Crude Awakening at Phillips Petroleum

Updated from 10:31 a.m. EDT

Phillips Petroleum's (P) warning of a significant first-quarter shortfall Tuesday could be the first of several negative preannouncements among oil refiners over the coming days and weeks, analysts say.

"This is a function of the macro environment, not so much a Phillips-specific problem," said Tyler Dann, an analyst at Banc of America. "You're going to see other companies" warn, too.

Phillips said it expects a "slight" net operating loss in the first quarter, well below analysts' 37-cent earnings estimate, because of weak refining and marketing margins.

The downstream business environment -- the refining of crude oil and sale of fuel to customers -- was "the weakest in years," as demand for distillate products such as heating oil and jet fuel remained sluggish, analysts said.

Phillips said prices for petroleum products did not keep pace as crude oil prices began to recover, resulting in considerably lower marketing margins.

Drowning Downstream

"Oil, gas, refining and marketing were all down," said Frederick Leuffer, an analyst at Bear Stearns. "It was not a good quarter."

Although oil prices have climbed recently amid tensions in the Middle East, oil prices were down by about $7 per barrel in the first quarter compared with the same period last year. Meanwhile, natural gas prices in the quarter were down by about $4 per cubic 1000 feet, according to Leuffer.

Last week, British Petroleum(BP) said its first-quarter refining and marketing margins were down about 30% and 45%, respectively, from the fourth quarter of last year, and the company said the downstream business, in aggregate, was at its weakest level since the early 1990s.

Leuffer said companies that derive a large portion of their earnings from refining are "pretty exposed," particularly Valero Energy (VLI), Sunoco(SUN) and Marathon Oil (MRO)

Valero is expected to earn 67 cents a share in its first quarter, according to Thomson Financial First Call, while Marathon is expected to record a profit of 22 cents a share. Sunoco is seen posting a loss of 69 cents a share compared with a profit of $1.26 last year.

Black Gold, Red Ink

"I'm looking for most of the major U.S. oil refiners to lose money," Leuffer said.

Mark Gilman, an analyst at First Albany, agreed that Marathon Oil has the potential for a disappointing quarter similar to that of Phillips. "This has not been flagged," he said, adding that Exxon Mobil (XOM) also could miss the current estimates of 40 cents a share.

Thomson Financial First Call estimates that earnings in the energy patch will decline 62% from last year but some believe even that may be too optimistic. Most oil companies will report their results in the final week of April.

While analysts are concerned about oil refiners, they note that the magnitude of Phillips' drop was surprising. Dann said costs associated with closing down some of its refineries in the quarter impacted the results by about $40 million, or 10 cents a share. The firm said those costs are expected to have less of an impact in the second quarter.

The consensus estimates may have been so far off for the first quarter because of possible confusion over the Tosco business, which Phillips acquired in the third quarter of last year, according to Dann. Some believe there have been little to no cost savings or synergies from the combination.

Still, analysts say that macroeconomic factors certainly played a large role in the earnings shortfall, and those same factors could impact other companies' financial results.

Hess Truck's Coming

Companies that are more focused on the upstream business, or exploration and production, could see slightly better results though.

Occidental Petroleum (OXY), for example, could at least see its first-quarter profits rise from the fourth quarter. The company is expected to earn 18 cents a share in the quarter, but that is way down from the $1.38 profit recorded in the year-ago period.

According to Gilman, Amerada Hess (AHC) and Chevron Texaco (CVX) also are likely to meet current estimates. Amerada is seen posting a profit of $1.14, compared with $3.79 last year. Chevron is slated to record a profit of 70 cents, down from $2.22 last year.

The current spike in energy prices could give many companies a boost in the second quarter, and Prudential Securities analyst Michael Mayer said he would be a buyer of Phillips on any weakness. Still, some analysts question how sustainable current energy prices are, given that demand is expected to remain anemic for the rest of the year.

Shares of Phillips were down 3% to $59.98 Tuesday. Last month, shareholders approved the firm's $27.6 billion merger with Conoco Inc., which will create the third-largest U.S. oil company after Exxon Mobil and ChevronTexaco.

Other oil stocks also were lower, with Exxon and Marathon Oil down 1% to 42.74 and 28.19, respectively.

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