ROYAL DUTCH SHELL GROUP .COM THE WALL STREET JOURNAL

THE WALL STREET JOURNAL: After the Windfall Profits: "Next Thursday, chieftains from Exxon Mobil, ConocoPhillips and Royal Dutch Shell will appear before a joint Senate committee to explain why Uncle Sam shouldn't relieve them of some of the nearly $23 billion in profit they earned in the third quarter. Sometimes, congressional witnesses need to keep their mouths shut, as Frankie Pentangeli did when asked about Michael Corleone. ": Friday 4 November 2005

Sliding Energy Prices Pose
Bigger Problem for Big Oil;
'Sweet Spot' for Chemicals
November 4, 2005

Surging energy prices fattened Big Oil's coffers and caused a stir on Capitol Hill -- nothing Wall Street hasn't dealt with before. Now that energy prices are retreating, other companies stand to benefit for unlikely reasons. This week, we welcome guest writer Phil Alaron, a senior analyst at Alaron Trading, who says surging energy prices and a robust economy go hand in hand.

Scott Patterson: Companies that raised prices for their goods to keep pace with surging energy costs can reap rewards if they can make those price increases stick while energy prices retreat.

Certainly, many corners of the economy will get some relief if energy prices continue to fall. Consumers will have more jingle in their pockets to spend at discount retailers this holiday season. Airlines will shell out less for jet fuel, and even beaten-down auto makers might sell a few more gas-chugging SUVs.

But things could be even better for a handful of chemicals companies -- DuPont and Dow Chemical the biggest -- that tried to counter higher raw-materials costs with their own price increases -- a feat retailers, auto makers and airlines have largely been unable to duplicate amid the cut-throat competition of "employee pricing" and steep discounts. If chemicals makers manage to keep those price increases intact, and some analysts suspect they will, that could yield fatter profit margins and stronger earnings in coming quarters. "The pressure valve gets relieved on the cost side of the equation, and the potential for them to maintain their prices could very well hold," said Owen Fitzpatrick, managing director at Deutsche Bank Private Wealth Management.

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Is it fair to impose windfall taxes or other measures on oil companies? What is the best way for investors to bet on sliding energy prices?

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DuPont raised prices 4% across the board in the third quarter. Dow Chemical started charging more for products ranging from latex, used to make tight-fitting, stretchable products like gloves, to caustic soda, an ingredient used in bleach, soap and detergents. So far, customers have swallowed higher prices. Earnings at Dow Chemical and DuPont topped Wall Street's forecasts in the third quarter. DuPont, though, lowered forecasts for the fourth quarter.

If energy prices keep sliding -- a big if -- investors could find a "sweet spot" with chemicals makers, says Michael Judd, an analyst at Greenwich Consultants. The companies will have to lower prices at some point if raw-materials costs fall, but there is a lag. "That's when margins are maximized," he said. Dow Chemical said it will monitor falling energy prices and that it bases the prices it charges for its goods on many factors. DuPont declined to comment.

The sweet spot, however, is already shrinking. While shares of DuPont are down 11% year-to-date, and Dow Chemical is 7% below water, they are each up about 12% since late September. By the time "oil prices come down significantly, the stocks will have already appreciated," said John Buckingham, portfolio manager of the Al Frank fund. A slowing economy presents another obstacle for chemicals companies, but most sectors face that problem. If energy prices come back down to earth, that could provide juice to keep the economy going strong and demand for chemicals makers' products robust.

Mark Gongloff: Next Thursday, chieftains from Exxon Mobil, ConocoPhillips and Royal Dutch Shell will appear before a joint Senate committee to explain why Uncle Sam shouldn't relieve them of some of the nearly $23 billion in profit they earned in the third quarter. Sometimes, congressional witnesses need to keep their mouths shut, as Frankie Pentangeli did when asked about Michael Corleone. Not these witnesses; they need to sing like Kelly Clarkson to keep Capitol Hill happy. But no matter how well they perform, they'll be a sideshow to the real threat to Big Oil profits that lurks in the futures pits.

