Weak demand will test mettle of the Big Five

Given crude's retreat to less than half its price last summer, it is no surprise that profits for the five biggest US and European oil companies tumbled.

The "Big Five" oil companies reported second-quarter earnings last week, and the results were not pretty. Given crude's retreat to less than half its price last summer, it is no surprise that profits for the five biggest US and European oil companies tumbled between 53 and 71 per cent from a year earlier. But only two companies, BP and Chevron, managed to increase their oil and gas output, and three saw profits decline from the previous quarter, when crude was priced even lower.

As for second-quarter earnings compared with the same period last year, Chevron's performance was worst, while BP's was the best of the bunch. But the companies' comparative operational performances were also revealing. The amounts of oil and gas pumped by ExxonMobil and Royal Dutch Shell, the world's two biggest international oil companies, slid by 3 and 5 per cent respectively from a year earlier. Total of France joined those two laggards with a 7 per cent production decline.

The companies cited OPEC production cuts, militant attacks on oil and gas installations in Nigeria, and contract renegotiations in Libya among the reasons for their slipping output. Exxon and Total, along with Chevron, also failed to parlay rebounding crude prices into sequential quarterly earnings improvements. Exxon posted a 10 per cent drop in profits from the first quarter and Chevron a 5 per cent decline, while Total's earnings dipped by 1 per cent. The companies blamed high exposure to European and North American gas markets in which prices fell during the second quarter, as well as increasingly tight refining margins, for their failure to squeeze juicier profits from stronger crude prices.

But at BP, profits bounced 71 per cent in the second quarter from the previous three-month period, while oil and gas production rose 4 per cent compared with the same quarter last year. The big difference between BP and its rivals was that the British company seemed to be progressing well with a programme to streamline its operations. After 18 months at the helm, the BP chief executive Tony Hayward has cut 5,000 jobs and delivered US$2 billion (Dh7.34bn) of cost reductions. He did that while increasing production from the big Thunderhorse oilfield in the Gulf of Mexico.

Mr Hayward is targeting a further $1bn of savings this year and hopes to raise BP's output by 3 per cent for the full year. Shell has also seen the need to operate more efficiently, but is less advanced with its programme than BP. On Wednesday, the Anglo-Dutch company's new chief executive, Peter Voser, unveiled a corporate reorganisation scheme that would merge operating divisions and cut management staff by 20 per cent.

Significant overall workforce reductions and cost savings would follow, he promised during his first conference call with media since taking over last month from the previous Shell chief, Jeroen van der Veer. Mr Voser also said Shell would scale back capital spending this year by 10 per cent. By contrast, the US-based Exxon, which was previously an industry benchmark for tight cost control, spent roughly the same amount on finding and exploiting oil and gas in the first half of this year as it did in the first six months of last year. The company chairman and chief executive, Rex Tillerson, did not see a 66 per cent slide in profits as sufficient reason to host the company's quarterly investor conference call. Instead, he let David Rosenthal, the vice president of investor relations, field questions.

Mr Rosenthal said Exxon was pressing ahead with liquefied natural gas developments in Qatar and with a Canadian oil sands project - both part of Mr Tillerson's plan to raise the company's oil and gas output by 2 per cent this year. That could justify keeping capital spending high. But Exxon's inability to deliver part of the promised production increase during the first half of this year underscores the challenges it will face to reach its full-year target.

With few signs of an imminent upturn in global oil demand, OPEC is unlikely to reverse this year's output cuts when it meets next month. The Iranian OPEC governor, Mohammed Ali Khatibi, said on Friday that some members might even push for another cut if crude retreated. At the same time, the budgets of most oil-producing states are stretched and their governments are under increased political pressure at home to hold on to a bigger share of oil and gas revenues.

Even Canada, which has encouraged foreign investment in its oil sands, has raised taxes on oil production. And in countries from Nigeria to Iran in which oil wealth has largely failed to improve the lives of ordinary citizens, the added strain brought by the global economic crisis is stoking political unrest. That makes the recent production increases of BP and Chevron all the more impressive. Both companies have recently started pumping oil from big new fields in the Gulf of Mexico, while Chevron also started oil production from an oilfield off the coast of Brazil.

However, at current crude prices, profits are razor thin on such costly deepwater projects, and shaving costs becomes imperative. Chevron's 71 per cent plunge in second-quarter profits attests to this. One of BP's recent tactics has been to team up with China's biggest state-controlled oil producer to help control costs while operating under tough contract terms in a resource-nationalistic jurisdiction. The company's project with China National Petroleum Corporation to nearly triple output from Iraq's biggest oilfield would link BP's expertise to the Chinese state-controlled company's low-cost service teams.

Only time will tell if the alliance will yield dividends for the companies. But one thing is certain: weak oil and gas demand will test the resilience of oil executives for the rest of this year and beyond. @Email:[e-mail]