Exxon Mobil Corp. (XOM) and Royal Dutch Shell PLC (ADR: RDS.A, RDS.B) announced record quarterly income of more than $10 billion yesterday (Thursday).  But continued production problems and declining output caused both companies to miss analyst expectations, and concerns about reduced U.S. consumer demand weighed on shares.

Exxon Mobil reported that second-quarter income rose 14% to $11.68 billion, marking the highest one-quarter earnings level ever for a U.S. company. The profit, which amounted to $2.22 per share, was up from $10.26 billion, or $1.83 per share, for the same period last year.

Meanwhile, Royal Dutch Shell also was able to breakthrough the $10 billion level when it reported second-quarter income increased 33% from $8.67 billion to $11.56 billion.

On July 11, oil futures hit an intraday high of $147.27, but since then have dropped to the low $120s-level. Oil for September delivery closed at $124.08 yesterday on the New York Mercantile Exchange.

But even high oil prices couldn’t help the two companies beat analyst expectations, causing both stocks to take a hit. Exxon Mobil shares dropped $3.95, a decline of 4.68%, to close at $80.43, while Shell’s A-shares shed $2.90, a decline of 3.94%, to close at $70.79.

“If oil prices are going up $20 and $30 a barrel a quarter like they have been, it hides a lot of flaws,” Brian Gibbons, an analyst at New York-based CreditSights Inc. told Bloomberg News. “The question on everyone’s mind is, how [does Exxon] expect to grow production given the restrictions on access to reserves?”

Oil Production Problems

Production is down at both Exxon Mobil and Shell as their current oil fields mature. Both are spending billions on research and development of new fields, as well as projects such as tar sands fields, which were previously considered unprofitable. But it could be several years before these new explorations pay off.

Exxon Mobil’s oil and gas production declined 7.8%, Bloomberg reported, due in large part to state seizure of company assets in Venezuela.

Shell has had tremendous difficulties with its Nigerian holdings, as continued attacks by the Movement for the Emancipation of the Niger Delta, or MEND, have had a serious impact on the region’s production.

In June, Shell was forced to shut down a site that had produced 220,000 barrels per prior to an attack. And earlier this week, the Dutch oil company declared force majeure on its Nigerian exports after yet another attack.

“We had just this Monday the close-in of Nembe Creek, which is an additional 40,000 barrels per day,” Shell Chief Executive Officer Jeroen Van der Veer said, Reuters reported. “It’s too early to say how long that will last.”

Shell’s production slumped 1% in the quarter, to 3.05 million barrels of oil a day, MarketWatch reported.

Dip in Oil Demand

At the same time, oil majors are faced with declining demand as high oil prices are forcing budget-conscious consumers to change their habits to reduce oil use.

“People have changed their driving patterns because of high prices,” Lynn Westfall, chief economist at Tesoro Corp.’s (TSO), a San Antonio refiner said, DowJones reported. “The earliest would be next year sometime before we might see a reversal.”

U.S. demand for gasoline declined 3.2% in the month ending July 25, the Energy Department announced. Tesoro’s Westfall said the decline was due to changing driving habits, rising unemployment and the increased popularity of more fuel-efficient car models.

In many ways, these changes in consumer preferences are more than just a short-term fix. With oversized sport-utility vehicles going the way of the dodo, some of that consumer demand is unlikely to ever return, even if gas prices eventually come down from their current highs.

News and Related Story Links:

• The New York Times:
  Rising Oil Prices Swell Profits at Exxon and Shell

• Bloomberg News:
  Exxon Profit Rises Less Than Estimated; Output Drops

• Reuters:
  Exxon has record profit again on soaring oil prices

• Reuters:
  Shell loses 40,000 bpd from Nigeria pipeline attack

• MarketWatch:
  Royal Dutch Shell’s profits top $11 billion

• CNNMoney:
  Tesoro Economist: No Recovery In US Oil Demand This Year

• Wikipedia:
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• Money Morning:
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By Mike Caggeso
Associate Editor

High gas prices have forced Exxon Mobil Corp. (XOM) – the world’s largest oil company – from the retail gasoline business, the company said late Thursday afternoon.

There are about 12,000 gas stations with the Exxon sign at the entrance, though the company owns about 2,220 of them. And Exxon plans to sell those over the next few years, Reuters reported.

Texas leads the states with the most company-owned gas stations with 190. Florida has 170, the Associated Press reported.

“We are in a very, very challenging market. Margins are reduced,” Exxon spokeswoman Prem Nair said in a statement. “We feel the best way for us to grow and compete is through our distributor network.”

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Exxon stations may be everywhere but retail gasoline sales are only a small portion of the company’s revenues. And with gasoline costing 31% more than a year ago and crude oil prices at record levels, it’s also one of the most unprofitable.

This doesn’t mean we’ll stop seeing the ubiquitous blue signage across the country. Exxon will continue selling fuel to station owners who pay to use the company’s brand name.

Oppenheimer & Co. (OPY) analyst Fadel Gheit estimated the stations’ profit margin was between 10% and 15% (the company doesn’t release margins for its retail division), which is about one-third of its margin for crude oil production.

