Big oil, big impact: Markets brace for plunge in profits as oil majors report 4Q results

Energy Associated Press

It's just a forecast, and for only one of 10 industry groups in the stock market. Yet it has almost singlehandedly turned what had been a promising earnings season into a grim one.

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Profits for companies in the Standard & Poor's 500 index are expected to grow at one of the lowest rates in years, just 1.4 percent. The culprit: Energy companies that suffered as oil prices plunged. Their profits are expected to drop 25 percent, a collapse of fortune nearly unheard of outside of a recession, and one that has weighed on the stock market.

Investors will find out just how ugly the earnings are as oil companies report results over the next several days.

So far, things don't look so good. Several oil producers and service companies have announced layoffs and reductions in spending on new drilling projects. BP told workers Monday that it would freeze pay for 2015. On Thursday, Royal Dutch Shell posted a 57 percent drop in fourth-quarter earnings.

Chevron reports early Friday, followed by Exxon Mobil and BP next week.

BIG OIL, BIG IMPACT

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Lower oil prices are good for the economy and most businesses, but they are bad for the stock market in the short term. Energy companies have an outsized effect on the S&P 500 index because they are among the most valuable members of it.

Instead of giving equal weight to each of the companies, the S&P 500 ranks them according to their market value. Exxon Mobil, worth $385 billion, is about 10 times the average value of a company in the index

Why does that matter? Every percentage move in Exxon's stock, up or down, pushes the index up and down as if Exxon were 10 companies. Exxon's stock has fallen 16 percent from June when oil began to slide from $107 a barrel to $44 currently. Chevron, another heavyweight in the index, has fallen 27 percent.

DAMAGE DONE?

Stock prices have already suffered because investors know what's coming.

Big oil earnings are relatively predictable because oil production is fairly steady and prices are set on open markets. While a company such as Apple can surprise investors by revealing just how popular a new product is with consumers, oil is always in fashion. Analysts can make reasonably good guesses about how much oil a company produced in a quarter, and what prices they were able to sell it for.

When all the results are tallied, the plunge in energy company earnings is expected to be by far the worst among the 10 sectors in the S&P 500, according to FactSet, a financial data provider. Without that hit, earnings for the S&P 500 would be on track to grow a healthy 4.6 percent.

"Rising tides lifted all ships, and now the tide is coming down and all ships are falling," said Fadel Gheit, an analyst at Oppenheimer & Co. "We know how this is going to end."

POSSIBLE UPSIDE?

Companies such as Exxon, Chevron, Shell and BP don't just produce oil, they also buy and refine it into fuels and chemicals. When oil prices fall, refining profits often rise. Exxon, Chevron and Shell all posted higher earnings in the third quarter of last year even as oil prices slumped. That's because refining profits rose more than production profits fell.

Shell's large profit drop in the latest fourth quarter could have been a lot worse. The plunge in crude prices meant Shell's refining operations paid less for the oil it buys on the open market. That helped refining earnings jump 167 percent.

Refining profits at other big oil companies might rise again in the fourth quarter, analysts say. Still, crude prices almost certainly fell too far for refining to make up the difference.

WHAT NEXT?

Big oil companies are careful not to forecast prices, especially in the short term. But they will offer clues about how long they think low prices will last in what they say about drilling plans.

The analysis firm Wood MacKenzie predicts that oil and gas companies will spend $50 billion less this year in North America than last year, a drop of nearly 40 percent.

Oil companies are among the biggest corporate spenders because the cost of exploring for and producing oil and gas in difficult places is high. Chevron's Gorgon natural gas project in Australia, for example, is expected to cost $54 billion.

Costs could fall, though. When oil prices drop and drilling activity slows, rig operators and other companies that work for big oil producers charge less. That could make some projects more profitable.