Two Sides To The Dear-Oil Coin

Score another win for Big Oil.

On Jan. 3, the second successive day that crude fetched $100 per barrel on futures markets, share prices for oil firms with U.S. operations--such as ExxonMobil, Chevron, ConocoPhillips, BP and Royal Dutch Shell--all closed up.

What's more, a new report by the U.S. government's Energy Information Administration further warmed the hearts of the oil bulls. Since last week, the U.S.'s stock of crude has dropped by 4 million barrels, and since mid-November it has fallen by 25 million barrels--a 7% decline. Adding fuel to the fire, the U.S. reportedly has no plans to tap its Strategic Petroleum Reserve.

But the outlook is not all rosy; "Big Oil" has many little parts. Exploration and production firms do well when prices are high, but refiners feel a squeeze.They have to pay top dollar to buy the black stuff from those producers.

This has been evident since at least the third quarter of 2007. Refining companies Valero Energy, Sunoco and Tesoro all took a hit financially during that time (the most recent period for which data are available) largely because of high crude prices. Shares in each of those companies have dropped since oil topped $100 per barrel, with stock prices for all three companies tumbling more than 4% Thursday.

Even the majors, which have both drilling and refining capabilities, are not immune to refining's tight margins. ExxonMobil, Chevron and the like have all seen some drag on their recent profits because of the strains on their refining operations.

There's an additional factor that could drive up crude prices even further: dwindling reserves. According to Lucian Pugliaresi, president of the Energy Policy Research Foundation, a Washington-based group that analyzes oil economics, a "perfect storm" of events within the last five years--including political instability in Iraq, Venezuela and Nigeria--has undermined production expectations by as much as 3 million barrels per day.

"The real issue is: what's it going to cost to replace these reserves over time," says Pugliaresi. "That's going to be expensive." He laments that even with crude trading at $100 per barrel, there's still little political will in Washington to expand offshore drilling or to open up Alaska's Arctic National Wildlife Reserve for more production.

Not good news for gas guzzlers. The Energy Department reports that within the past year, average gasoline prices have risen from $2.33 per gallon to $3.04 per gallon--a 30% increase. Most of this increase occurred during early 2007 in the run-up to the summer driving season. But since at least May, the margin between crude and wholesale gas prices has increasingly shrunk, according to AAA's Fuel Gauge Report, a daily updated indicator of retail gasoline prices. So if crude continues to rise, gas prices should follow suit.

A silver lining to the prospect of the $100 tank of gas? A recent paper by the American Petroleum Institute, Big Oil's industry group, shows that mutual funds, IRA holdings and pension funds account for more than 70% of the ownership of publicly traded U.S. oil and natural gas firms. If the price of crude continues to rise, investing in oil firms might just be the best way to offset those high prices at the pump.