“I think the decision came that it’s more of a headache than it’s worth,” Gheit said.

Gas stations can’t pass higher prices onto consumers as easily as oil companies pass prices onto them. On top of that, car owners nationwide are taking serious steps to curb gasoline and energy usage, doing everything from using other forms of transportation to buying more fuel-efficient vehicles such as hybrids.

Exxon’s decision follows that of competitors Royal Dutch Shell PLC (ADR: RDS.A, RDS.B) and BP PLC (ADR: BP), who are also moving away from station ownership.

“They can actually point their attention to some other area where you can make money,” Jeff Lenard, a spokesman for the National Association of Convenience Stores, told The AP. “Retail is incredibly volatile. This way, they can (sell gasoline) wholesale and count on a fairly predictable income.”

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Exxon Mobil Corp. (XOM) has obtained a court order to freeze $12 billion in assets from Petroleos de Venezuela as compensation for nationalization projects.

It is the boldest retaliation yet by an international oil major against the trend of governments usurping control over natural resources as energy and commodity prices have soared.

"The freezing order prohibits [Petroleos de Venezuela] from disposing of its assets worldwide up to a value of $12 billion," Margaret Ross, a spokeswoman for Exxon Mobil said in a prepared statement.

Last summer, Venezuela forced six oil majors to hand over equity stakes of 60% or more to Petroleos de Venezuela. However, Exxon Mobil and Conoco Phillips (COP) opted to walk away from their contracts rather than accept a minority role. Exxon was forced to relinquish control of its Cerro Negro affiliate as well as its joint venture to develop the La Ceiba oil field.

Exxon and Conoco say they invested more than $3.5 billion in their Venezuelan oil ventures. They have filed arbitration requests with the International Center for Settlement of Investment Disputes, but it could take years before the dispute is resolved.

"What Exxon did makes perfect sense," James Williams, head of London-based oil consultancy firm WTRG, told BusinessWeek. "They want to make sure that there is something they can get."

It’s bad timing for Petroleos de Venezuela, which is struggling to finance its debt. The company took on $13.1 billion in new debt last year, El Univesal reported. Its overall debt now stands at $16 billion.

While Petroleos de Venezuela has been the beneficiary of higher oil prices and Hugo Chavez’s nationalization projects, the company’s wallet has also been tapped by the government, which is struggling to finance social development programs.

In 2006, Petroleos de Venezuela spent $13.3 billion on state-run social programs, up from $6.9 billion in 2005 and more than double the amount the company invested in oil and natural gas projects.

Now, Petroleos de Venezuela is struggling to raise money for a $77 billion investment program to more than double Venezuela’s oil output. Oil production has dropped 25% since Chavez took office in 1999.

Petroleos de Venezuela bonds posted their biggest-ever intraday drop on Friday. The yield on its 5.25% bond due in April 2017, jumped 90 basis points (0.9%) to 11.63% at 10 a.m. according to Bloomberg News.

The asset freeze will make it "virtually impossible" for Petroleos de Venezuela to borrow money in international markets, Boris Segura, a Latin America economist at Morgan Stanley, told Bloomberg.

Venezuelan Energy and Oil Minister Rafael Ramirez said that Petroleos de Venezuela was preparing its defense and would fight the ruling.

"This is pure judicial terrorism," Ramirez told reporters in Caracas. "If they think that with this they will get us to backtrack on our nationalization policies, well, gentlemen from Exxon Mobil, you are dead wrong again."

Ramirez dismissed the compensation demands of the world’s largest oil company as "ridiculous" and accused it of violating arbitration proceedings.

Venezuela is just one of many emerging nations seeking to extort more money and power from foreign oil majors developing national assets.

Last year, Royal Dutch Shell (RDS.A, RDS.B) was pressured into selling 50% plus one of its shares of the Sakhalin-2 oil and gas project to Russia’s state-owned energy giant, OAO Gazprom.

Most recently Eni S.p.A (E), the Italian oil company, ceded its control over operations at the Kashagan oil field in Kazakhstan, one of the world’s largest undeveloped reserves to Kazakhstan’s state oil company, KazMunayGaz.

Related Articles and Links:

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Shares of PetroChina Co. Ltd. (PTR) soared during its Shanghai initial public offering yesterday (Monday), making the state-owned oil and gas giant the largest company in the world by market capitalization. The Beijing-based company raised $8.94 billion, driving its total market value north of $1 trillion.

PetroChina is now twice the size of Exxon Mobil Corp. (XOM), which was worth $480 billion at the close of trading Monday.

With such an exorbitant valuation, market-watchers are growing more fearful of a China-based asset bubble that’s posing a threat to that nation’s continued economic advancement.

For decades, savings accounts with low interest rates were the only savings vehicles China’s consumers had available. Suddenly, the stock market is open to them – and at a time when share prices are soaring. The net effect has been to create a speculative culture not unlike the one that fueled the dot-com boom here in the United States in 1998 to 2001 – an investment mania whose implosion tipped the U.S. economy into a fairly rough recession. A booming stock market in China has fueled that speculative fervor.

