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Mixed Earnings Reports Suggest Big Oil May Have Peaked

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Companies may have to shrink to stay profitable.

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First-quarter earnings reports are in, and the world's biggest oil companies are reporting mixed results.

ExxonMobil (NYSE:XOM), the largest producer of natural gas in the US, reported quarterly earnings of $9.10 billion, down 4.2% from $9.50 billion in the same quarter a year ago. Yet it beat Wall Street expectations, owing to a spike in natural gas prices during the winter and a boost in its quarterly dividend. The brutal winter in the eastern US drove natural gas prices up, giving the company more revenue than expected.
 
Royal Dutch Shell (NYSE:RDS.A) also beat expectations, allowing its stock price to jump 3% after reporting. But in a sign of just how low expectations have fallen, Iain Pyle, an analyst with Bernstein Research, said Shell's latest quarter "was kind of a quarter where everything went right," but still saw its profit decline by 44% in the first quarter compared to a year earlier, according to the Wall Street Journal.

Chevron (NYSE:CVX) is due to publish its earnings on May 2, and investors have welcomed its announcement that it's boosting its quarterly dividend by 7%. However, the company issued an interim report in April and warned that things weren't going so well. Chevron also had a very bad 2013: Its net income for the fourth quarter dropped by 32%.

BP (NYSE:BP) saw its quarterly earnings drop to $3.2 billion, a 24% drop from a year ago, but a 14% jump from last quarter. Its stock price climbed by 2.5% as BP also announced an increase in the quarterly dividend.

The results come as business activities are being complicated by geopolitical events. The escalating Western sanctions on Russia over its actions in Ukraine have injected uncertainty into the huge investments that BP, Shell, and ExxonMobil have in Russia. "I don't think we will be jumping into new investments in the short term," Royal Dutch Shell's chief financial officer, Simon Henry, said in a conference call on April 30.
From an investor's standpoint, the earnings reports highlight a troubling trend: Several big companies are experiencing stagnating or declining oil production. ExxonMobil's quarterly production on an oil-equivalent basis dropped 5.6% year-on-year. Shell's was down 4% over the same time frame. BP reported an 8.5% decline. ConocoPhillips (NYSE:COP) had a modest decline.

"These companies are spending a lot of money and they aren't seeing the returns," said Brian Youngberg, an analyst at Edward Jones, according to the Los Angeles Times.

Ultimately, the huge problem is the difficulty in finding new sources of oil. "Like its peers, (Exxon) is growth-challenged on the production front," Youngberg added.

With fewer major new discoveries coming in, and legacy wells flat or declining, oil companies are seeing the cost of a barrel of oil rising. Their response appears to be moving to leaner operations, avoiding huge, expensive projects, and returning profits to shareholders. ExxonMobil slashed capital expenditures by 28% for the quarter. Shell is undergoing a two-year, $15 billion divestiture campaign. BP plans on divesting $10 billion from its Alaskan assets and returning much of the cash to shareholders.

Divestment has led to a flurry of deals in the first quarter -- the most in over a decade, in fact. "Divestitures are driving activities as companies continue to back their core operations," said Doug Meier of PricewaterhouseCoopers, according to Fuel Fix. "They're shedding those noncore assets to reinvest in their core business or make profits available to shareholders."

The inability to boost production has the companies spending less on new projects to reduce costs. This may soothe the concerns of investors in the short term, but it means that the companies won't be able to lift production over the long term. In any event, we may be hitting an inflection point; Big Oil's size may have peaked, and to stay profitable, companies have no choice but to shrink.

This article was written by Nicholas Cunningham of Oilprice.com.
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