THE WALL STREET JOURNAL: Oil Profits May Be Peaking: "Shell recently announced that its giant gas development in Sakhalin, Russia, could cost as much as $20 billion, twice the original estimate.": TUESDAY 26 JULY 2005

The world's major oil companies are expected to report banner earnings as they start unveiling quarterly results this week. But with the companies' costs rising and energy-price increases slowing, many analysts say, 2005 may prove to be the industry's high-water mark for some time.

BP PLC, the second-largest publicly traded energy company by market capitalization, is expected to post record net profit for its second quarter when it releases its results today. Analysts expect the three largest companies -- BP, its bigger rival Exxon Mobil Corp. and No. 3 producer Royal Dutch Shell PLC -- to post net income for the April-June quarter that is up as much as 40% from a year earlier. The Big Three are on pace to post combined net profit of about $60 billion for the full year.

There's no doubt that the oil and natural-gas industry will continue to generate staggering profits. But analysts expect 2005 to mark a peak for now, if oil prices moderate next year as many expect, and if costs for drilling, exploring and transporting oil continue to rise.

In a report published last week, Merrill Lynch & Co. said the aggregate net income of the 70 largest companies in the sector is expected to rise 26% this year to $230 billion, on sales of $2.57 trillion, up nearly 10%. The reasons: high oil prices and fat refining margins, plus a pickup in oil-field services, particularly in rates for drilling rigs. The 70 companies are expected to return about $110 billion to shareholders this year through dividends and share buybacks, Merrill Lynch added.

But next year, the sector's net income is forecast to decline to $205 billion due to an expected easing of oil prices and slimmer margins on gasoline and other refined petroleum products. Increased spending on new oil and gas projects, now being ramped up to offset depletion of existing fields, is starting to take a toll. Shell recently announced that its giant gas development in Sakhalin, Russia, could cost as much as $20 billion, twice the original estimate. Merrill Lynch says that the cost of finding and developing oil rose 22% in 2004.

Giants such as Exxon, BP and Shell are enjoying fat years as they bring on-stream large oil and gas projects begun years ago that were meant to earn handsome returns if oil traded at around $20 a barrel. In the second quarter, the price of a barrel of U.S. benchmark crude averaged $53.20, up 39% from $38.30 a year earlier. Europe's North Sea benchmark crude rose even more in the second quarter -- by 51% to $52.90 a barrel from $35.10 a year earlier.

As a rule of thumb, BP said in a trading statement early this month, every $1 rise in the price of North Sea benchmark Brent crude translates into an extra $500 million in annual operating profit. BP's overall production was expected to have risen by about 5% in the second quarter from a year earlier, according to analysts at Deutsche Bank.

Exxon is expected to report Thursday an approximately 40% increase in earnings over the year-earlier quarter, though its production is expected to stay basically flat, according to Deutsche Bank and Oppenheimer & Co.

Amid heated talk of mergers in the industry, driven largely by eagerness to gain access to big new stores of fossil fuel, Exxon has counseled calm. The company has hinted it thinks oil prices will fall, and has largely batted aside questions about how it will deploy a mounting cash pile that at the end of last year stood at $23.1 billion.

Exxon said earlier this year that it will expand stock buybacks to reduce the number of shares outstanding. But it has said it feels no need for more-aggressive measures, such as granting shareholders a one-time special dividend or buying another company.

Exxon also has brushed aside concerns about whether it is finding enough new oil and gas to meet rising global demand. In recent meetings with investors, Exxon officials have tried to put the excitement over the bidding war for California-based Unocal Corp. into perspective. While Chevron Corp. and Chinese oil company Cnooc Ltd. are competing to snap up Unocal, Exxon officials said Exxon plans over the next three years to boost its production by three times Unocal's 2004 production level.

At Shell, despite an expected 3% fall in production, higher oil prices are expected to boost exploration and production profits by 43% in the second quarter and lift companywide earnings once again when the company reports on Thursday, Deutsche Bank estimates. France's Total SA is expected to report an increase in net income of 30% to 40% or more on Aug. 4. "If anything, it should be toward the upper end of that," said Lucas Herrmann, a Deutsche Bank analyst in London, citing output growth at the company and strong refining margins. Total is Europe's largest refiner of crude oil.

Chevron and ConocoPhillips are both expected to turn in record quarterly profits due to high oil prices and strong downstream operations, particularly U.S. refining margins.

Conoco, which will report tomorrow, is likely to post a 14% boost in production, mostly thanks to the equity investment it made last year in Russian oil major OAO Lukoil, says investment firm Oppenheimer. Profits at the Houston company are expected to be 39% higher than in the same quarter a year earlier.

Oil and natural-gas production is expected to fall 7% at Chevron, which will report Friday, as normal field declines and an absence of any large new projects take a toll. Production should get a boost later this year with the start-up of a large deepwater offshore West Africa project.

Still, Chevron is likely to report an 11% increase in earnings, says energy analyst Fadel Gheit at Oppenheimer, because of high commodity prices.

"What else do you expect if you have $50 oil?" he asks. "If you don't have a record [quarter], you better go find another business to be in."

Write to Bhushan Bahree at bhushan.bahree@wsj.com