China’s state-run media has reported that the number of share trading accounts now exceeds 100 million. According to the state-run Legal Daily, investing has become so popular in Wenzhou, one of China’s richest cities that the government had to ban public officials from trading at work or from leaving work to conduct trades.

All of the excitement has resulted in a massive run-up in stock shares, and fueled some highly successful IPOs, some of which are increasingly overvalued. China’s CSI 300 stock index has nearly quadrupled in the past year, and is currently trading at 42 times projected earnings, according to the International Herald Tribune.

"There is an accumulated desire to invest," Li Hongtao, an analyst with the Zhejiang Yongan Futures Company, told the International Herald Tribune. "People are heavily influenced by their families, friends, and colleagues at work. A lot of them don’t have any knowledge of the market or any idea of the risk."

It is that level of investor enthusiasm – perhaps even euphoria – that has flooded the Chinese market with excess wealth and liquidity. The value of mainland China’s public offerings this year has hit a record $61 billion. By comparison, listings in the United States and the United Kingdom have generated $51 billion and $43 billion respectively. 

As a result China is now home to five of the world’s ten largest companies. By market capitalization, it has the biggest bank, insurance company, telecommunications carrier, airline, and now energy company. Unfortunately, bigger doesn’t necessarily mean better…

Thanks to PetroChina’s wildly successful IPO, its mainland shares are trading at a 150% premium to its Hong Kong shares. And while the company may be worth twice as much as Exxon Mobil, it is half as profitable. In the first six months of 2007, PetroChina’s net income was $10.9 billion, while Exxon Mobil raked in $19.5 billion. 

"They are not of the strength of Exxon Mobil," John Vautrain, senior vice president of Purvin & Gertz, an energy economics consultancy based in Singapore, told IHT. "They are very strong in China and that is good if you make money, but China is not a good place to be a refiner at the moment. They are deeply underwater, losing a lot of money in refining."

Gains in PetroChina’s shares in Shanghai have more to do with China’s investors chasing returns than it does the outlook for the company’s exploration and production operations, or its refining business, Larry Grace, an oil analyst at Kim Eng Securities Co. in Hong Kong, told Bloomberg News.

"Production is static with limited upside for the next three to four years. As for the downstream, the price controls and overall regulatory trend limit the company’s earnings," Grace said.

China controls fuel prices to shield consumers in the world’s most-populous nation from accelerating inflation. The policy limits the ability of PetroChina and other state-owned energy companies to pass on the burden of higher crude oil costs. The losses are even more devastating now that oil is trading above $96 a barrel.

Warren Buffett, chairman of Berkshire Hathaway Inc. (BRK.A, BRK.B), didn’t hesitate to dump his 2.34 billion shares earlier this year.

"It’s easy to be carried away in the stock market when things are going very well," he said during an interview in the northern Chinese city of Dalian, during a recent visit to China. "We at Berkshire never buy stocks when we see prices soaring."

Buffett just announced that he’s taken positions in some-20 companies in Korea, a market with much lower valuations.

Other investors have followed Buffett’s lead and sold off their China holdings. Indeed, shares of PetroChina fell the most ever in U.S. trading Monday, after Bear Stearns Cos. Inc. (BSC) recommended investors sell the shares because they were too expensive compared with rivals such as Exxon Mobil.

"We see little fundamental reason why PetroChina should outperform other Chinese oil companies or even the China market," Bear Stearns analyst Adam Clarke wrote, citing record oil prices and the company’s completion of the biggest share sale this year.

PetroChina’s New York shares slid almost 13% Monday, dropping $32.96 each to close at $222.10. In Hong Kong, the stock dropped 8.2% to HK$18.

The iShares FTSE/Xinhua China 25 Index exchange-traded fund (FXI) – an ETF viewed as a proxy for the broader China stock market – fell 8.78%, or $18.28 a share, to close at $189.81 yesterday. The FXI ETF is down 14%, or $29.75 a share, from its 52-week high of $219.56.

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• Money Morning:
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• Money Morning Investment Analysis:
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•  Money Morning:
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• Bloomberg:
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Alleging that Canada has violated the North American Free Trade Agreement with unlawful restrictions, Exxon Mobil Corp. (XOM) has announced its intention to sue Canada in early November for more than $40 million. Arkansas-based Murphy Oil Corp. (MUR) has also warned Canada of its intent to sue for more than $10 million.

In their August filings, both companies argued that, under NAFTA, Canada agreed not put any "local content" requirements into effect.  Local content consists of rules or regulations that require companies to source a percentage of goods and services from local vendors.

However, Exxon and Murphy Oil both allege that the Canada-Newfoundland Offshore Petroleum Board established several "guidelines and/or obligations" that violate those terms of the agreement.  The regulations require the petroleum companies operating in the region to spend a fixed percentage of revenues in Canada, and to set up a fund for unspent money to be used for research and development in Newfoundland and Labrador.

Exxon and Murphy have filed for redress under Chapter 11 of the NAFTA treaty, which affords companies the right to demand compensation from signatories in violation of the agreement.

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