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October 31, 2013 1:10 pm

Exxon struggles to find growth in fast-changing landscape

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Exxon Mobile©AP

When ExxonMobil’s chief executive Rex Tillerson met investment analysts for the first time after taking over from Lee Raymond at the start of 2006, his theme was continuity.

“We maintain our long-term perspective and disciplined approach to investment and focus on world-class operational performance,” he said.

US oil majors

US oil majors
Shareholder returns, safety record and share prices

He has been as good as his word. Exxon still holds true to the strategy and culture that Mr Tillerson inherited. Around it, however, the energy industry has been transformed. The shale boom, reviving first natural gas and then oil production in North America, has upended conventional wisdom about the industry’s future.

The new landscape has been difficult for all the large international oil companies, but some have risen to the challenge better than others. Exxon has outperformed its European rivals BP, Royal Dutch Shell and Total, but it has lagged behind other US companies: not just the small and midsized producers who are the standard-bearers of the shale revolution, but also large groups such as Chevron, ConocoPhillips and Occidental Petroleum.

In the past five years, Chevron’s shares have risen 62 per cent, Conoco’s 85 per cent and Occidental’s 76 per cent, but Exxon’s are up only 18 per cent.

After a 10 per cent fall in earnings per share last year, Exxon’s third-quarter results suggested it was on course for a further decline in 2013, with a 14 per cent drop to $1.79 for the three months to September.

The results were slightly better than analysts had expected, and Exxon’s shares rose 1.2 per cent to $89.86 in New York. This year, however, they have gained only 3.5 per cent, underperforming rivals in the sector and the 24 per cent advance in the S&P 500.

Mr Tillerson, who met leading shareholders in New York earlier this month, is facing questions about what he can do to re-energise the company’s performance.

A story that speaks volumes about Exxon, told by the company’s executives, is the history of the Blackbeard well that it drilled in the deep waters of the Gulf of Mexico in 2005-06. The well was extremely tough going, with high pressures and temperatures, and the team drilling it worried that it was unsafe. After they had gone down more than 30,000ft, and spent $187m, Mr Tillerson decided to call a halt. The drillers pulled out and sealed the well.

When BP was faced in 2010 with its similarly troublesome Macondo well, about 100 miles away in the gulf, it chose to press ahead, and the project ended in a catastrophe.

Exxon’s approach to safety was radically overhauled after the 1989 Exxon Valdez spill, and for more than a decade its meticulous control of its operations has been reflected in its industry-leading safety performance. In the past four years, 25 people have been killed in work-related incidents at Exxon, compared with 27 at Chevron, 38 at BP and 46 at Royal Dutch Shell.

The caution shown at Blackbeard is also reflected in the company’s investment decisions. Exxon takes pride in having the highest return on capital of any large western oil group, at 25 per cent last year, and the “disciplined” approach to investment decisions needed to protect that position. Only the highest-returning projects will be sanctioned.

The consequence of being more selective is that it invests less heavily than many other oil companies. Chevron, for example, will this year spend about $1 in capital for every $6.40 it receives in revenues. Exxon will spend only $1 for every $10 of revenues.

As a result, its production has stagnated. While US oil output has risen 50 per cent in the past five years, thanks to the shale boom, Exxon’s oil production is down 9 per cent. Only a surge in its gas output, helped by the $41bn acquisition of shale gas producer XTO Energy in 2010, has enabled Exxon to report total production up 8 per cent since 2008. The group does not have leading positions in either the deep waters of the Gulf of Mexico or onshore US shale oil, two of the world’s most promising regions for production growth.

Back in 2006, Mr Tillerson suggested Exxon’s production would be about 5m barrels of oil equivalent per day in 2015. Now it looks more likely to be about 4.4m boe/d.

Pavel Molchanov, analyst at Raymond James, says that sluggish growth is the principal reason why Exxon’s share price has underperformed its US rivals.

“Capital has been flying to high-growth more aggressive oil and gas stocks, and Exxon is definitely not one of those,” he says. “People want companies that are growing production by 5 or 10 or 15 per cent a year.”

Exxon has said it expects its production to grow by 2-3 per cent a year during 2013-17.

The larger the company grows, the harder it is to find investment projects that will make a significant difference to growth. It is also harder to replace oil and gas reserves as they are extracted; Exxon needs to prove up more than 1.5bn barrels of oil and gas every year simply to keep its reserves roughly steady.

“This company is just so big,” Robin West, senior adviser to consultancy IHS, says. “The reserve replacement treadmill is an enormous task.”

Paul Sankey, an analyst at Deutsche Bank, has a solution. He is urging Exxon to take advantage of its massive cash flow – $21.3bn in the first six months of this year – to raise its dividend faster. The dividend has gone up for 31 successive years, but the company still has a lower yield than its peers.

He wrote in a recent note: “If ExxonMobil truly believes in its business model, step increases in dividend, rather than massive new capital intense projects, may be the way to long-term share price appreciation.”

He suggested raising the dividend by 15 per cent or more each year, and curbing capital spending, which for all Exxon’s discipline has been rising each year.

Exxon has had a preference for share buybacks over dividends as a way to return capital to shareholders, but a reduction in buybacks in the first half of the year from $10.7bn in 2012 to $9.7bn in 2013 has contributed to investors’ nervousness.

Short of that sort of dramatic move with the dividend, Exxon shareholders’ other best hope may be that something goes wrong in the oil market. If the oil price were to drop significantly, then the go-go smaller production companies that are living beyond their means and relying on regular injections of capital could find life becoming very difficult.

In those conditions, Exxon’s relative caution about investment, and its relatively larger downstream businesses such as refining and chemicals, would become valuable strengths.

As Mr Molchanov puts it: “This is the most defensive oil stock in the world . . . It invariably does relatively well in a period of downward-sloping oil prices.”

One trigger for such a fall in prices could be a continued boom in US oil production, hitting the market while the economy slows and demand weakens. In that case, investors might conclude that Exxon has adapted well to the shale boom after all.


Next step will be difficult one


ExxonMobil, like other large western oil companies, is suffering from having exhausted the gains from the mega-merger wave of 1998-2001, writes Ed Crooks.

So argues Robin West of IHS, the advisory group, who says: “The question is what do they do next. It’s very difficult, and the bigger they are, the more difficult it is.”

For Exxon, the acquisition of Mobil in 1999 brought access to the huge gas reserves of Qatar, and the knowhow in liquefied natural gas needed to export to eager markets in Europe and Asia. The development of LNG in Qatar has been one of Exxon’s mainstays of the past decade.

With a market capitalisation of about $390bn, though, Exxon’s size makes it impossible for another acquisition to be similarly transformative, unless it is another mega-merger, which would face political and administrative barriers that are likely to prove prohibitive. By the same token, hopes of a bid for Exxon, or even aggressive moves by an activist investor, strain credulity.

Exxon’s 2010 acquisition of XTO Energy, a leading shale gas producer, for $41bn including debt, was its attempt to join the shale revolution. But the deal was unfortunately timed. It established Exxon as by some distance the largest producer of US natural gas, just as its price was slumping. Exxon says it is under no pressure to develop XTO’s reserves quickly, and can afford to be patient and wait for higher prices and better returns.

Shale development, with multiple wells costing about $5m-$10m each, is a very different business from the multibillion-dollar projects used for conventional oil. In acknowledgment of that, Exxon has retained XTO as a separate organisation, with headquarters in Fort Worth, Texas, about 25 miles from group head office in neighbouring Irving. Some of its management structures and practices are also different.

The success of the strategy, however, remains to be proven.

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