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Exxon - If You Cant Produce Oil, Sell Assets

Companies / Oil Companies Jul 28, 2012 - 10:26 AM GMT

By: Andrew_McKillop


Best Financial Markets Analysis ArticleThe second-quarter results for Exxon, which was the world's biggest company by market capitalization until Apple moved into that slot, confirm a stack of trends in world energy and the global economy. Exxon Mobil is still the world’s biggest oil company by market value, even if its combined oil and gas reserves are now minuscule relative to those of a long list of both OPEC and NOPEC national oil companies. Its de facto shift, like the other "historic oil majors" to the refining downstream, energy trading, non-energy activities - and gas production and the hunt for global natural gas resources - makes Exxon highly vulnerable to the global economy's performance, and to falling oil prices.

Its second-quarter results show that Exxon earned a lot less than most analysts had expected because global oil demand has stalled, led by stubborn shrinkage or at best "flat line demand" in the world’s largest economies. Exxon was also heavily penalized by the USA's incredibly low natural gas prices, which at around $3 per mln BTU price US gas at about $17.40 per barrel equivalent.

Exxon is above all realworld, these days. For the "historic oil majors" (which included Exxon, Mobil, Shell, BP, Chevron, Texaco, ARCO, Total, Gulf, ENI, and others) this starts with downsizing. Only a few figures are needed to show this: announcing the new and downsized earnings of Exxon, its CEO Rex Tillerson said his corporation plans to direct $37 billion of spending worldwide in 2012 to the goal of adding 1 million barrels equivalent per day of new oil production capacity by 2016. Not only the total cost of this downsized goal, but the time needed to achieve it are striking, even stunning. The keyword "equivalent" underlines that a part, probably most of this extra 1 Mbdoe of capacity by 2016 will come as natural gas liquids, even shale oil and condensed oil from natural gas production streams.

Until 2009, world oil demand growth often attained as much as 0.8 - 1 Mbd every year, and in some years well above this: up to 2 - 2.25 Mbd extra demand in a single year, but that was in "another age", before 2009.

Exxon's earnings fell short of analyst estimates for the second straight quarter, as the company's total production on an oil equivalent basis, with a fast-rising natural gas component and declining oil component, struggled to achieve an average in second quarter 2012 of 4.15 million barrels a day. This was the lowest quarterly average since 2010, when oil prices were still slowly recouping the losses made in 2008-2009. Current weak performance of Exxon, and several other "historic majors", underlines a major fact for global oil: below about $75 per barrel it is getting hard not only to produce more oil, but to maintain current production output.

Inside the US, what are suicidally low natural gas prices for producers un-surprisingly do not help "integrated energy companies", producing both gas and oil. It makes them hostage to high oil prices, needing them to cross-subsidize their gas exploration, development and production.

Exxon's sales rose 1.5 percent to $127.4 billion, and the company's initial claim that this did not contain any special or one-time gains was quickly contradicted by the corporation itself: some $7.5 billion of earnings were due to asset sales-based gains, making up 47 percent of the per-share earnings. Asset sales, and asset trading are now a normal part of Exxon's operations, shown by the role of asset sales in the company's apparently flourishing refining buisness.

Exxon's refining profit quadrupled in the second quarter to $6.65 billion, but $5.3 billion of this came from the company's one-off sale of a chunk of its Japanese refining business, to Tonen General Sekiyu.

Just as troubling for Exxon's real profitability and showing its total dependence on high oil prices, the corporation's earnings decline has almost exactly tracked oil prices. Brent crude futures, now the benchmark for over 60 percent of world oil trade, averaged $108.76 a barrel during the quarter, a 7 percent decline from a year earlier. Exxon's earnings fell by a little more than that amount.

Oil demand in the U.S. and China, whose combined consumption of around 28.1 Mbd ranks at about 31 percent of world total oil demand, has now almost perfectly flat-lined for one year. The EU27 countries, in 2012, are in their sixth straight year of oil demand contraction.

