Oil Prices and Oil Company Profits


"With oil prices rising, we might expect a surge of upward earnings estimates for oil companies, but so far that is not the case. Are analysts implicitly suggesting that oil prices are going to fall back down?"

Unless you have been home in bed for the last two weeks, you have probably noticed that gas prices are rising. Yesterday when I filled up, it was $3.65 a gallon; just a few weeks ago, prices were below $3.30. The cause is, of course, rising oil prices. This morning WTI crude was going for $108.53/barrel (bbl), while a month ago prices were just $99.47/bbl. At the start of the fourth quarter, oil prices were hovering in the high $70s. The international price of oil, as measured by Brent crude is much higher, and has been for a while now.

The oil companies did better than average in the fourth quarter, with total net income for the energy stocks in the S&P 500 rising by 9.61%, while with almost all the results in, the S&P 500 has so far seen the total net income rise by 7.14%. On the top line, energy topped the charts, with a 13.43% year-over-year (YOY) rise, almost twice the 6.83% rise in revenue posted by the S&P 500 as a whole.

However, that is not expected to last. In the first quarter energy companies are actually expected to see their total net incomes fall by 3.79% YOY, which is weaker than the 2.58% drop that is expected for the S&P 500 overall. On the revenue side, growth is expected to drop to 5.05% for the energy stocks, and 6.83% for the S&P 500 overall.

For all of 2012, the analysts are even more pessimistic for energy firms relative to the overall market, with earnings growth of just 0.73% while the S&P overall is expected to see growth of 9.41%. As far as revenue is concerned, for the full year, energy company revenues are expected to fall 1.18% for the full year, while the S&P 500 is expected to rise by 2.51% in 2012.

One might think that with oil prices rising, we would be seeing a surge of upward earnings estimates for the oil companies, but so far that is not the case. In fact, the ratio of upward to downward revisions for 2012 earnings is 0.54, or almost two estimate cuts for every increase.

So, do you think the analysts are implicitly suggesting that oil prices are going to fall back down, or do you think that the analysts are way off-base, and that the estimates will soon turn around and start to rise?

Personally I think the later is the case. If Iím right, the energy companies, which have among the lowest price-to earnings ratios of any sector (autos and financials are very close), will turn out to be wonderful places to be this year.

Dirk van Dijk, Zacks Investment Research


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