Option Investor

Major Energy Earnings On Tap

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Energy earnings increase significantly this week headlined by Exxon and Chevron. The earnings reports we have seen have been positive with Schlumberger the strongest so far. Conoco reported last week and although earnings fell -19% there were plenty of charges and special circumstances offsetting the drop. Conoco still beat their previously lowered expectations and analyst estimates of $1.95 with earnings of $2.08 per share.

Of those companies already reported the story has been pretty much the same. Finding oil is tougher, getting it out of the ground is more expensive and depletion is eroding existing production. The drop in energy prices also took their toll but not as much as you would think. Conoco said weather delays and slowing production from their fields in the northern Rockies was a drag on earnings. They increased investments in exploration to $391 million in Q4 compared to $229 million in Q4-2005. Conoco also said production declines in Venezuela and uncertainty around the globe was weighing on its outlook. With the new wave of socialism in Russia I fear Conoco's $20 billion investment in Lukeoil is increasingly at risk. Were it not for Russia I would be a strong buyer of COP.

Exxon reports earnings next Thursday and analysts expect $1.51 per share on revenue of $100 billion. This will be a drop of -9% from Q4-2005 and -16% from Q3. Exxon raked in $37 billion in profits in 2005 and that will be hard to top in 2007. Prices received for oil have dropped an average of $11 per bbl and refining margins have declined with the price of oil. UBS said upstream costs for the integrated oils has risen +11% year over year while upstream profits have decreased by a like amount. The new energy bill repeals $14 billion in subsidies for gulf exploration and raises the royalties $9 per bbl of oil produced. This will further depress profits from those companies exposed to the measure. You can bet that they will be begging oil companies to increase exploration in the Gulf within the next 10 years and offering additional incentives to do so.

Companies in the portfolio reporting next week include:

Mon - TSO (date changed)
Wed - HES, SUN
Thr - MRO, VLO

Some companies not in the portfolio:

Tue - SII, WFT

Earnings the following week include:

5th - GRP, HERO, HEP
6th - ATO, ATW, CCJ, NOV
7th - BHP, DVN, ICO
8th - DO, NFX

The price of oil surprised almost everyone with a continued rise this week to test resistance at $55.50 repeatedly. The gains were blamed on nearly every reason imaginable except the most obvious. A colder weather forecast for February suggesting a draw down in heating oil supplies was one reason. Continued attacks in Nigeria and pledges from the rebels to continue the fight was given as another. The increased rhetoric against Iran was also seen as the U.S. drawing closer to an Iranian conflict and a possible drop in output from that country. Venezuela's almost daily call for OPEC to cut production further was seen as the squeaky wheel that might eventually get some attention. In a surprising move Venezuela ordered production cuts of 106,000 bpd from four projects in the Orinoco belt as part of its 138,000 bpd OPEC cut allotment from November 1st. It is now nearly Feb 1st and VZ is just now getting around to making the cuts called for as of Nov-1st. VZ did not say where the additional 32,000 bpd would be cut. VZ is also facing another quota cut of 57,000 bpd as of Feb-1st for the second round of OPEC cuts. If OPEC bad boy Venezuela is finally going to actually cut production then prices have a good chance of continuing their uphill move.

OPEC has never been known for following through with production cuts without a lot of arm-twisting by the OPEC leaders. The fact that Venezuela is finally going to do something other than whine about prices suggests somebody was leaning on Chavez pretty hard. He needs that oil money more than most OPEC members to support his regime and keep his socialist programs running. I am very surprised he is actually going to make the cuts and that suggests to me that OPEC is serious about pushing prices higher. Conoco also said that Libya ordered a cutback in Conoco's production to bring it inline with its reduced OPEC quota.

We also saw the drop to $50 the prior week as an expiration week event. Many traders see that $50 level as strong support and the rebound has brought a lot of fence sitters off the sidelines in hopes of getting in on the ground floor for the next market uptick. A bounce in natural gas prices also lent support to oil. Gas prices spiked to $7.60 after a -149bcf drop in supplies from the cold weather in the northeast. Supplies are still 21% over the 5-year average and it would take a new ice age to exhaust them in this cycle. However, because last years withdrawals in Jan/Feb were well below normal we could see some numbers reported this year showing higher demand for that period. This could provide some upward pressure for prices even though it is just an anomaly and not a sign of increased demand. Gas futures expire on Monday and that should produce some additional volatility in both gas and oil.

Saudi Arabia is expected to award a $1 billion contract to Belgium dredging contractor Jan De Nul to build a 41 kilometer causeway into the Manifa offshore field. The contract will also call for the construction of several "drilling islands." This is part of a $10 billion effort to develop this field with future production of 900,000 bpd. The causeway, produced by dredging dirt from the bottom of the shallow water and creating an elevated base for a highway, will also involve creating 4 oil pipelines and a water supply system. Saudi plans to inject 1.35 mbpd of aquifer water into the field to maintain pressure as the oil is removed. The causeway is expected to be completed in 2009 with the addition of the 900,000 bpd of heavy crude scheduled for 2011.

BHO said this week the Atlantis project in the Gulf will cost an additional 50% to bring into peak production. This raises the cost to $1.5 billion with production expected to begin late in 2007. BHP own 44% and BP 56%. Production capacity is estimated to be 200,000 bpd and 180,000 mcf of gas. Atlantis was supposed to begin production in 2006 but it was delayed after BP's Thunder Horse project had sub-sea manifold problems in the deep water. BP decided to take another approach to engineering the Atlantis manifolds. Production at Thunder Horse has been delayed nearly a year by the technical problems.

The DOE released data showing a substantial drop in supply trends over the last 60 days. The graphic below shows the dramatic deviation of actual inventory levels (red) with average inventory ranges (blue). The extreme deviation narrowed substantially in December and early January and came very close to falling into the normal range. If these lagging OPEC are really going to occur and colder weather is going to linger for 2-4 weeks as expected we could see supplies quickly fall back into the normal range. This would eliminate the appearance of a glut and remove some of the volatility from the market. If the production cuts stick then prices should rise into the summer as we head into hurricane season once again. That is a lot of "ifs" but it is what drives the market.

Pemex, the state owned oil company in Mexico, has begun to cancel contracts for oil exports to the U.S. due to accelerating declines in existing production. Pemex currently produces 3.3 mbpd and exports 1.5 mbpd to America. Pemex expects to cut exports to the U.S. by 150,000 bpd in 2007 with cuts rising to 500,000 bpd by 2010-2011. According to David Shields, Mexico's leading oil analyst, the situation is much worse than they are reporting. According to Shields production is expected to fall below 2.5 mbpd and possibly farther. Pemex has admitted that depletion in the giant Canatrell field is nearing 10% per year.

Jim Brown

March Crude Chart - 60 min

February Gas Futures Chart - Daily


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