Where's the oil money going?

published 12 December 2005

Are oil firms making money? Yes. The high oil price is feeding directly into their profits and many are now making more money than they can comfortably spend. Thanks to crude prices averaging $41 in 2004, the world's ten biggest oil companies earned profits in excess of $100bn last year - more than the total GDP of Malaysia. ExxonMobil - the world's biggest publicly traded oil company - made $25bn and Britain's BP $16.2 bn. In all, the top-ten companies' 2004 sales exceeded $1trn - more than the GDP of Canada.

What are they spending it on?

They would like to spend it on new investment in oil fields, but there aren't enough opportunities for all of them. There isn't much more exploration to be done in places such as North America or the North Sea. The result is that too much money is chasing too few new prospects in places such as Kazakhstan and Angola, and overall spending on new exploration is actually declining. Instead, the larger integrated oil companies are giving their money back to their shareholders and firming up their balance sheets. Last year, the big firms spent about 24% of their cash on dividends, 12% on share buybacks and 12% on cutting debt. ExxonMobil spent $9.95bn on buying back its own stock; Royal Dutch/Shell has pledged to hand out $10bn in shareholder dividends this year; and BP will return as much as $23bn to investors in 2005 and 2006.

Certainly, the amount of cash sloshing about has raised speculation about a wave of mergers in the industry, something that has created speculative interest in the sector. Industry journal Petroleum Economist believes the remaining independent US firms are the most likely to be bought out following several deals last year, including Kerr-McGee's acquisition of Westport Resources. Bear Stearns' oil analyst Frederick Leuffer published a report this week predicting a sharp pick-up in merger and acquisition activity. He cites Unocal, Murphy Oil and Marathon Oil as prime takeover and restructuring candidates, and sees Royal Dutch/Shell, Conoco-Phillips, Chevron Texaco, Occidental Petroleum and Total as possible buyers. In addition, he notes that the Chinese oil companies PetroChina, CNOOC and Sinopec are all looking to increase their oil reserves via acquisitions.

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The oil producing countries. For them, high oil prices mean a welcome surge in income (as well as a de facto tax on oil-consuming nations). According to calculations by Sharif Ghalib, a senior analyst at New York research firm Energy Intelligence, the eleven members of Opec will earn combined oil-export revenues of $360bn in 2005, assuming an average oil price of $41. But if prices were to average $60, revenues would jump to $567bn: each dollar increase adds a massive $10bn to Opec's revenues.

One of the reasons the 1970s oil shocks led to world recession was that the oil producing counties didn't offset the dampening effect of high oil prices elsewhere by spending more themselves. This time round, it's different. The world's most expensive hotel, the Emirates Palace - built at a cost of $2bn, and clad with 6,000 square metres of gold leaf - opened recently in Abu Dhabi, and is just one example of oil wealth being spent, not hoarded. Saudi Arabia has increased its budget by a massive 40% to pay off arrears to contractors and farmers, and meet a long and urgent list of domestic spending plans aimed at cutting unemployment and quelling discontent. Venezuela raided its oil fund for similar, politically motivated reasons last year - and governments in Iran and Sudan are getting a helping hand from the high price of oil too. Only Norway and Russia are tucking their oil revenues away for a rainy day.

Other than by investing directly in energy stocks, by betting on sectors that stand to gain from the oil exporters' spending. According to Ajay Kapur, at Citigroup Smith Barney, that includes construction equipment, engineering, luxury goods, European property, defence, aircraft and wealth-management companies. In particular, Kapur tips Caterpillar Inc; two Italian firms, the defence and aerospace group Finmeccanica and jeweller Bulgari; British fashion group Burberry; and two banks - UBS and Deutsche Bank. Ben Walker of Gartmore Investment thinks luxury hotels are likely beneficiaries, recommending Starwood Hotels and Resorts Worldwide and Hilton Hotels, and thinks air-travel stocks such as Rolls-Royce, Boeing and United Technologies, will be positively affected.

Simon Wilson’s first career was in book publishing, as an economics editor at Routledge, and as a publisher of non-fiction at Random House, specialising in popular business and management books. While there, he published Customers.com, a bestselling classic of the early days of e-commerce, and The Money or Your Life: Reuniting Work and Joy, an inspirational book that helped inspire its publisher towards a post-corporate, portfolio life.

Since 2001, he has been a writer for MoneyWeek, a financial copywriter, and a long-time contributing editor at The Week. Simon also works as an actor and corporate trainer; current and past clients include investment banks, the Bank of England, the UK government, several Magic Circle law firms and all of the Big Four accountancy firms. He has a degree in languages (German and Spanish) and social and political sciences from the University of Cambridge.