BLOGGER CONFERENCE CALL

TO DISCUSS INDUSTRY EARNINGS

FEATURING
JOHN FELMY,
CHIEF ECONOMIST,
API

MONDAY, APRIL 23, 2007

Transcript by:
Federal News Service
Washington, D.C.

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 Following is the transcript of the conference call. It was moderated by Juan
Palomo of API, who introduced John Felmy.

00:00:30 JOHN FELMY: I’ll just make a brief introductory statement.

As you know, earnings are going to be released for the companies, the bulk of it
this week and next week. While I can’t forecast what the individual earnings
performances will be of each individual company – first of all, I’m not a financial
analyst; second of all, it’s a complex calculation – we do know that we saw our crude oil
and natural gas prices down this quarter, first quarter year over year. We have also seen
refining margins up. So how the individual company’s performance will be will be a
function of what share of your business is in those individual categories. Some of the
initial statements from analysts were anticipating a decline, but we’ll see as we go
forward.

It’s possible that you’ll see the performance that we’ve seen recently where in
terms of cents on the dollar you see the oil industry coming in around 9, 9.5 cents. That’s
important because in noting what our earnings are, the numbers of course are first of all
very large, because the companies are very large. Exxon Mobil could be one of the top
20 countries in the world in terms of size if it were a country. So very often we find that
these numbers are so large that people tend to misunderstand and misinterpret them.

But if you look at the history of the industry going back several years, you see
that in many cases our performance in terms of cents on the dollar of earnings are
probably a little bit like Lake Wobegon’s children: above average, but not significantly
so.

In fact, if you look in 2006, the average earnings for the industry were 9.5 cents
on the dollar and that compares to all manufacturing, which is roughly 8.2. Now, when
you take out the car companies, which of course have had a challenge over the past year,
and you take those negatives out, if you look at the average for manufacturing it works
out to 9.5 cents on the dollar also. So the industry earnings are very much in line with
that of manufacturing, less than many other industries, and certainly not out of line in
terms of everything they have to do to find, produce, refine, market, transport oil to
consumers. So that’s my first point.

The second point is that what do we do with earnings? Well, we continue to

reinvest. The industry invests vast amount of money in terms of finding oil and gas, in
terms of developing infrastructure to ship, refine, transport, get it to consumers 24 hours a
day, seven days a week. The Oil and Gas Journal, for example, last year estimated that
the total capital expenditures in the industry was $176 billion. And this year they are
estimating in a survey that they have that it’ll be $183 billion.

Now, the industry invests in both oil and gas to find more fuels to continue
flowing for the future as most forecasts indicate that we’ll need, but they also invest in
alternatives. We invest in emerging energy technologies such as frontier hydrocarbons,

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energy efficiency. We invest in gas to liquids, LNG, and in renewables such as cellulosic
ethanol and solar, wind, geothermal and so on. So the industry in the five years of 2000
to 2005 invested about $98 billion in those emerging energy technologies.

So we are all looking forward to supplying energy for the future in terms of what
we’ll need because virtually all the forecasts from the conventional organizations such as
the EIA, IEA, and so on indicate that you’re going to have continued demand growth for
energy of all types and also petroleum in the future. That’s my second point.

The third point, very briefly, is that the industry has been attacked numerous
times over the past few years as though the industry is some kind of inanimate object and
people and politicians have threatened to take money away from the industry via
increased taxes or penalties or something along that line. We find that especially
unfortunate, because our companies are owned by millions of Americans who have put
their hard-earned savings into retirement accounts that own these companies. For
example, 41 percent of the equity of the oil companies is owned by retirement plans
alone. And then we have millions of other Americans in their other savings instruments
have also invested.

As I like to say, you know, our companies are not owned by space aliens. They
are owned by millions of Americans who rely on these dividends and rely on
performance of the equities, and also performance in terms of stock buybacks to support
those equities. So fundamentally, when you hear folks saying they’re just going to take
money away from the industry and do whatever they say they are going to do, we find
that especially unfortunate, because it’s really Joe and Martha out in America who are
invested in these companies and it is fortunate for those folks that they do have earnings
to be able to support their secured future.

With that I will stop and be happy to take any questions to start.