For Exxon and any other integrated energy company producing both gas and oil there is no way out: if they want to stay in the oil-and-gas business, especially in the US but soon outside the US also, they need high oil prices. Gas prices can only fall outside the US, and low prices inside the US are wreaking havoc on company profitability - even threatening their survival. Natural gas prices are, as shown by the company fortunes of gas-majority producers like Chesapeake and Exxon's gas subsidiary XTO, which cost Exxon nearly $40 billion to buy in 2009-2010, semi suicidal.

Gas futures in New York through the second quarter fell 46 percent compared to a year earlier, and  averaged $2.35 per mln BTU. Ths was the lowest quarterly average in 13 years, since 1999. Gas prices, earlier in 2012, prompted Exxon's Rex Tillerson to warn that Exxon and other US gas producers are “losing our shirts” amid a glut of North American shale gas supply. Outside the US the natural gas exists, for sure and certain and in immense quantities - but developing and producing it is costly.

The gas glut most surely does not only affect Exxon. Royal Dutch Shell has also "gone for gas" and today produces about 55 / 45 of its total energy output as gas energy and oil energy. For the second quarter, Shell's earnings were also down, by about 13 percent at $5.7 bn, like Exxon's well below most analyst forecasts. 

Gas is now the most-widely used US furnace fuel and the USA's second-largest generating source for electricity, but suicidally low prices due to rising output make it a losing bet for energy explorers. In turn this makes oil the "only solution", for energy producers who intend to stay in integrated oil-and-gas production and the O&G downstream. To be sure: this means expensive oil, because low-priced oil will be as lethal to company fortunes as bargain basement priced natural gas. If a serious slump happens in world oil prices - this will bring dangerous times for the "historic majors", and others.

Already today, analysts criticize Exxon's acquisition of XTO Energy, ranking Exxon the largest US gas producer, in front of Chesapeake Energy Corp. The Chesapeake story or saga is well known today, prompting analysts who in 2010 thought Exxon's buy out of XTO was a great move, to say that today almost any other major oil company, with less exposure to US gas is a more compelling investment and trading play, under current and likely emerging conditions.

While obviously never, ever saying this Exxon and the other "historic majors", and a large, easily analysed and identified number of other major oil-and-gas producers need high oil prices. They have already had to abandon all hopes of keeping natural gas prices high - which 5 years ago could attain over $12.50 per mln BTU in the USA. Natural gas prices, in the US, have fallen by about 66 percent in 5 years - making their last, best hope "triple digit" oil prices.

On the world scene, not only the "historic majors" but also once-powerful, recently-powerful players as big as Gazprom of Russia are being forced to contemplate an ever approaching and large cut in their earnings on gas production and exports. Quite soon, Gazprom will be forced to abandon "oil indexed" gas pricing, and the results will be terrible for Gazprom.

The upsetting and transforming role of surging gas finds, production and supply has now created a context where companies as big as Exxon, BP, Shell, Total, ENI, and the gas majors are trapped in a hole where the only way out is through "triple digit" oil prices. How these players strive to keep oil prices high will be an interesting scene to observe and analyze, but under real and current oil market conditions, even $75 per barrel is cloud cuckoo and massively overpriced!

By Andrew McKillop


Former chief policy analyst, Division A Policy, DG XVII Energy, European Commission. Andrew McKillop Biographic Highlights

Co-author 'The Doomsday Machine', Palgrave Macmillan USA, 2012

Andrew McKillop has more than 30 years experience in the energy, economic and finance domains. Trained at London UK’s University College, he has had specially long experience of energy policy, project administration and the development and financing of alternate energy. This included his role of in-house Expert on Policy and Programming at the DG XVII-Energy of the European Commission, Director of Information of the OAPEC technology transfer subsidiary, AREC and researcher for UN agencies including the ILO.

© 2012 Copyright Andrew McKillop - All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

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