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Why Big Oil Will Pump Out Big Earnings

NEW YORK ( TheStreet) -- The biggest oil companies, such as Chevron (CVX - Get Report), Exxon Mobil (XOM - Get Report) and ConocoPhillips (NOK), have tremendous complexity in operations and ultimately in profitability.

There are exploration and production divisions, enormous segments dealing with transport and refining, and separate segments for natural gas, liquids and chemicals.

As complex as these companies are, the price of a barrel of crude oil is still the most important input to their earnings results and therefore has the biggest impact on their stock prices. It is no wonder that these mega-cap oil companies' share prices have historically followed the price of the oil they generate.

Much has been written about the "commodity crumble" this summer, when crude oil prices dropped more than 20% and copper and other base metal prices fell more than 30%.

Many analysts are therefore less optimistic about the earnings reports expected soon from the big integrated oil companies.

Although I don't think that this is the best moment to buy these shares, I'm not deterred from them based upon what oil has done in the past three months.

If anything, I believe that earnings are much more likely to surprise to the upside. In fact, the much-discussed "depression" in commodity prices and oil in particular is being overblown and misinterpreted.

To prove this, let's have a look at the crude oil chart going back to the first of the year.

Source: Bloomberg.

I am using the Brent crude chart traded by the IntercontinentalExchange because this benchmark has more closely tracked real physical oil prices -- the ones that will affect earnings the most.

First, it should be immediately apparent how expensive crude oil has been this year. It rose to more than $100 a barrel in the first quarter and since then has traded significantly higher than that, save for last week's momentary dip.

This means prices have easily been 25% higher than they were in 2010, and that will deliver a not-insignificant boost to oil companies' earnings compared with last year.

The second thing you'll notice is that although prices have moderated somewhat in the third quarter, the average price of oil hasn't really declined all that much. In fact, the average price of oil is down hardly more than $5 a barrel from the second quarter to the third.
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