ExxonMobil: Balanced Portfolio Drives Outperformance, But Challenges Persist

BMI View: 2013 was a disappointing year for ExxonMobil with the company seeing profits and production fall compared to 2012. We believe 2014 will be a more successful year with a number of major projects scheduled to come on-stream over the course of the year, enabling the company to increase production compared to 2013. However, we note increasing project costs and softening oil prices as a deterrent to the long term growth strategy of the company. Furthermore, despite a very strong asset base, opportunities for organic expansion are limited, while global competition for new resources is increasing. ExxonMobil's balanced portfolio incorporating LNG, natural gas and liquids as well as its position in East Africa and Russia will be key to future growth. Of particular importance is the potential in Tanzania, the Kara Sea and the Bazhenov shale, all of which will be more extensively explored in 2014.

ExxonMobil 2013 Results Overview

ExxonMobil's (XOM) fourth quarter and full year results for 2013 disappointed with full year revenues down 27% from 2012. Earnings were impacted by lower production volumes and lower net gains from divestments.

Falling Revenues
ExxonMobil Revenues 2009-2013, US$mn

ExxonMobil: Balanced Portfolio Drives Outperformance, But Challenges Persist

BMI View: 2013 was a disappointing year for ExxonMobil with the company seeing profits and production fall compared to 2012. We believe 2014 will be a more successful year with a number of major projects scheduled to come on-stream over the course of the year, enabling the company to increase production compared to 2013. However, we note increasing project costs and softening oil prices as a deterrent to the long term growth strategy of the company. Furthermore, despite a very strong asset base, opportunities for organic expansion are limited, while global competition for new resources is increasing. ExxonMobil's balanced portfolio incorporating LNG, natural gas and liquids as well as its position in East Africa and Russia will be key to future growth. Of particular importance is the potential in Tanzania, the Kara Sea and the Bazhenov shale, all of which will be more extensively explored in 2014.

ExxonMobil 2013 Results Overview

ExxonMobil's (XOM) fourth quarter and full year results for 2013 disappointed with full year revenues down 27% from 2012. Earnings were impacted by lower production volumes and lower net gains from divestments.

Falling Revenues
ExxonMobil Revenues 2009-2013, US$mn

The downstream sector performed worse with global revenues falling around 380% on 2012 as refining margins were squeezed. In particular the non-US assets performed badly with Exxon's refining margins in Europe and Asia-Pacific especially poor. We expect the company's European business to continue to struggle, though Exxon's extensive midstream position in the US should enable it to optimise delivery of domestically produced crude to its refining centres, maximising margins in its US business.

Upstream earnings fell over 14% as ExxonMobil was impacted by lower than expected liquids output. While the company's earnings from US assets grew around 6.7% from increased unconventional oil production, non-US revenues fell almost 15%. The fall in ExxonMobil's production has partially been put down to a softening of the oil price, however field decline in Nigeria as well as delayed production from the Kearl oil sands project, and an indefinite delay to the start up of Kashagan, have meant liquids targets were not met. Revenues from the chemicals sector remained largely flat.

ExxonMobil Earnings By Sector, US$mn
Earnings By Sector 2013 2012
Upstream 26,841 29,895
Downstream 3,449 13,190
Chemicals 3,828 3,898
Source: ExxonMobil

ExxonMobil has been focusing on a strategy with a strong liquids production outlook in order to benefit from the historically high oil prices. As a result the company slightly increased its global production of oil in 2013, increasing around 0.8% from 2012, but this came at the expense of reduced investment in natural gas, where production fell 10.7% over the year. A breakdown of ExxonMobil's production by region provides a little more insight into current market dynamics.

Strong oil prices saw an increase in oil output from the Americas as investment in US onshore developments - particularly the Bakken, Permian and more recently Utica - as well as Canadian oil sands added to the production portfolio. However, the lower Henry hub prices saw a lack of investment in the gas sector, hence the reduction in gas output from the US. As a result around 85% of ExxonMobil's rigs are focused on oil plays and we expect this trend to continue unless the Henry Hub price sustains at a higher level. We do highlight that although Exxon are well placed in the US unconventional market we expect oil production growth to slow in 2014 and beyond, limiting opportunities to match the growth seen over previous years.

Slowing Oil Production Growth
US Oil Production & Y-o-Y Growth, ('000b/d, %)

Output from the Europe region remains largely un-impacted with declining oil production but improved gas production. However, the Dutch government's decision to reduce production from the Groningen field by around 7% a year to 2016 will reduce ExxonMobil's gas output levels over the next few years. Nevertheless, with the limited opportunities remaining in Europe we believe Exxon is well placed in Romania's Black Sea and in Norway's strengthening offshore.

