls it the "high water mark mentality." Things were awesome at $60. Until companies saw profits at $130. Now $60 is a pittance. One thing that has changed is the magnitude of the recession. I can certainly understand conservatism in the face of economic uncertainties, but it's amazing what a price spike can do to expectations.

I'm certainly not shedding any tears for Chevron. They operate in a cyclical business. It's the reason why a windfall profits tax will never get past the conversation/argument stage. The ultra-high profits are unsustainable. They'll just have to settle for obscene profits.

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