NEW YORK (CNN/Money) -
With American motorists shelling out over $2 a gallon for gas, oil companies have managed to pile up the cash. The question now is, what are they going to do with it?
Give it back to shareholders? Buy each other out? How about more oil production? More likely it will be a combination.
As oil continues to trade near $50 a barrel, profits for big oil producers have skyrocketed.
Fadel Gheit, an energy analyst at Oppenheimer & Co., a New York brokerage, says that oil companies have record amounts of cash sitting on their balance sheets.
Where's the reinvestment?
Cost-conscious consumers might wonder why oil firms don't pour that money back into exploration and development to bring more product to market and lower prices, and investors say excess profits should go towards production and development.
"If they had plenty of opportunities, as an investor you would want them to plow it back into the business," said Fred Fromm, manager of the Franklin Natural Resources Fund. "But they need to generate good returns."
And therein lies the problem, say some observers. The last several decades have seen a worldwide decline in drilling rigs and the number of people qualified to operate them.
Moreover, much of the easily recoverable oil has already been recovered, or lies in countries with limited access for foreign, publicly traded oil companies.
Publicly traded oil companies hold only 18 percent of the world's proven reserves, said Dorothea El Mallakh, head of the International Research Center for Energy and Economic Development. The rest is held by national or semi-national oil companies like those of Saudi Arabia, Russia, Venezuela or Nigeria.
If the publicly traded firms simply throw more dollars at exploration and development projects using the same limited pool of workers, equipment and oil fields, the end result would be to simply drive up the cost of production, says Larry Goldstein, president of the Petroleum Industry Research Foundation.
"The companies want to invest their dollars," said Goldstein. "But just spending money doesn't mean you'll find more oil."
So for the time being, Goldstein believes the flush firms will use a combination of limited research and development, some acquisitions and some dividend increases or share buybacks to keep the excess cash from accumulating.
Watch out for acquisitions
Other analysts say the companies could deal with the cash build by making acquisitions.
"It's the only way, there's nothing else" said Gheit, the Oppenheimer analyst.
He said most firms have already paid down their debt, have earmarked lots of money for stock buybacks and are wary of increasing dividends too much in such a cyclical industry.
He mentioned Occidental Petroleum (Research) as one company ripe for takeover, but was quick to add it could be anybody.
"Anything smaller than ChevronTexaco you cannot rule out," he said, claiming Exxon could swing an acquisition of $50 billion in cash if need be. "They can afford to pay a premium and still pull it off."
Gheit wasn't the only analyst to mention Occidental.
"It's a fabulously run company," said Bruce Lanni, an oil analyst at A.G. Edwards.
Lanni said Kerr-McGee (Research) is also attractive to would-be dealmakers, noting the company's access to coveted deep water fields in the Gulf of Mexico.
But overall, he feels the industry will shun acquisitions at these high prices and focus instead at returning money to shareholders.
Business as usual
For their part, oil companies aren't rushing into anything.
Roddy Kennedy, a BP spokesman, said the company has no plans to spend more on drilling or exploration and will continue to return the extra cash to shareholders in the form of dividend increases and stock buybacks.
"We've set a strategy for growth and we're quite confident we can achieve that growth with the capital expenditure we're got," he said.
Exxon's CEO Lee Raymond echoed such sentiments, indicating the company was in no rush to make acquisitions while oil prices remained high.
"I'll bet (prices) will be lower at some point," Raymond recently told the Wall Street Journal. "We're not going to do anything stupid. We're going to manage (our cash) like we manage everything else."
It's a strategy some call dangerous.
"We're going to have a crisis this summer," said Peter Fusaro, chairman of Global Change Associates, a for-profit energy and environmental consulting firm in New York.
Fusaro said the crisis will come in the form of local gas shortages and said while there will be political calls for investigations, no one is taking the action now to head off those shortages.
However he agreed that a lack of rigs, personnel and drilling options limit oil companies' ability to bring new product to market.
He predicts that the U.S. will face a gasoline shortfall because of a shortage of refining capacity (a new refinery hasn't been built in the U.S. since 1976) and a lack of a national energy policy.
Although the Bush administration recently outlined an energy strategy that included, among other things, building refineries on military bases and easing barriers to building natural gas terminals and nuclear plants, Fusaro said its not enough.
He said the industry need clear, long-term environmental regulations companies could plan around before they will invest money in new refineries or technology, and called for rapid increases in fuel efficient vehicles.
"Commercialization of new technologies is were we need to go in a big hurry," he said. "But we're not getting there. In the short term, we're up the creek."
For more on the 2005 oil crunch, click here.