African oil output remained relatively flat but gas production fell considerably as mature Nigerian assets saw large decline rates. Exxon's gradual move away from difficult operating environments could support longer term production continuity. Production from the Australia/Oceania region fell slightly but remained largely unchanged. We believe major LNG export projects in the Australia/Oceania region should help support production growth in 2014, particularly with Asian LNG market demand remaining strong for the time being.

ExxonMobil Production By Region
Oil, '000b/d 2013 2012
United States 431 418
Canada/South America 280 251
Europe 190 207
Africa 469 487
Asia 784 772
Australia/Oceania 48 50
Worldwide 2,202 2,185
Gas, bcm 2013 2012
United States 1,294 1,395
Canada/South America 129 132
Europe 1,187 1,175
Africa 219 620
Asia 1,580 1,656
Australia/Oceania 1,281 1,325
Worldwide 5,690 6,303
2013 2012
Oil Equivalent Production ('000b/d) 4,175 4,239
Source: ExxonMobil

Major Projects To Drive Production Growth

In order to stem falling production and dropping revenues, ExxonMobil is hoping to bring a number of major projects online in 2014 and add production of in excess of 500,000 barrels of oil equivalent (boe). The company has a wide range of globally dispersed projects due to begin production in 2014, though we note many continue face challenges with attaining their scheduled start up. Furthermore, some of the largest of the projects listed below were expected on-stream last year. The Kearl, Banyu Urip and Kashagan projects were all planned with a 2013 start up in mind. However, now that these projects are deferred to 2014 there is an improved outlook for Exxon, providing the projects do complete as planned.

Anticipated Major Projects For 2014
Country Project 000boe
Canada Kearl Phase 1 170
Indonesia Banyu Urip 75
PNG PNG LNG 62
Nigeria Usan 54
Kazakhstan Kashagan Phase 1 49
Angola Kizomba Phase 1 40
US Lucius 29
Russia Arkutun Dagi 27
Source: Company Information, BMI Research

Despite Exxon's strong production portfolio, over the longer term the company may hit some difficulties. The company put considerable investment into Canada's oil sands, and while this venture will give Exxon a large non-declining asset base, limitations on infrastructure will restrict the company's ability to export large volumes. Pipeline and rail infrastructure will sufficiently support the current Phase 1 of the Kearl project, but expansions will likely need major new pipelines to be built. We have long held the view that bottlenecks in export infrastructure could limit growth in this area ( see, 'Infrastructure Presents Supply-Export Paradox' June 21 2012, and more recently , 'Midstream Infrastructure Still The Missing Link', January 14 2014). Oil sands could play a major role in ExxonMobil's liquids production growth over the coming years but midstream solutions will be key.

Exxon is facing increasing challenges in its Iraqi operations. The company is heavily invested in the West Qurna field in Southern Iraq, however it has fallen out of favour with Baghdad after signing 6 production sharing contracts (PSCs) with the Kurdistan Regional Government (KRG). With the situation between Erbil and Baghdad still unresolved, despite having licences in Kurdistan, we believe Exxon could face trouble exporting any oil produced in the region. Baghdad is targeting 4.7mn barrels per day (b/d) by 2015 and 9mn b/d by 2020, though we are more bearish, taking the view that production will be around 3.9mn b/d and 5.7mn b/d in the same years.

Bearish Outlook On Disruption And Delays
Iraqi Crude Oil Production ('000b/d)

Added to this, the possible divestment of some or all of the company's stake in the West Qurna project would remove significant production assets from their portfolio, substantially reducing liquids output.

On the upside, ExxonMobil also has one of the most enviable shale positions in North America and has seen strong production growth from its Bakken and Permian acreage. The company is expanding operations in the Woodford Ardmore formation while is also having growing success in the Duvernay play in Canada. Exxon recently improved its position by buying up more acreage in the Utica and Wolfcamp formations. While we see oil production growth slowing in the US, it remains a stable business environment providing a concrete production base.

A further strength to ExxonMobil's portfolio is the solid backbone of global LNG projects. PNG LNG remains on target to ship LNG as planned in Q3 2014 and along with assets in Qatar, Australia and potentially the US, will give the company a long term non-declining asset base from which to gain sustained returns.

Tanzania has proven to hold significant natural gas resources with Exxon well positioned holding around 475-560bcm of gas in place with joint venture partner Statoil. Further wildcat and appraisal drilling will take place in 2014 in order to fully understand the opportunities. No timeframe has yet been given for a final investment decision (FID) on a possible LNG export facility, but this could materialise in the coming years with continued successful drilling results. The sheer volume of gas in place in Tanzania makes this a crucial future growth market for Exxon.

