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Exxon's Silver Lining Has A Cloud


It would be an exaggeration to say that oil company executives don't like high oil prices. But only a small exaggeration. The celebrating is certainly muted in Irving, Tex., where on Jan. 30 Exxon Mobil Corp. (XOM) reported the biggest annual profit in U.S. history: $36 billion. "We don't get excited in the highs and we don't panic in the lows," a spokesman says.

Hard to believe, but oil at more than $60 a barrel creates big headaches for Big Oil. It angers both customers and Congress, which once again is making noises about a windfall profits tax. Shareholders aren't especially grateful, either, seemingly operating on the belief that any idiot could make good money selling oil at the highest prices ever. At around $62, ExxonMobil's share price is no higher than it was last March.

But the biggest problem with costly oil is that it makes it tougher to line up new supplies. Countries that sit on lots of oil -- such as Iran, Kuwait, Libya, Russia, Venezuela, and Nigeria -- drive harder bargains with the supermajors like ExxonMobil when oil prices are high. Oil-rich nations are reluctant to part with irreplaceable natural resources at prices below where they stand now. The Western oil companies want to cut deals on the assumption that oil will drop back to $25 or $30 a barrel. But that's hard to argue when the oil for delivery in December, 2012, is trading at $64.

When the supermajors can't negotiate access to new fields, their production drops. This isn't just hypothetical: The most important fact in ExxonMobil's quarterly earnings report was that oil and natural gas production fell 3.6% in 2005 from 2004, continuing a five-year downtrend. (Excluding onetime factors such as hurricanes, it fell 1%.) If the company can't ramp up output by getting access to new fields, it will be a cash cow slowly going dry. Not a good prospect.

Fortunately for ExxonMobil and for consumers, it appears that its production is indeed rising again. Analyst Daniel L. Barcelo of Banc of America Securities (BAC) in New York estimates that its output will grow around 5% in 2006, with increased flow from Angola, Nigeria, Azerbaijan, the U.S. Gulf of Mexico, and Norway.

It's a struggle, though. Big Oil's negotiations over production-sharing deals have gotten seriously sticky. Libya opened itself to foreign investment in December, 2003, after it renounced terrorism and weapons of mass destruction, but it wasn't until last year that it finally came to terms with its erstwhile U.S. partners. The expected price of crude was a big part of the hangup. Exxon has been battling Venezuela, led by leftist Hugo Chávez, who insisted that all foreign oil companies convert their operating contracts into joint ventures with the government. In December, Exxon sold its stake in one Venezuelan oil field rather than meet the country's demands. Even Britain whacked the oil majors last year, increasing taxes on North Sea oil.

PILE OF CASH

Behind the skirmishes is the inescapable fact that countries awash in oil revenue simply don't need the deep-pocketed Western majors as much as they did in 1998, when oil touched $10 a barrel. Meanwhile, today's high prices are attracting competition for deals from smaller rivals, which tend to accept smaller profit margins. And costs are going up along with prices. The new oil is hard to reach or of low quality, like the gunk in Alberta's "tar sands."

Oil is like the bond market in that a price rally, while welcome, creates reinvestment headaches. Bondholders make a killing when bond prices rise, but when the bonds mature they're stuck with a pile of cash that they're forced to reinvest at lower yields. Ditto for oil executives when oil prices rise. ExxonMobil has a hoard of $33 billion in low-yielding cash in spite of paying $7 billion in dividends and buying back $16 billion of shares last year. "It gets harder every year" to put the money to good use, says analyst Jacques Rousseau of Friedman Billings Ramsey. Oil shareholders know what the oil executives have done for them lately. They're asking a tougher question: "What will you do for me next?"

By Peter Coy


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