00:05:48 SKYMUTT: Yeah – this is – go ahead if you want – I’ll go ahead then.
This is Skymutt on Daily Kos.

I have a question to your last point about the investment of retirement accounts in
big oil. Last year, Exxon Mobil alone bought back $30 billion of its own stock, which
seems to be taking money out of – taking stock out of the pool that could be invested by
the public, which would reduce the stake American retirees in oil companies. I want your
comment on that.

00:06:34 MR. FELMY: Well, the fiduciary responsibility of the executives of

these companies is to manage their businesses so that they have good returns to their
shareholders.

You do that by several ways when you have cash flow that you’re working from.
You invest of course, as we mentioned, which is a vast amount; you pay dividends, which
is a return to your shareholders in terms of their earnings; you can buy back stock, which

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what that does it boasters the share price of the individual company’s equity and that
helps your shareholders; or you keep retained earnings in terms of – for a rainy day or
cash flow for what you need.

So what individual companies do is a function of what their perception of is best

for their shareholders. They have been heavily criticized for doing stock buybacks, but in
fact if you compare the stock buyback rate of the oil companies with that of the S&P
industrials, on average you’ll find that the share of net income that goes to stock
buybacks is much less than that of the average S&P industrial. So many of the criticisms
we feel are just – do not take that into account and are unfortunate, but it’s really the
fiduciary responsibilities of trying to get to that point.

00:07:54 MR. PALOMO: Josue, you had a question?

00:07:58 JOSUE SIERRA: Yeah. You talk about refining margins being up.
We’ve been hearing a lot on the news that one of the big challenges to the – one of the
reasons for the rising price in gasoline is the limited amount of refineries.

Considering that, where is the rise in refining margins coming from? How are the
oil companies achieving that?

00:08:22 MR. FELMY: Well, what we’ve seen so far this year in terms of
supply and demand fundamentals is the following: while we have heard a lot about
outages and unplanned outages and planned outages, what we saw actually was a case
where the industry produced record amounts of gasoline in the first quarter, but we had
very strong demand.

Gasoline demand year over year was up 1.7 percent year over year, which is
higher than it was, say, for example, in 2006 when it was only 0.8 percent. You combine
that with a decline in imports of gasoline, primarily from Europe, either due to some
unplanned or planned outages there or a strike in one instance. We saw imports of
gasoline decline.

So what we saw was a tighter market. We saw increases in crude oil costs, for
example, of about 37 cents a gallon. We saw increases of ethanol cost that could be, if
you blend the 10 percent, an additional five cents per gallon. And you compare that, for
example, to gasoline prices, which were up about 70 cents. So we did see some margin
improvement from low levels at the beginning of the year and that’s reflected in what
you’ll see from earnings from the refining sector of the industry, but it was due to the
supply and demand fundamentals for gasoline.

Now, that’s different in diesel. Diesel was a little bit different because you saw
both record production of diesel fuel, you saw demand up pretty strong because we
continue to use a lot of diesel fuel with a booming economy, but finally what was – and it
was a bit surprising – we actually saw imports of diesel fuel up significantly, so that

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market was considerably softer and in fact you saw diesel prices up about 40 cents a
gallon.

So you have two different markets that are driving the margins for the refineries at
this point.

00:10:25 MR. SIERRA: Follow up to that: what is being done about the limited
amount of refineries available and how is that challenge going to be dealt with in the
future with the rising demand and obviously the rising price because of limited refinery?
What are oil companies doing about that?

00:10:42 MR. FELMY: Well, the first thing that oil companies are doing is
looking forward and thinking about expansion.

By reference, if you look over the last 10 years, it’s true that we haven’t built a
refinery in that period – in fact, we haven’t built a brand new, state-of-the-art, grassroots
refinery in 30 years – we have succeeded in expanding the existing capacity by the
equivalent of a new refinery every year within the existing refinery fences.

If you look forward to the announcements that the refiners have made, it looks
like that trend will continue over the next five or so years. If it does, we’ll actually reach
a point where we’ll have record refinery capacity that will exceed the higher level of
capacity we had in the early 1980s when small refineries were heavily subsidized, and
when those subsidies disappeared so did those refiners.