We believe that Russia is probably the most critical country to ExxonMobil's longer term future and is seeing the biggest drive of exploration expense from the company. This is largely due to the vast potential of the resource and the limited competition due to the nature of Russia's heavily state-influenced upstream. Exploration will be focused on the Kara Sea and in the vast Bazhenov shale, both of which are expected to see intense geological study and exploratory drilling in 2014. The shale play will need a significant amount of drilling to de-risking and better understand the geology and potential production profile of the formation, and though this could take some years it holds substantial potential. The Kara Sea remains a highly technically challenging target due to its Arctic environment, though also holds considerable oil and gas potential. Both ventures are therefore expected to be very costly, but could offer the kind of returns needed to sustain ExxonMobil's production profile over the longer term.

In order to fund this extensive programme ExxonMobil is planning to stick to its US$185bn investment structure outlined in 2012. This specifies capital expenditure of around US$37bn a year, though the company did overspend in 2012 and 2013 and is now targeting expenditure of US$38bn a year to 2016.

Capex Curbed But Remains High
ExxonMobil Capital Expenditure 2009-2016 (US$bn)

Big Oil Big Challenges

Big oil is facing a number of issues impacting the future of the business. This problem is not unique to ExxonMobil, though being the largest shareholder owned oil and gas company in the world it is one of the most affected. Chief among the challenges are the rising industry costs that are reducing the return on capital invested. Many of the major companies have struggled to explain the cost increase, though a combination of factors are likely playing a role:

  • Many of the newer oil and gas developments are far more technically challenging than the traditional low-cost, shallow-depth conventional onshore developments. More of Exxon's projects are in offshore and unconventional projects, which come with higher upfront costs and longer return on investment. Exxon's involvement in the Kashagan field has been a clear example of this, becoming the most costly oil project in the world (around US$50bn).

  • Safety is becoming a growing concern, particularly as oil and gas companies come under greater scrutiny in unconventional developments and environmentally sensitive areas. Greater expenditure is having to be made to ensure paramount safety. Failure to invest sufficiently in safety could see a similar fate to that of BP, which lost around half its value following the Deepwater Horizon disaster. Exxon is increasingly moving away from its high risk Arctic offshore developments in places like Greenland and Alaska, instead putting more focusing on lower risk operations such as in the US.

  • Project delays are also impacting costs as the longer companies have to wait for a return on investment the more profit is lost. Many of Exxon's mega projects, including some of the largest starting up in 2014, have been impacted by delays.

  • Finally, there is increasing competition for fewer resources meaning companies have to bid higher to win new exploration acreage. National Oil Companies (NOCs) still retain the bulk of the world's oil resources, which largely remain shut to international oil and gas companies (IOCs). NOCs, particularly from energy poor nations such as China and India, are increasing the competition for frontier resources as they increasingly venture out of their domestic markets.

What this means for Exxon:

Due to higher expenditure and limited production growth, Exxon is facing greater pressure from shareholders to provide returns. The company has refrained from significantly lowering its capex programme to mitigate high outgoings but has had to increase dividends to maintain investor interest, and provide a competitive investment opportunity.

The reserve replacement rate (RRR) is usually the gold standard of judging an oil companies success. However, we believe that due to Exxon's size achieving over a 100% RRR will be increasingly challenging to reach. Organic oil production growth for a company of Exxon's size is increasingly unrealistic with fewer major discoveries being made, while there is only a limited amount of mergers and acquisitions that can add to shareholder value. ExxonMobil did not announce a RRR for 2013 in its year-end presentation, though did state that the company did not have a specific reserve replacement target. Instead it was outlined to analysts and investors that the company will not spend shareholder's money specifically to achieve a 100% RRR, preferring to focus on high value added projects. While we feel this is a significant statement from a company which has traditionally focused on a strong RRR, it may indicate Exxon's focus to more selectively apply its finances.

Supporting our view that Exxon could be facing a more challenging future is the recovering economy in the US making, improving investment opportunities in equity markets. We have seen a softening of the oil price, though it remains historically high, and we expect further downside pressure over the coming years.

Softening Oil Price
WTI And Brent Price Forecast (US$bn)

This change is impacting ExxonMobil's growth potential as future earnings will be reduced, and it may indicate that some equity investors could look for better returns elsewhere as the outlook for ExxonMobil's growth prospects weakens. This is particularly the case for investors looking for steady returns as US Treasury bond yields improve. In order to stay remain as attractive as possible to investors Exxon may choose to increase dividends, meaning less money will be reinvested into the growth of the company.

Growth Opportunities Waning
US 10 Year Government Bonds vs ExxonMobil Dividend Yield

Furthermore, a good measure of confidence in the company is the price to book ratio, which has been in a downward trend over recent years, though has flattened more recently. While it should be noted this is an area where ExxonMobil continues to outperform its peers, the general trend highlights falling investor confidence in the company's ability to grow.

P/B Ratio Falling
ExxonMobil Price-To-Book Ratio 2007-Current
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