IT'S TIME TO PREPARE FOR PRICE CRITICISM

Oil and gas companies should prepare for the downside of rising oil prices. Following sharp jumps in profits of large companies last year, product price hikes are certain to arouse industry's perennial detractors.

The complaints are easy to predict, which should make preparing for them easy as well. The nags will say that:

Last year's profit jumps prove that oil companies don't need higher prices.
Companies raise product prices as soon as crude prices jump but lower product prices slowly when crude prices fall.
Therefore, higher product prices now are unwarranted and unfair.

Companies must have answers ready.

THOSE PROFIT GAINS

Profit gains last year are irrelevant to the market turnaround evident so far this year. They mainly reflect depressed earnings of 1992, when companies took large extraordinary charges for restructuring and an accounting rule change. In last year's second half, product prices were skidding along with crude values, signs of a fundamentally weak market. Many companies scored profits nevertheless due to earlier cost cutting.

Now prices-both crude and product are rising because demand is rising toward limits of supply, especially in the U.S. Consumption in the U.S. for the year so far is 5% ahead of last year's level. Refineries are operating at 95% of capacity. Inventories are behind year-earlier levels and falling.

When asked about oil prices, companies should keep these solid downstream developments in mind and not fall into the trap of focusing just on the crude market. Some analysts still wonder why crude prices have risen by $3-5/bbl since April. With oil galloping through the distribution and processing chain in the U.S. and at least trotting through the system in Europe, a better question is why prices haven't risen even more.

Companies must be ready to explain to their detractors that crude and product prices move in relation to one another as supply and demand change. In the modem market changes are visible and fast. Spot and futures prices signalled this latest market turn early in the year, when the product slide began to flatten. Indeed, product strength has pulled crude values out of their slump. With demand so robust, product prices seem destined to pass year-earlier levels fairly soon. If and when that happens, the nags will highlight a couple weeks' worth of data and complain that companies "raised prices" at the first sign of crude price recovery. The answer to that: Market strength, not company manipulation, raises prices. And this is a strong market.

WITHHOLDING SUPPLY

To one other perennial complaint companies must confess partial guilt. Inevitably, someone suggests that companies have withheld supply in order to drive up oil prices. The charge is partly true.

Companies have laid off tens of thousands of workers and shut in tens of thousands of wells. They have reduced crude oil distillation capacity in U.S. refineries by 17% since the peak year of 1980. Resulting cuts in production and refining limits certainly amount to withheld supply. But the motive has been to survive market tumult, runaway environmentalism, and political antagonism, not to drive up prices. If companies could manipulate prices, the cuts would not have been necessary.

Companies savvy enough to make money in the modern petroleum market should be able to find common ground with the nags. The common ground is the market, in which everyone plays a role yet no one controls. Companies able to explain that will have more customers and fewer critics than companies that don't make the effort.