So the industry is looking very carefully about what the growth is, because DOE
is forecasting a growth in demand for petroleum over the next 20-some years to 2030 of
about 28 percent, so we’re going to need more capacity or we’re going to need to import
more.

Now, importing may be a cost effective way to do it, get product in the United
States, but then you have to be sure that the product that you’re importing meets our very
strict clean air requirements. And so there’s a balance in terms of how you want to have
refinery capacity here versus product that you can import. Fortunately, Europe has been
switching to more and more diesel engines and diesel cars and that has left some excess
gasoline that could be exported to the U.S.

00:12:27 MR. SIERRA: When you talk about expanding refinery capacity
within the U.S., how is that being achieved? Simply through process improvements or
are we talking about technological progress that is helping these old refineries produce
more?

00:12:41 MR. FELMY: It’s a combination. It’s both capital expenditures in the
sense of having bigger pipes and bigger tanks and increases in size, but it’s also
technological improvement in terms of getting greater yields from, for example, the crude

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oil so that you get more product out of the same barrel of crude and you reduce the
product that you don’t use as much.

So for example, we’ve seen yields this year of gasoline and diesel fuel both go up
and yields of the less usable products of residual fuel or petroleum coke or things like that
go down and so what you see is both a combination of the sizing along with the
technology and yield adjustments in terms of creating that. That includes a whole host of
new catalysts that you introduce and new learning processes that you go through, for
example, on how you take more and more sulfur out of gasoline and diesel fuel.

00:13:42 MR. SIERRA: Thank you.

00:13:44 SKYMUTT: This is Skymutt again. I want to ask you about what’s
sometimes known by critics as corporate welfare. For instance, there’s a provision in the
2005 Energy Bill that’s going to be under effect this year that’s going to give up to $1.5
billion over the next 10 years to a consortia of energy companies for researching the
ultra-deep undersea gas drilling.

How would you respond to your critics who say that that’s less warranted given
high prices for energy and high profit level for the industry?

00:14:23 MR. FELMY: Well, if I remember correctly, those provisions for

developing deep-sea technology for exploration and production primarily go to
universities. I don’t believe that they are destined for the companies themselves.

They were largely, I think, intended for technological development in universities

in like Texas, for example. I could be wrong, but that’s what memory serves me on what
the intent of that was and the industry itself was not destined for those funds.

00:15:04 MR. PALOMO: Any more questions?

00:15:06 SKYMUTT: Yeah – maybe a question about a particular area. I’ve

been interested about the Williston Basin in North Dakota and Montana. I am interested
in why hasn’t there been more production there to date?

It is increasing rapidly, but levels are still pretty low compared to some estimates
of the amount of resource in the area. And I was just wondering what are the limits to
production in the area and what potential effect could they have on the amount of
domestic production and the bottom lines of the oil companies?

00:15:47 MR. FELMY: I don’t have a good estimate that I can share with you in
terms of what the total potential is there, but my understanding of that area is that it’s
limited by transportation capacity.

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 You don’t really have extensive pipeline networks that come out of there and so it
really does limit the amount you can produce. It also can have an impact on the price of
that produced oil because of course it’s isolated.

So my sense is that they have had some good discussions about moving forward
on expanding pipeline capacity and you may see considerably more production. As I
recall, also, it’s a pretty good quality of oil, so it’s desirable in that sense and so one
would expect that you see more development of it, but as I said I think it’s primarily a
transportation limitation that had limited production there.

00:16:46 MR. PALOMO: Anything else you guys would care to know about
earnings that john could answer?

00:16:53 SKYMUTT: I have one more question about – I guess it’s sort of
related to that. I’ll go ahead and ask it. Why hasn’t domestic investment increased more
rapidly than it has given that the price for a barrel of oil has basically tripled within the
past decade? Why has there not been more investment in domestic production?

It doesn’t seem that areas for investment have been taken of the table. I know that
there’s been complaints by the industry that there’s not – the most attractive areas are not
opened for investment, but – maybe I can just get your comments on why there hasn’t
been a bigger ramp-up in domestic investments?

00:17:49 MR. FELMY: Well, I think your last comment is really on the mark:
that the most attractive areas indeed are not on the table and if you want to expand
investments, you need places where you can invest.

