Taking Aim at Oil's Riches

Times Staff Writer

Even for Big Oil, the numbers have never been as big as this.

When major U.S. energy companies including Exxon Mobil Corp. and Chevron Corp. announce their third-quarter earnings in the next few days, the results are certain to be staggering.

Pumped up by soaring prices of oil, natural gas and gasoline in August and September, Exxon Mobil alone is expected to report quarterly profit of about $8.7 billion. That would be more than what such titans as Coca-Cola Co., Intel Corp. and Time Warner Inc. earn in an entire year.

For the energy companies, the record results amount to an embarrassment of riches -- an invitation for attack by foes and even by some traditional allies.

"The question increasingly is going to be, what is the industry going to do with this money?" said Amy Jaffe, head of the James A. Baker Institute Energy Forum at Rice University in Houston.

On Tuesday, House Speaker J. Dennis Hastert (R-Ill.) called on the companies to spend more to build refineries and boost production to help "ease the pain" of high energy prices.

"It's time to invest some of those profits," Hastert said at a news conference in Washington.

With oil holding above the $60-a-barrel mark, double the level of two years ago, some Democrats in Congress have another idea: Slap the industry with a windfall-profit tax like the one imposed in 1980.

Some consumer advocates, meanwhile, want Congress to mandate that a share of oil and gas earnings be plowed into alternative-energy research.

The sheer size of the industry's profit mountain makes it a tempting target. Together, the 29 major oil and gas firms in the Standard & Poor's 500 stock index are expected to earn $96 billion this year, up from $68 billion last year and $43 billion in 2003.

Yet the industry disputes critics who say it is failing to invest enough of that money to find new sources of oil and gas.

Energy companies will spend an estimated $86 billion on capital expenditures in the U.S. alone this year, the American Petroleum Institute says, citing Oil & Gas Journal data. That's up from $76 billion in 2003.

Exxon Mobil said its capital and exploration expenditures were projected to be about $17 billion this year, up from $14 billion in 2004. The company plans to spend $17 billion to $18 billion a year from 2007 through 2010, spokesman Robert Davis said.

Chevron is involved in more than 20 exploration projects worldwide that would involve outlays of about $1 billion or more, compared with a handful of such projects a few years ago, a spokesman said. The company this month gave the go-ahead to a deep-water drilling project in a Gulf of Mexico field where Chevron believes more than 100 million barrels of oil may lie.

But as gasoline supplies have tightened this year and pump prices have topped $3 a gallon, many industry critics have focused their wrath on the refining business. The last new U.S. refinery was completed in 1976.

Jamie Court, president of the Santa Monica-based Foundation for Taxpayer and Consumer Rights, alleges that the industry has "intentionally reduced refining capacity to pump up profits to world-record levels."

The industry, however, contends that it has been hamstrung by environmental laws and other restrictions on refinery construction and expansion.

Nonetheless, existing U.S. refineries have been expanding capacity by about 1% a year for the last decade, mainly by facility upgrades, said Rayola Dougher, an economist at the American Petroleum Institute.

Some analysts question whether, even with federal help, the industry could justify the cost of new U.S. refineries. If gasoline prices were to fall sharply, perhaps because of stepped-up conservation, such projects could be financial albatrosses.

"Building a refinery is a 30-year commitment," said Nick Cacchione, an analyst at energy research firm John Herold & Co. in Norwalk, Conn.

Meanwhile, energy companies' owners -- their investors -- have their own idea of what to do with the avalanche of cash: They'd like much of it paid to them in the form of dividends and stock buybacks.

Many shareholders and industry executives have a far different perspective on current oil, natural gas and gasoline costs than do their consumers. They remember how the oil price surge of the late 1970s, amid turmoil in the Middle East, went bust in the early 1980s.

What followed were nearly 20 years of mostly depressed prices, which also depressed the industry's earnings and stock prices.

San Ramon, Calif.-based Chevron, for example, earned no more in 1998 than it had in 1985.

Coca-Cola, by contrast, earned nearly five times as much in 1998 as it had 14 years earlier.

What also went bust in the 1980s were many of the diversification moves the energy giants made with their then-record earnings of the 1970s. Mobil, then an independent firm, bought retailer Montgomery Ward in 1976, only to dump it 12 years later.

Exxon invested in an office-products business; Gulf Oil, since merged into Chevron, mulled over buying Ringling Bros. and Barnum & Bailey circus, although its board ultimately vetoed the idea.

Advice often given by academics to the oil companies in the 1970s was to diversify away from the energy business because oil was running out, said Michael Lynch, president of consulting firm Strategic Energy & Economic Research Inc.

"Not only did they do all these dumb things, but they did so on the advice of damn near everybody," Lynch said.

Even companies that eschewed venturing into non-energy businesses were slammed if they invested heavily in high-risk exploration and development projects in the '80s, only to find that tumbling oil prices made the investments uneconomical.

By the early 1990s, "It looked like money down a rat hole," said Severin Borenstein, director of the University of California Energy Institute in Berkeley. "I can certainly see why they'd be cautious now. Just because you're making an extra $35 a barrel doesn't mean you should be pouring that into exploration."

Today, any aggressive capital spending program by an energy company probably would face much more severe review by its shareholders, given fears that the boom of the last few years could quickly give way to a bust.

David Dreman, a veteran investor who heads Dreman Value Management in Jersey City, N.J., believes that energy companies' smartest use of cash may be to increase their stock dividends, buy back shares or buy other oil and gas companies outright.

"The cheapest way of getting oil now is to do it by acquisition" of other firms, said Dreman, who owns shares in Chevron, which recently bought Unocal.

Yet mergers may just further anger critics who say energy firms are failing to invest heavily enough in potential new energy sources. That is seen as one justification for a windfall profit tax.

Sens. Jack Reed (D-R.I.) and Byron L. Dorgan (D-N.D.) are pushing a bill that would essentially levy a tax surcharge on oil firms when oil's market price exceeds $40 a barrel. The money would be rebated to consumers.

The industry contends that such taxes would be unfair and would restrain exploration.

"We should learn from history. The [1980] crude oil windfall profit tax reduced domestic oil production and increased imports of foreign oil," said Exxon Mobil's Davis. That tax was repealed in 1988.

Borenstein said he also considered a windfall tax a flawed idea. Although high oil and gas prices are unarguably a wealth transfer from consumers to the energy industry, it was the opposite in the 1980s and 1990s as prices fell, he said.

"Unfortunately, sometimes you see big wealth transfers occur when something becomes scarce," Borenstein said.

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