In late 2011, ExxonMobil announced plans to drill for oil in disputed land between Kurdistan and the rest of Iraq. Baghdad’s government, fearing the move could break up the country, threatened to eject the company from a big project near Basra, in the south of the country.

Exxon ignored them, knowing the encounter was a mismatch. Iraq’s revenue from oil sales that year amounted to about $80bn. Exxon’s revenue came in at more than $430bn. The move exemplified the geopolitical chutzpah of America’s best-known energy producer — the kind of clout that persuaded Donald Trump to make Rex Tillerson, Exxon’s then chief executive, his first secretary of state.

Almost a decade later, Exxon’s Kurdish investment has gone nowhere and its big project in southern Iraq is producing a fraction of its original target. Far from showing Exxon’s international mastery, these days Iraq is just another oil arena where things did not go as the company had planned.

“Exxon was a superpower in every sense of the word — a blue-chip stock that handed out money year after year, a firm with a calling card to foreign leaders that rivalled even top international diplomats, and with geopolitical savvy that bested most intelligence agencies,” says Amy Myers Jaffe, professor at The Fletcher School at Tufts University. “It was one of the safest bets on Wall Street.

“But no more does it have this status,” she adds.

Even before coronavirus shattered the global oil industry Exxon — once the world’s most valuable by market capitalisation — was struggling. But the pandemic has left the company exposed. In March, rating agencies downgraded it; in August it lost its place in the Dow Jones Industrial Average to a software company. And once famous for high margins and low leverage, Exxon is now mired in debt and expected to report its third consecutive quarterly loss on Friday.

ExxonMobil intends to increase its fossil fuel output by almost a third in the next four years © Bloomberg

Analysts say a quest for fast oil-production growth and an addiction to risky, high-cost projects has hobbled the company in recent years.

Yet Exxon’s response has been to double down on oil and gas, plotting another huge surge in output. As rivals fret about peaking oil demand and start trying to navigate a global energy transition away from fossil fuels to cleaner energy, Exxon is making a huge bet on oil’s future.

“Some believe the dramatic drop in demand resulting from coronavirus reflects an accelerating response to the risk of climate change, and suggest that our industry won’t recover,” Darren Woods, the company’s chief executive, told staff last week. “But as we look closely at the facts and the various expert assessments, we conclude that the needs of society will drive more energy use in the years ahead — and an ongoing need for the products we produce.” 

If Exxon is right, its gamble will rescue the company as projects from New Mexico to Guyana begin pumping crude oil into a rising market, while its refineries and petrochemicals plants feed an increasingly prosperous world for decades to come. Exxon, not its European rivals, would stand to gain. But an already sceptical market will punish the company severely if this bet fails too.

“Exxon is committed to the future of fossil fuels” says Paul Sankey, an oil analyst who runs Sankey Research. “If it is wrong, it has an existential crisis.”

Line chart of Sum over previous four quarters ($bn) showing ExxonMobil's cash revenues no longer cover capex and dividends, prompting a rise in debt

Era of missed opportunities

For decades Exxon has not questioned the idea that global population growth and a rising middle class would trigger demand for more oil and gas. The priority for an oil company, therefore, was to keep finding more hydrocarbons, replace those it produced and minimise costs.

Lee Raymond, Exxon’s chief executive from 1993 to 2005, added scale with the addition of Mobil in 1999. And then he honed a high-margin model that churned out bumper profits, even through lean patches, and paid one of Wall Street’s most cherished dividends. Mr Tillerson, his successor, took charge in an era of perceived supply shortages. And as oil prices soared towards their historic peak in 2008, Exxon scoured the world for new reserves and big developments.

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In subsequent years it launched a huge bitumen mining project in northern Canada — Kearl, run by its local affiliate Imperial Oil — and signed up to develop Iraq’s West Qurna 1, in one of the world’s largest oilfields. With Vladimir Putin watching on, Exxon signed deals with Russia’s state-controlled producer Rosneft and planned a colossal offshore exploration and production programme in the Kara Sea north of Siberia.

A 2013 deal between Exxon and Russia’s state-controlled producer Rosneft later fell foul of sanctions © Serge Karpukhin/AFP/Getty Images

Yet it is now seen as an era of missteps and missed opportunities for the company. As wildcat drillers in the US were busting open a century’s worth of new shale gas reserves — the start of a supply revolution that would turn the global energy market on its head — Exxon demurred, backing big capital projects overseas instead. When it eventually dipped its toe into this new unconventional resource, the company focused on German and Polish shale fields.

