Rising costs erode oil industry's profits

From the Financial Times

By Ed Crooks in London

Published: September 3 2008 23:36 Last updated: September 3 2008 23:36

Oil companies’ profitability fell last year as rising costs eroded gains from the rise in oil prices, an industry study has found.

The companies’ return on capital from their oil and gas production fell to 19 per cent, 3.5 percentage points lower than in 2006, according to the study from IHS Herold, a research firm, and Harrison Lovegrove, a corporate finance firm owned by Standard Chartered bank.

The study of 232 leading quoted oil and gas companies also found that they had not increased their total reserves last year, and raised production only slightly.

Rodney Schmidt of Standard Chartered suggested that if oil prices continued to fall, oil companies could face growing difficulties. “We are now at a point of greater uncertainty...where there are questions about demand and about where prices will end up. At the same time, profit margins have not been increasing.”

Company profits have been squeezed because costs have risen along with revenues, and governments of resource-holding countries have been taking a greater slice of the proceeds through tax increases or contract renegotiations.

Although big companies have still been making record profits, they have also had very high levels of capital expenditure. Organic capital spending, excluding acquisitions, has soared from $139bn in 2003 to $342bn last year, the study found.

The result has been that, in spite of the steep rise in oil prices over the decade, profitability has risen only slightly from 16.5 per cent of cumulative capital costs in 2003 to 19.1 per cent last year.

The difficulties facing the industry are also reflected in slow production growth, which averaged just 1.3 per cent last year. Production increases in the US, Russia and the Caspian area and the Asia Pacific region were offset by declines in Canada, Europe, and South and Central America.
Companies also found it hard to add to their reserves: proved oil reserves dropped by 1.5 per cent, while gas reserves rose 3.3 per cent, reflecting a shift by many international companies away from oil towards gas, which is often more difficult to extract and market profitably.

Copyright The Financial Times Limited 2008