Commentary: Big Oil's Priority: Pump Up the Stock Price

It has been the problem that won't go away: the skyrocketing price of oil. Already three times this year, OPEC has increased its oil production quotas in an effort to alleviate the pressure.

So what about the major non-OPEC oil companies, who, along with a number of non-OPEC nations, collectively produce more than half of the world's crude? Surprisingly, while OPEC is pumping harder than it has in decades, some of the world's largest oil companies are actually producing less. BP ( BPA) slashed its production by 4% and midsize producers such as Texaco Inc. ( TX) and Occidental Petroleum Corp. ( OXY) have been even less active. Both saw their worldwide oil output slide 7% in the first half of this year. Together, ten of the largest reduced their output by 0.4% in the first half of this year, according to a recent report from Merrill Lynch & Co. ''The lack of a production increase from non-OPEC sources is a big reason why prices remain high,'' says Merrill Lynch analyst Steven A. Pfeifer.

Many longtime industry watchers say that's because a new reality has set in among the world's oil titans. Wall Street has demanded that companies like ExxonMobil Corp. ( XOM) and the Royal Dutch/Shell Group ( RD) increase profits to buttress their long-languishing stock prices and avoid the boom-and-bust cycles that once defined the industry. Daniel J. Rice, manager of the $800 million State Street Global Natural Resources fund, is one of many money managers who, under threat of selling off shares, has continually pressured oil company executives not to overspend in the pursuit of production increases. ''We give them money, they produce a lot more, and the price goes down,'' he says.

The focus on profits has only been excacerbated as oil companies on Wall Street have had to compete for capital with technology companies and other outperforming stocks. As a result, the majors have reacted to the current crude price runup by being ultraconservative in pursuing new fields. ''The major oil companies are not responding to the high prices with significantly increased exploration and production spending,'' explains Pfeifer.

Consequently, last year, while prices were on the rise, oil companies replaced just 92% of their production through new discoveries. That was below their three-year average replacement rate of 95%, according to Arthur Andersen.

To be sure, the world's oil companies are not asleep at the well. This year, Merrill Lynch is expecting exploration and production spending at the companies it follows to rebound by 16% to nearly $34 billion. Unfortunately for the world's energy consumers, most of that spending is coming in the second half of the year and won't translate into new oil supplies for many months.

And not everyone is opening their spigots. Exxon and Royal Dutch slashed their oil exploration and production budgets by more than 30% in the first half of this year. At Chevron Corp. ( CHV), the cuts were less severe, but a still hefty 8% drop.

But with oil now bouncing around the mid-$30s, how do these producers continue to rationalize such tightfistedness? Many cite the fact that it was a scant two years ago that overproduction in the face of weakening demand from Asia caused the price of oil to fall to a meager $10 a barrel. Producers are naturally wary of a repeat. ''We take the long view of oil and gas prices,'' says Chevron Corp. Chairman and Chief Executive David J. O'Reilly. ''It's counterproductive to overreact to prices that are either atypically low or high.''

STIFF CRITERIA. Recent statements by some of the men who run the major oil companies reveal just how conservative they have become regarding their pricing forecasts and their production investment decisions. The key in determining new spending these days is not how high oil is--it's how far it could fall. BP Amoco PLC Chairman John Browne put out a press release in July that said his company only invests in projects that will be profitable at prices as low as $11 a barrel. ExxonMobil Chairman Lee Raymond told analysts much the same thing in August: ''All projects must meet our return-on-capital requirements in a low-price environment.''

Given such stringent investment criteria for new wells, it's no wonder that high prices have left the major oil companies gushing profits. At the ten large companies tracked by Merrill Lynch, net income more than doubled in the first half of this year, to $26.4 billion. ''The new mantra at the oil giants is conservative and cynical,'' says Arthur L. Smith, chairman of oil company researcher John S. Herold Inc. ''After years of being bludgeoned by institutional investors about their low returns on capital, they are out to prove they can make money.'' Faced with a choice between making Wall Street happy or pleasing the world's energy consumers, the major oil companies have clearly chosen sides.

By Christopher Palmeri
Palmeri covers the oil industry from Los Angeles.

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