Shell takes damaging hit in North American shale patch as Big Oil profits tumble

HOUSTON -- The oil and gas giants are reporting sharp hits to earnings during the second quarter of the year, despite high crude oil prices that are encouraging a drilling boom.

The companies blamed the steep year-over-year income dips to large one-off transactions that distorted last year's numbers, along with a tougher business climate for refining. Refineries are having a harder time posting big profits these days as North American and international oil prices have reached closer alignment with one another.

Slight production declines and shut-ins for maintenance may have also taken their toll, but the overall negative performance compared to last year led investors to take it out on share values.

Exxon Mobil Corp. and Royal Dutch Shell PLC posted disappointing second-quarter 2013 earnings results yesterday, prompting traders to pull their share values lower. Analysts are also expecting Chevron Corp. to report lower earnings compared to the same period in 2012.

Exxon Mobil, the world's largest publicly traded, vertically integrated petroleum company, told investors and analysts that its second-quarter earnings slid by 57 percent compared to this period last year. The company posted earnings of about $6.9 billion for the quarter, down from a lofty $15.9 billion earned in the second quarter of 2012.


Shareholders responded by shaving about 1 percent off the value of Exxon Mobil's shares in trading at the New York Stock Exchange.

For the first six months of this year, Exxon Mobil's earnings are also a lot lower than what the company posted in the first half of 2012, about $16.4 billion versus nearly $25.4 billion, or a 34 percent drop.

The company told investors that the sudden plunge was mainly caused by an accounting discrepancy. Last year, the company added a $5.3 billion gain from one-time business transactions in Japan to its overall earnings, inflating the number compared with this year's estimate. Still, the company acknowledged that earnings are 19 percent lower when those sales are not included in the total.

Exxon Mobil is still feeling the burden of being saddled with a portfolio that's too heavily weighted toward natural gas, a legacy of its acquisition of shale gas driller XTO Energy. Exxon Mobil now holds huge volumes of gas assets, but the value of that production plummeted shortly after that acquisition.

"We acknowledged the fallback we had in upstream unit profitability given the mix of our production since the XTO acquisition, and just reinforcing that we're very aware of this," said David Rosenthal, the company's vice president for investor relations. "We're working on it. Some of the portfolio projects that are coming online, particularly the liquids projects, are coming to fruition."

Rosenthal told analysts to expect improvements over the next two to three years as new crude oil projects coming online lifts the firm's prospects, even if gas prices stay low.

Exxon Mobil also attributed much of this loss to weaker refining income, something that many analysts had expected.

New crude oil transportation infrastructure, primarily rail and pipeline, has come online in recent months in the United States, easing the North American bottleneck that was preventing inland crude oil producers from fetching better prices for their rising supplies, obtained mainly from shale deposits.

Gulf of Mexico coastal refiners were well-placed to take advantage of that bottleneck, buying cheaper North American-priced crude and then refining and exporting finished products based on prices more closely associated with the international Brent contract. Now, growing North American supplies are more closely tied into international markets, bringing the West Texas Intermediate (WTI) benchmark price closer to Brent. Thus, refineries have largely lost this arbitrage opportunity.

Exxon Mobil says its global earnings from the downstream refining and marketing side of its business slid by $6.25 billion compared to last year, but most of that drop reflected the $5 billion sale of Japanese downstream assets in 2012. Still, downstream earnings would be lower by around $554 million if that one-off transaction were excluded from the estimate.

U.S. downstream earnings fell by $586 for the company during the quarter compared to second quarter 2013. Then the company reported earnings of more than $800 million.

Shell hit hard in U.S. shale patch

Anglo-Dutch international oil and gas conglomerate Royal Dutch Shell reported feeling a sting to its business similar to Exxon Mobil's.

Shell reported a 60 percent decline in profits compared to the same quarter last year. That firm announced earnings of $2.4 billion for the quarter on a current cost of supplies basis, an accounting method used commonly by the company and comparable to the net income figure used by U.S. firms.

The company earned just under $6 billion in the same quarter of last year. The drop shook investors, and both of Shell's U.S. tickers fell more than 5 percent on the day.

Much of the drag, surprisingly, came from its own North American shale portfolio, with the company hinting at troubles in U.S. tight and shale oil development. Shell took impairments of $2.07 billion, mainly due to results and updated data in its liquids-rich shale plays.

The company wouldn't specify which plays underperformed. Its position in North American resources now stands at a value of roughly $24 billion.

"We are now entering a period of focusing our portfolio down to our best liquids plays, whilst maintaining key dry gas assets for longer-term integration value," CEO Peter Voser said during a call with analysts.

Voser promised investors that the company is taking a fresh look at its shale oil holdings in the United States and Canada, focusing on the best while moving quickly to rid itself of underperformers.

"We have some nine operational theaters in North America. This should reduce to about half that number over time, as we focus down this portfolio while growing our business," Voser said. "We expect to see a step up in asset sales for North America resources plays in the next 18 months."

Voser continues to hold that North American shale investment will eventually present a "success story" for his company, and he denied that the company had moved into U.S. and Canadian shale oil and gas plays too hastily to catch up with the rest of the industry. Still, with gas prices expected to stay relatively weak for the time being, Shell said is expecting that its Upstream Americas division will be in the red for the rest of this year.

Whether this type of strategy will play on Wall Street remains unclear.

Several prominent analysts have shown a keen eye for bloat at oil and gas companies -- and a broad definition of what counts as bloat. Many industry watchers argue that the nature of the North American shale hydrocarbon action is best suited for companies that release downstream, midstream, and even parts of their upstream businesses.

Paul Sankey, an analyst with Deutsche Bank, gave full voice to this view yesterday. Speaking on CNBC's "Fast Money" program, he said it's surprising how hard it has been to make money investing in oil and gas firms, despite the high price of oil.

"We like breakup, we like restructuring," he said. "We think that companies should be smaller, more levered, quicker-moving, more exposed to U.S. growth. We love the U.S. growth theme. We think that's a unique theme globally. We want to be really exposed to that without all the baggage that these guys carry."

Among large energy firms, Sankey said, the most profitable investments have been those with activist investors that push companies toward restructuring.

"The tough one is, do you go after the really big guys? How do we get after Exxon or Shell in terms of trying to get activists active there?" he said. "And I think the sheer scale of them prevents that happening, and that's why they're less attractive to us."

More refining troubles

Like Exxon Mobil, Shell has found it more difficult to make money from refining and marketing. Quarterly numbers posted by ConocoPhillips, also reported yesterday, hinted at this hit to the bottom line that narrower refining margins have taken.

Now shed of its downstream refining and marketing business, ConocoPhillips reported a more modest decline in profitability compared to last year's quarter, but still said this was also affected by one-time transactions in 2012. On Thursday, ConocoPhillips executives reported second-quarter earnings of around $2.1 billion, down from $2.3 billion in the same period in 2013, representing a decline of about 8.7 percent.

Minus special transactions, the company says earnings from operations expanded by nearly 20 percent.

Phillips 66, the new company formed with ConocoPhillips' old downstream portfolio, didn't fare so well during the quarter. That firm said its earnings slid from $1.2 billion in second quarter 2012 to $935 million in second quarter 2013.

ConocoPhillips said a focus on North American tight and shale oil development and a modest increase in production figures helped to sustain its business performance even as overall profitability from oil production fell from where it was last year.

"We were on plan, just like last quarter," Matt Fox, the company's executive vice president for exploration and production, said during a conference call to highlight company performance.

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