We have the East Coast, West Coast completely off limits, the Eastern Gulf of
Mexico, and of course everyone knows that parts of Alaska that are off. In order to be
able to make investments, you need to have resources that are promising, so that you get
a return to your shareholders.

But also we have had pretty substantial increases in investments. For example,
according Oil and Gas Journal it went up about 35 percent last year in exploration and
production. That’s a pretty sizable increase and it could have been more if we had more
prime areas that we could go to. So I think it’s a combination of limitations.

It’s also a function of the prudence of the executives who are making these
decisions because while oil is today at $63 or over $64 as the last one I checked, it’s not
clear it will always be that point. Just five years ago or six years ago we had $17 oil, so
these companies that are managing their business are looking to make investments that
last for 30 years on average, and so you have to be able to make an investment that
you’re sure you’re going to make a return to your shareholders and so expectations about
pricing being high forever or just being automatic are a challenge in terms of what you do
with capital spending because I remember back when I was working on energy
consulting in the early 1980s and everybody forecasted that we would have $100 oil by

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2000 and then shortly after that we had $8 oil. That’s the experience that the senior
managers of these companies are facing with and so they are being very prudent with
other investments.

00:19:48 MR. PALOMO: We’ve gone about 25 minutes. We have five more
minutes to go if we’re going to do the 30-minute time limit, but if you have any more
questions we’ll keep on going.

00:19:58 MR. SIERRA: I was wanting to – I don’t know if this is totally

investment earnings related, but I am just wanting to hear more about what sort of
investments the oil industry is doing in terms of environmental care – not just direct
environmental care, but environmental stewardship in how they operate.

And related to that perhaps a comment/question is, what are doing to

communicate and make the public stakeholders aware of these? This is obviously a
growing concern in our culture today and so I was just wondering if you could tell me
something interesting about that.

00:20:37 MR. FELMY: Well, that’s an excellent point. It is related to earnings

because if you look at the investments that the industry has made over the last 10 years in
environmental expenditures, it’s been roughly on the order of about $90 billion. Of that,
about $50 billion is investments in refineries, for example, to either reduce emissions or
to change the fuels to cleaner burning fuels.

And those are investments that have potentially large payoffs. For example, the
ultra-low sulfur diesel program this year will allow the introduction of clean burning,
efficient diesel engines in the United States for the first time significantly potentially in a
couple decades, so that could have an important effect in terms of reducing emissions and
improving efficiency. We also make major investments in terms of these environmental
expenditures, so you have fewer releases, so that your communities are affected less, your
workers are safe, and things along that line. So we have invested substantially in that
area.

What are we doing about this? Well, I have been engaged in terms of talking with
anybody who will talk to an economist about what the industry is doing, and a host of
things across the industry whether it be the earnings, whether it be what’s happening with
gasoline prices, whether it be expenditures – on and on and on – and trying to reach out
to tell people what the facts are, just as I am doing right now with this conference call,
and we’re committed to continuing to do that – to educate folks in what’s going on.

And an important point about the investments in environmental expenditures, of

course, that’s an investment that you can’t then spend on a piece of capital equipment for
expanded capacity, so we’ve got that tradeoff going on in the industry also.

00:22:36 MR. PALOMO: Any more questions?

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 00:22:38 SKYMUTT: I don’t have any additional questions.

00:22:40 MR. SIERRA: That’s it for me.

00:22:42 MR. PALOMO: Well, I again appreciate you joining us. A reminder: if
you have any more questions you think of after the call has ended, send me an email and
we’ll try to get it answered. We will have more conference calls on different subjects and
we’ll notify you and hope that you can join us again.

00:23:00 MR. SIERRA: All right. Would it be possible to get my hands on the
recording?

00:23:04 MR. PALOMO: Yes. I’ll get back to you on that.

00:23:08 MR. SIERRA: Right. It’s kind of hard to type notes as I am listening
and talking and it would be helpful if I could relisten to the questions and answers and all
that.

00:23:14 MR. PALOMO: Yeah. We’ll have the transcript and the recording on
the web, so –

00:23:18 MR. SIERRA: Great.

00:23:20 MR. PALOMO: Great. Thank you.

(END)