Crude prices at a $100/barrel should boost major international oil companies' profits, but increasing competition from governments and suppliers for a bigger share of the bonanza will cap their gains.
Shares in European oil companies opened higher on Thursday after U.S. crude hit a record $100/barrel on Wednesday.
The DJ Stoxx European oil and gas sector index was up 1.9 percent at 8:40 a.m. EST on Thursday, echoing a smaller rise across the U.S. oil industry on Wednesday.
These high oil prices are good news for oil companies as they may help the oil 'majors' maintain their very high level of profits into 2008, Antoine Leurent at KBC Securities said in a research note.
Yet higher prices are not all good news for the oil majors whose operations span from pumping crude to operating forecourts.
In November, Christophe de Margerie, Chief Executive of France's Total, warned that if crude continued to rise, upward trends on taxes and production costs could worsen.
The cost of hiring and operating rigs, building platforms and employing qualified staff has rocketed in the past three years, as high oil prices boosted investment in exploration.
Resource holding nations also raised taxes and renegotiated contracts, safe in the knowledge that the cash-rich but opportunity-poor oil majors had little option but to accede.
Higher oil prices more than made up for this trend, allowing oil companies to post record earnings -- until the third quarter of 2007, when many companies reported profit drops.
As crude accelerated toward $100 in recent months, analysts upgraded their earnings forecasts and target share prices for oil stocks again. But many are skeptical of how much of the oil price upside the majors can retain for themselves.
The oil majors don't correlate that strongly with crude prices, said Colin McLean, head of equities at SVM Asset Management.
SMALLER PRODUCERS, SUPPLIERS BENEFIT MOST
The oil majors' ability to benefit from record oil prices is hobbled by the fact natural gas accounts for around 30-40 percent of output -- and this reliance on gas is growing.
Also, the oil majors have large refining divisions and the resurgence in this industry in recent years has meant processing crude is a bigger part of their business than in the past.
Higher crude prices are likely to put pressure on refining margins, analysts said, such that this recent cash cow could be choked.
Finally, the production sharing contracts, under which the oil majors extract an increasing portion of their oil and gas, tend to award the lion's share of any high oil price windfall to resource-owning governments.
These trends have led many investors to look elsewhere to ride the oil price boom.
The best way to play the prospect of a sustained high oil price environment is probably (to buy) well-financed independent exploration and production (E&P) stocks, McLean said.
The smaller oil producers such as London-based Tullow Oil Plc tend to have greater correlation with oil prices because their assets are often more oil-focused and they usually lack ancillary activities such as refining and petrochemicals which may be a drag on earnings.
Indeed, after oil hit $100 on Wednesday, shares in U.S. E&P companies including Anadarko Petroleum rose while Exxon Mobil Corp (XOM.N: Quote, Profile, Research), Chevron Corp and ConocoPhillips traded down.
In Europe on Thursday, Tullow and peers Premier Oiland Dana Petroleum outstripped gains at BP, Shell and Total, the three biggest European oil firms.
McLean also tipped shares in the companies which build, supply and operate facilities for the majors as more likely to benefit than the majors themselves, echoing an investment theme many analysts have backed in recent years.
Analysts at JP Morgan have forecast 24 percent earnings growth per annum over the period 2007-2009 for the European oil service sector, while the bank expects BP to post a rise in profits of only 7 percent this year and 5 percent in 2009.
Tight markets for the supply of their goods and services is expected to allow companies such as Italian engineering company Saipem (SPMI.MI: Quote, Profile, Research) to extract more of the price of a barrel of crude for themselves.
Executives at the oil services companies see their pricing power as payback for the tough years in the late 1990s and early part of this decade when the oil majors slashed their exploration budgets and squeezed their suppliers -- actions which led to the erosion of capacity in the oil services sector.
Shares in U.S. oil services companies Halliburton and Weatherford International were among the big gainers in the U.S. oil industry on Wednesday after the record was hit.
European sector leader Saipem traded up almost 2 percent and number two by market capitalization, France's Technip traded up 1.4 percent.
(Editing by Erica Billingham)