The State of the Oil Industry

Hillary wants the oil company's profits. But are all things what they seem. The oil sector is nowhere near as healthy as it appears, and even if it was, Hillanomix would likely put the stake into it.





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Of all the candidates on economic issues, Hillary Clinton concerns me the most. Every statement that she has made on the economy is that she will interfere in the markets and that her economic intelligence is incredibly shallow. One of her many pronouncements was that she wanted to "take the profits" of oil companies to fund some of her "green" programs." It would be hard to imagine something that would play more havoc with the energy sector. And as Carl Mortished writes in the Times, the oil industry is not as healthy as it would appear:

Bloated with profits and rolling in cash, but it isn't nearly enough. Oil companies confound our senses with big numbers - BP earned $17 billion (£8.6 billion) last year, a meagre performance compared with Shell's $28 billion, revealed last week. The European twins are hopelessly outclassed by ExxonMobil. The American ended the year with $40 billion tucked under its belt.

Don't be fooled; this pumped-up industry is impoverished, both in performance and opportunity. Beset from all sides, by inflation, weak operations and lack of opportunity, the oil majors have reverted to Plan A - cut the costs and raise the dividend.

The alternative to upsetting the staff would be to cut the payout and dismay the shareholders. For an oil company, yield is sacred, a Rubicon that must never be crossed.

It's just not good enough, says Tony Hayward about BP's numbers. The chief is in cheese-paring mode, demanding a 15-20 per cent reduction in overheads. Over at Shell, the mood is equally grim, with the entire IT staff to be removed from the payroll and ructions in Nigeria as the joint venture that houses Shell's embattled Niger Delta operation is put through the wringer.

Oil companies go through periodic shake-ups - it is in the nature of these beasts to add fat in the good times - but this is more than the scraping of a layer of surplus marzipan. The industry is suffering from a cost explosion that is eroding its ability to deliver satisfactory returns from exceptional oil prices.

Spending just keeps going up. Since 2003, Shell's capital budgets have doubled to more than $24 billion, but output of oil and gas has declined every year and the company gave warning last week that 2008 would be another year of falling production.

The massive investments are needed if Shell is to replace its output of 3.8 million barrels per day and at the same time fill the yawning gap that remains after the reserves scandal of 2004. Shell was coy about this year's reserve numbers, preferring to copy ExxonMobil and maintain radio silence until March. However, its hint that it had discovered one billion barrels of “resources”, to be distinguished from more rigorous “reserves”, is not comforting. In the space of a year, Shell pumps about 1.2 billion barrels, an indication of the huge challenge faced by these companies.

So, Shell and BP must spend, but are they really investing heavily? Or is it just that every barrel is costing a lot more? The evidence suggests the latter. Both companies cite near-double-digit rises in capital costs. Building things costs more, the cost of steel, cement and labour is on a never-ending escalator. Both companies are raising their capital budgets by around 10 per cent, in line with inflation, but industry statistics suggest that Shell and BP's 8-10 per cent inflationary adjustment is somewhat flattering.

IHS/CERA, the American consultancy, publishes an index of oil and gas industry inflation. The index shows that costs have almost doubled in less than three years. It's not unreasonable to assume that the oil majors get better terms than most operators, but they are also among the biggest consumers. You can only come to the conclusion that spending by the big battleships is not going up and is probably in decline in real terms.

That is troubling news for anxious energy consumers, but it is not entirely surprising. Over the past couple of years, BP and Shell have learnt that big, expensive projects go wrong in spectacular ways. Errors in management and design have cost BP many billions of dollars, from the Thunder Horse project to the Texas City fire. After several years of rampant spending that produced indifferent results, oil companies are looking for greater certainties, more discipline and better returns. The foot is easing off the accelerator.

It is ironic that $100 oil has not done much to boost BP's free cash flow, which fell $4 billion last year, in part due to the extra costs of clearing up the Texas City mess. As a result, BP had barely enough cash to cover $18 billion of investments and pay the ordinary dividend. Still, the British oil company has decided to boost the final dividend by 30 per cent, raising the annual payout from $7.8 billion in 2006 to $8.6 billion in 2007. . . .

