From the Pages of the WSJ

Oil Profit May Fall, but U.S. Drivers Help to Keep It From Hurting

By RUSSELL GOLD

April 21, 2007

The half-dozen Western companies that put the "big" in Big Oil are to report their first-quarter earnings starting this coming week, beginning with BP PLC Tuesday and followed by Exxon Mobil Corp. Thursday. Profits are expected to be down about 10% from a year earlier, largely because of crude-oil and natural-gas prices that have eased a bit from their highs.

Profits easily could have fallen more. But Big Oil has received a major assist from U.S. drivers, who have kept the pedal to the metal even as gasoline prices have climbed 23% since the beginning of the year. Brisk demand in the U.S., combined with refinery outages, has slashed gasoline-inventory levels and is pushing pump prices over $3 a gallon in some markets.

All this means that results from oil companies' refining operations -- which turn crude oil into gasoline, heating oil and diesel and jet fuel -- are likely to be strong. Bruce Lanni, an A.G. Edwards energy analyst, forecast that earnings from pumping oil and natural gas out of the ground would be down 21% for the sector, but earnings from refining and marketing the gasoline would be up 41%.

This is good news for Big Oil's investors because the companies' exploration and production units -- which traditionally have provided the bulk of profits -- are being squeezed by a combination of lower commodity prices and higher costs to drill new wells. Perhaps even more threatening to future profitability, foreign producer nations such as Venezuela and Algeria are demanding a bigger cut of the action as they negotiate new contracts or renegotiate old ones with Western companies.

By contrast, conditions for oil companies continue to improve on the refining side. There has been "outrageously bullish" data on U.S. gasoline supplies, according to Barclays Capital analysts Paul Horsnell and Kevin Norrish. Gasoline inventory has fallen for 11 straight weeks, including most of the first quarter. Barclays estimates a 2.3% rise in gasoline demand in the first quarter compared with a year earlier.

Gasoline prices also are being lifted by supply constraints. Several refinery problems in California, Texas and elsewhere held down production of gasoline and other refined products. For example, a fire knocked Valero Energy Corp.'s 170,000-barrel-a-day McKee refinery in Sunray, Texas, out of action for two months, and it is only now coming back on line. Refinery profitability "is definitely going to be the only bright spot for the entire sector," says Neil McMahon, a London-based analyst at Sanford C. Bernstein. The first quarter traditionally generates strong margins, because of seasonal factors, he says.

Of course, this won't last forever. U.S. drivers begin to slow down their fuel consumption once regular gasoline prices top $2.50 a gallon, which they did in early March. This easing of demand, coupled with the refinery restarts and a changing slate of available crude oil, likely will mean refining profits will ease up on the accelerator in the second quarter. The U.S. gas price, meanwhile, currently $2.88 a gallon after a rapid climb, is expected to pull back and average $2.81 a gallon this summer.