The stakes are certainly high for the black-gold kings and their investors. A populace enraged by the high cost of fueling its Hummers has formed an angry mob seeking to strip them of their loot. Lawmakers from both parties have stepped to the front of the pack to call for a variety of penalties, including one straight out of Sherwood Forest: taking money from the rich oil companies and giving it directly to poor people. Oil-industry analysts interviewed recently offered thoughtful and nuanced responses to such notions, calling them "chilling," "insane," "a waste of time" and "the biggest stupidity anyone could come up with." Perhaps.

But such considerations haven't stopped Congress in the past. A windfall-profit tax was enacted in 1980 -- the year oil hit its inflation-adjusted record high of about $90 a barrel -- that siphoned a percentage of oil companies' profits. Before it was eradicated in 1988, the tax generated some $80 billion in revenue, earmarked to help the poor and fund energy and transportation programs.

Analysts say this experiment in wealth redistribution crippled the oil industry, though a steady drop in oil prices that began shortly after the tax was enacted didn't help, either. Present-day critics of the tax, citing a Congressional Research Service study, say it cut U.S. production and exploration and increase U.S. dependency on foreign oil. Analysts say a new windfall tax would sink oil equities, which make up nearly 10% of the Standard & Poor's 500-stock index. In any event, the White House and some Republican leaders have said they wouldn't support an outright windfall tax, so it seems unlikely to pass.

But other ideas -- windfall taxes in all but name -- have received a warmer reception: forcing oil companies to build new refining capacity, for example, or to contribute to a reserve of energy products. The industry has lobbied hard against such punishments and may succeed in keeping them at bay.

But the biggest threat to oil profits isn't in Washington, but at the Mercantile Exchange in New York, where crude prices have fallen to three-month lows. Be it slumping demand, fears that the oil rally went too far or another reason, the result is the same: lower oil prices mean lower oil profits. And like the magazine-cover curse, congressional outrage could be an early sign of a longer-term crude-oil decline. It marked the peak of the oil market in the 1980s and again in the early 1990s -- when the idea of a windfall tax was briefly resurrected -- and may well do so again in the 2000s.

Phil Flynn, senior analyst at Alaron Trading: High energy prices have led to jaw-dropping oil profits and a lot of talk about price gouging and that old windfall tax. What isn't discussed is that along with the rise in energy prices, the U.S. has experienced an outstanding run of economic growth.

It is nearly impossible to separate the two. Recent data in the U.S. prove that our economy is flourishing despite the sharper toll energy costs are taking on consumers' wallets: Productivity and gross domestic product were strong in the third quarter. Factory growth, as measured by the Institute of Supply Management's manufacturing index, slowed only a hair in October. If energy prices are such a burden, wouldn't they be felt first more sharply in manufacturing? Yet, the ISM report marked the 23rd consecutive month of expansion in this important sector -- the longest stretch since the 1980s.

Higher oil prices and impressive oil-company profits are a byproduct of this growth. They show the health of not only the U.S. economy, but of burgeoning economies overseas. It isn't a coincidence that China is consuming a larger share of the energy pie as its economy expands at such a rapid pace. If the grumblers out there want to succeed in pulling down the high cost of oil, they will have to cut demand for that oil. That is achieved by drastic, questionable means: shaving profits and tamping down on economic growth.

There is another consequence to giving costly energy and record oil profits a bad rap. High prices encourage energy efficiency, conservancy and spur the quest for alternative fuels. Imposing a windfall tax on Big Oil's profits will discourage needed investment in these areas. High prices are the legitimate cure to high prices. If oil is always cheaper than the alternative, then other forms of energy will never have a chance to compete. And imposing unfair profit taxes could put the U.S. economy at a disadvantage in an oil hungry world.

Despite rising profits by major oil companies, world-wide proven energy reserves are falling. Take away the incentive for U.S. oil companies to invest in exploration, and the U.S. becomes even more dependent on foreign sources for energy. Tax U.S. oil profits, and other nations' oil companies will be more than happy to spend their fortunes to find new reserves. If U.S. oil companies don't have the money to compete, other countries will control more of the pie.

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