Crude Demand Falls, Profits to Follow? (XOM, CVX, COP, BP, VLO, TSO, WNR, SLB, HAL, NE, APA, DVN, CHK)

High prices have finally contributed to curing high prices in the world’s crude oil market. The gloomy economic forecasts for the second half of 2011 have combined with $120/barrel prices for Brent crude to send the price below $100/barrel and to push WTI prices momentarily below $80/barrel.

The International Energy Agency and OPEC agree that forecast demand growth in 2011 is 1.2 million barrels/day. The US Energy Information Administration has pegged demand growth in 2011 at 1.4 million barrels/day. The difference is that the EIA estimates US GDP growth of 2.4% in 2011, whereas OPEC believes US GDP will grow by a scant 1.8%. The IEA GDP growth estimate for North America is 2.7%.

The lowered demand estimates should moderate pump prices in the US and the rest of the world, but will certainly hit profits at major oil producers like Exxon Mobil Corp. (NYSE: XOM), Chevron Corp. (NYSE: CVX), ConocoPhillips Corp. (NYSE: COP), and BP plc (NYSE: BP). The largest contributor to big profits at these companies has been high prices for crude and for gasoline. They will still earn profits at $80-$85/barrel, just not as much. A drop to $75/barrel would be closer to the bone, and anything below that for an extended period of time could spell trouble.

The integrated oil companies’ refining operations will make up some of the difference, as their input costs will fall with the price of crude. Pure downstream outfits like Valero Energy Corp. (NYSE: VLO), Tesoro Corp. (NYSE: TSO), and Western Refining Inc. (NYSE: WNR) should also see a rise in profits, but the increase will be more modest, especially if the near $20/barrel differential between WTI and Brent closes.

As for service companies and drillers like Schlumberger Ltd. (NYSE: SLB), Halliburton Co. (NYSE: HAL), Noble Corp. (NYSE: NE), and others, their prospects are still solid, due in large part to development of shale oil and gas. An oil and gas industry group projects that up to 200,000 new jobs will be created in the oil & gas patch in 2011.

For several years now the industry has been concerned about a burst of petroleum engineers reaching retirement age with no replacements available. The situation has grown even tighter now, as companies like Apache Corp. (NYSE: APA), Devon Energy Corp. (NYSE: DVN), and Chesapeake Energy Corp. (NYSE: CHK) continue to troll for new engineering talent.

Both the IEA and the EIA are looking at the world’s economy through glasses that if not rose-colored are surely tinted by government projections and policy. OPEC’s US GDP growth estimate of 1.8% seems clearly more in-line with recent economic performance.

And cuts to federal and state budgets will soon put more Americans out of work. Anyone who expects reduced spending to put some life back into the US economy has simply not been paying attention or has some other ax to grind.

The main prop to crude prices is demand from China, which is expected to grow to at least 6.5 million barrels/day in 2011. Demand from developed countries is essentially flat to down. The shortfall due to the loss of Libyan oil has been made up, mostly by increased production from OPEC.

The main driver of crude prices is the same as it has always been: growing demand for an ever-shrinking supply. Speculation is not the culprit, nor is OPEC. Weak economic growth slows demand and forces prices down. The impact on the oil & gas industry will be noticeable, but not devastating.

Paul Ausick