This report analyzes the uses of accrued profits by the five major integrated oil companies from 2004 through 2007. Although the oil industry is composed of thousands of firms involved in many different aspects of the business, these five firms represent the visible face of the oil industry to the American public. These companies also earned 90% of the total earnings of integrated oil companies, and 74% of the earnings of all the integrated oil companies, the independent oil and gas producers, and the independent refiners and marketers in 2007. The increased price of crude oil since 2004 has been attributed to the growth in demand from China, India, the United States, and other areas, as well as to hurricanes Katrina and Rita and a variety of other factors. Few if any of these factors could be influenced by the five companies. Crude oil prices began their rise toward the end of 2003, and although volatile, have remained at, or near, historically high levels since then. In addition to the increasing price of crude oil, tightness in the refining industry contributed to the increase in petroleum product prices, notably gasoline. A slower pace of capital investment is consistent with a view that the currently high price of oil might decline in the future, leading to an investment reference price below the currently observable price, or a forecast that demand growth might slow or even decline. Several years in the permitting process might be expected. This, along with other reasons, like scaling the company to an appropriate size for international competition, has led to periods of merger and acquisition activity in the oil industry. If the number of shares falls, the actual return to shareholders from dividend payments is greater. In the real world of finance, however, where bankruptcy is a potential reality, many analysts look upon debt reduction as an important way to strengthen the balance sheet of a company, improving its financial health. Cash

When revenues and profits accrue quickly, and perhaps unexpectedly, there may be little alternative to holding those returns as cash balances until a strategy for using them can be developed and put in motion. In time, as corporate plans more reflect a crude oil market characterized by higher prices, long-term assets might be accumulated, supplies of both crude oil and petroleum products might be enhanced, and consumers might see a slacker market where prices may moderate from current levels.
The price of crude oil began to increase in the last quarter of 2003, and has led to the high prices observed from 2004 through 2007. The Iraq War, unexpectedly high demand growth in China, India, and the United States, and Hurricanes Katrina and Rita, along with a number of other factors, all contributed to the rising price.
An important result of these largely unexpected events was that the oil industry, as represented by the five major integrated oil companies doing business in the United States, experienced rapidly expanding revenues and profits. Some observers characterized these profits as "windfall" gains, while others pointed to the increasing scarcity and rising costs observable in the oil industry. Some saw "price gouging" in high gasoline prices, while others saw the market working to avoid physical supply shortages.
The larger profits experienced by the oil industry and the five major integrated oil companies can be used in a variety of ways. Profits might be used to expand exploration and development of crude oil resources to expand the supply of oil. Refineries might be constructed, and technology improved at existing refineries, to expand the supply of petroleum products, most notably, gasoline. Profits might also be used to provide increased returns to the owners of the oil companies, the shareholders. This end might be accomplished through dividend payments and share repurchase plans. Profits might also be used to improve the balance sheets of the companies through debt reduction, potentially improving their financial health should they face a downturn in the market in the future. Until the effects of corporate plans that reflect a market characterized by higher oil prices can be observed, profits might tend to build up as cash reserves, as experienced by some of the five firms since 2004.
How the profits generated over the past four years are used will help to determine whether oil and petroleum product markets remain tight with high prices, or whether they loosen, develop extra capacity, and lead to moderating prices.
This report will be updated.