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A Taxing Catastrophe

Not drunk is he who from the floor can rise again and drink some more.

- Old English field sobriety test

The above test should give you some flavor of the central place beer and pubs have occupied in Britain's history. British Bitters and Ales are famous world-wide. And there are a few British Porters that I could live on. For beer lovers across the world, the UK's corner pubs are temples and the wonderful craft brews they dispense are holy water. And now we learn that the pubs are in trouble and beer is fading across the pond, caused in large measure by the tax laws of the Labour government. This today from the Guardian:

Shakespeare may have declared "a quart of ale is a dish for a king", but five centuries on, Britain appears to have slaked its thirst for the humble beer.

Sales of a drink that, for many, is the cornerstone of British social life, have dropped to their lowest level since the 1930s, according to figures released today.

The British Beer and Pub Association (BBPA), which represents the brewing and pub industry, revealed that 14m fewer pints daily are being sold in pubs today - a slump of 49% since the peak in 1979.

Part of the long-term trend has been the move towards drinking at home. . .

. . . The BBPA, whose members account for almost all the beer brewed in the UK, says the situation is exacerbated by rising production costs as the prices of barley, malt, glass, aluminium and energy increase.

It also feels that the Treasury is picking on pints. Since 1997, beer duty has risen by 27% while consumption has fallen by 11%. Wine duty, meanwhile, has increased by just 16%, while wine-drinking has gone up by 46%. It's a similar story with spirits: although consumption has risen by 20% over the last decade, duty has increased by only 3%.

Rob Hayward, the chief executive of the BBPA, wants the government to help the brewing industry by reducing the tax burden. "We believe the benefits that have been enjoyed by other drinks from a tax freeze should be extended to Britain's national drink - beer," he said.

"The time to support our national drink is long overdue. We are calling for government policy to encourage and support Britain's businesses."

Mr Hayward added that although British beer had an impressive international reputation, the people who make it were being hamstrung by a tax policy that was "eroding the foundations of our business".

"We need a tax freeze and that is what we are calling on the chancellor to deliver," he said.

Major British brewers saw their profits tumble by 78% between 2004 and 2006. The BBPA says they are being further hobbled by the Treasury's insatiable coffers. It estimates that beer companies make only 0.7 pence profit per pint while paying the chancellor 33p a pint. Last week, two major brewers - Scottish & Newcastle UK and Carlsberg - warned pubs that rising costs and a poor summer meant that big rises in wholesale beer prices were likely.

A senior executive at S&NUK told the pub trade paper the Morning Advertiser that prices would probably increase "way above the rate of inflation" during the first part of next year. He said that rising cereal, crude oil and aluminium prices meant that brewers would be forced to charge more to recoup their losses.

Beer is not only falling victim to the growing fondness for wine among Britons. Its popularity is also suffering because of a cultural shift: the increasing taste for drinking at home. In 2005, 60% of all the wine sold in the UK was bought in supermarkets. And the wine and champagne market, which is now worth more than £10.2bn, increased by 26% between 2002 and 2006. Over the same period, sales of spirits and liqueurs went up by 16%.

. . . But he added: "Camra completely backs demands for a freeze in excise duty on beer, and would go further in calling for a reduction in the level of tax on Britain's national drink in order to bring people back to the pub."

Mr Morris said a reduction in duty would also counter the threat posed by the supermarkets, which use cheap beer as a loss leader.

"It is no coincidence that Britain has the highest level of excise duty in the EU and sales in the on-trade are falling, and yet binge-drinking is on the increase as supermarkets cynically exploit the consumer by offering cut-price booze to drink at home," he said. . . .

Read the whole article. You have to hate the left and their tax policies. Is there nothing then can't screw up? All I can say is "God save the Queen . . . and her wonderful pubs."

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