Exxon and the Historic Oil Majors Face Troubled Times

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Second-quarter results for Exxon, which was the world's biggest company by market capitalization until Apple moved into No 1 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. Using data for 2012 from Petrostrategies Inc, Exxon's combined oil and gas reserves place it 16th in the world - far behind the NOCs of Iran, the Gulf Arab states, Nigeria and Libya, and well behind Russia's Gazprom, Petro China - or the Egyptian General Petroleum Corp.

See: Worlds largest oil and gas companies

The other "historic oil majors" are in the same plight, even lower than Exxon, and like Exxon have shifted to the refining downstream, energy trading, non-energy activities - and gas production and the radically successful hunt for global natural gas resources. This makes Exxon and the "historic majors" vulnerable to the global economy's performance, very vulnerable to falling oil prices, and highly exposed to a coming gas glut and falling global gas prices.

Its second-quarter results show that Exxon earned much less than most analysts had expected. Reasons included the simple fact that 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. This is a 45 percent decline on prices even 1 year ago, and 66 percent since 2006.

Downsizing and Commodity Prices

Exxon is above all realworld, these days. Like the other "historic oil majors" (which included Exxon, Mobil, Shell, BP, Chevron, Texaco, ARCO, Total, Gulf, ENI, and others) Exxon has downsized. 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 spend $37 billion in 2012 towards 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 attained about 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 "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 output in second quarter 2012, of 4.15 million barrels a day. This was Exxon's lowest quarterly average since 2010, when oil prices were still recouping the losses made in 2008-2009.

Current weak performance of Exxon, and the other "historic majors" such as Shell and BP, underlines a major and somber 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. For the "historic majors" producing oil at below this price level is becoming, as they say in corporate communiques "challenging".

Energy commodity prices are more important then ever, for corporate visibility going forward. Inside the US what are suicidally low natural gas prices, for producers, do not help "integrated energy companies", like Exxon which produce both gas and oil. It makes them hostage to high oil prices, depending on high oil prices to cross-subsidize their gas exploration, development and production. Otherwise, rather simply, they risk to run out of business.

In second quarter 2012, Exxon's sales rose 1.5 percent to $127.4 billion. The company's initial claim that earnings based on 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. This came from asset sales. Asset sales and trading are now a normal part of Exxon's operations, and are of rising EBITDA importance for other "historic oil majors" which in Exxon's case are shown by the role of asset sales in the company's refining business.

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.

Losing Our Shirts on Gas and Praying for High Oil Prices

The likelihood that Exxon CEO Tillerson will grab the microphone to say he wants and needs triple digit oil prices is of course low, but he needs them. For Exxon and any other integrated energy company without access to low cost recoverable oil reserves, producing both gas and oil under present and emerging global economy energy and oil demand trends is getting a worse prospect almost by the day. 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.

Especially in the US, but this will progressively extend outside America in a predictable near-term future, ultimate low gas prices are wreaking havoc on company profitability. Under rational trends continued analysis, this may even threaten 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 June 2010, semi suicidal and offer no signs of major recovery.

Gas futures in New York through the second quarter fell 46 percent compared to a year earlier, and  averaged $2.35 per mln BTU. This was the lowest quarterly average in 13 years, since 1999. These price levels, 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, not only as shale resources and in staggeringly 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 its energy output split is about 55 / 45 gas energy and oil energy. For the second quarter, Shell's earnings were also down, by about 13 percent at $5.7 bn, and like Exxon's earnings well below most analyst forecasts.  The answer, for the "historic majors" is high oil prices.

Consumers are however already shifting away from oil, to gas, where they can. Gas is now the most-widely used US furnace fuel and the USA's second-largest generating source for electricity. Outside the US and especially in the Emerging and developing countries, oil-fired power production remains a major oil consumer, for a total of about 2 billion barrels a year in 2011: this market is not only threatened by gas, but also the fast declining cost of windpower and solar power equipment. For the "historic majors", suicidally low gas prices make it a losing bet for energy explorers, resulting in oil becoming the "only solution" for energy producers who intend to stay in integrated oil-and-gas production and in the O&G downstream. To be sure: this can only mean expensive oil, because low-priced oil will be as lethal to company fortunes as bargain basement priced natural gas.

Keeping Oil Prices High

What this means is that if the ever more possible serious slump happens in world oil prices - this will bring dangerous times for the "historic majors", and other energy players. Their corporate strategies will be an analyst's feast, predicting which one will break ranks first and sell more oil - despite falling prices. The range of major energy producers who will break ranks is in fact large, including many OPEC and NOPEC corporation, as well as the historic majors.

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 except Exxon, with less exposure to US gas, is a more compelling investment and trading play, under current and likely emerging market conditions.The oil-and-gas producers 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. They have been forced to accept that natural gas prices, in the US, have fallen about 70 percent in 5 years - making their last, best hope "triple digit" oil prices.

On the world scene, not only the "historic majors" but 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 the largest threat is simple to describe: under real and current oil market conditions, even $75 per barrel is cloud cuckoo and massively overpriced!

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About Andrew McKillop