Sanctions on Russia after it annexed Crimea in 2014 killed the Kara Sea venture. The hunt for shale gas in Europe was a dead end. The Iraqi investments underwhelmed investors. And while Kearl survived, it became a high-cost, high-carbon project that sucked up capital just as an era of scarcity flipped to one of abundance.

“Exxon was always good at betting the farm big at the bottom of cycles, and allocating capital counter-cyclically,” says Nick Stansbury, head of commodity research at Legal & General Investment Management, an Exxon investor.

“What went wrong? It thought it was allocating capital counter-cyclically, [but] into a cycle that didn’t happen and into assets that weren’t as good as everybody thought they were,” he adds.

Line chart of Share price growth (%) showing Big Oil stocks have been eclipsed by a leader in renewable enegy

Belatedly, recognising the promise of the shale revolution happening under its nose, Exxon’s $41bn purchase of XTO including its debt in 2009 made it the US’ biggest natural gas producer. But the bumper price reeked of panic.

Return on capital employed dropped from more than 30 per cent in 2008 into single digits in 2014. The production growth promised by Mr Tillerson failed to materialise. In the 15 years up to 2019, capital expenditure hit $350bn, but output ended lower. The balance sheet bulged. From 2015, cash flow from operations struggled to cover the sum of the company’s market-leading capex plus its dividend.

Peter Speer, an analyst at Moody’s Investors Service, estimates that Exxon needs an oil price of at least $55 a barrel to cover these spending needs, far above current prices of around $40 or those visible in the futures curve.

Other analysts are more sanguine. Exxon thinks in decades, says Doug Leggate, head of US Oil and Gas at Bank of America, and is spending at the bottom of an oil price cycle. “By definition you’re not going to have a lot of cash flow.”

Mr Woods has promised $15bn of asset sales to shore up the balance sheet. But only one big deal in Norway, worth $4.5bn, went through before the pandemic hit asset values, leaving the company a reluctant seller in a buyer’s market.

The West Qurna-1 oilfield near Basra, operated by Exxon, is producing a fraction of its original target © Essam al-Sudani/Reuters

Investors have punished the stock, which has fallen almost 60 per cent in the past five years. By contrast, Chevron — Exxon’s closest rival — is down by about a fifth. Carbon Tracker, a think-tank, calculates that between 2007 and 2019, Exxon shareholders collectively would have earned $400bn more if they had invested in Chevron instead.

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And investors see no easy solution. Deeper capex cuts on top of the 30 per cent drop already undertaken this year would jeopardise the medium-term production growth Exxon has promised. Slashing or suspending the dividend would destroy the rationale to hold the shares — a view reflected in a dividend yield that has soared above 10 per cent.

“Cut the dividend, cut capex — there’s no yield, there’s no growth,” says an executive at an institutional investor with a position in the company. “Why would we own the stock?”

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For now, the company is holding back the dam. Unlike Shell and BP, which used the oil price crash to rebase their dividends, Exxon’s board is expected to announce on Wednesday another 87 cents-per-share payout. It would make 2020 — the oil industry’s worst year in decades — the 37th year in a row that Exxon has increased its dividend.

Fossil fuel focus

The bigger difference between Exxon and its European rivals is about the future of oil and its role in any energy transition. BP, Shell, Total and Equinor have all begun to confront the implications of climate change for the oil business. BP recently published a scenario in which global oil demand would fall by almost half in the coming three decades. It has pledged to reduce its own fossil fuel output by 40 per cent by 2030.

Exxon, which intends to increase its fossil fuel output by almost a third in the next four years, sees things differently. It accepts that there will be a global energy transition — and that it must help tackle emissions — but believes oil will remain a pillar of the world’s economy. It estimates that demand will reach 111m b/d in 2040, compared with about 100m in 2019. A production increase equivalent to adding another Saudi Arabia would be needed just to try and meet this projected extra thirst for oil.

Even if the world successfully follows policies in line with the Paris climate agreement goals — implying a significant drop in global oil demand — huge new investment will be needed in oil and gas projects, Exxon says. It points to the International Energy Agency’s Paris-aligned sustainable development scenario and the agency’s view that cumulative investment in oil and gas will need to be around $13tn by 2040.

Officials were also quick to seize on Joe Biden’s remarks after the most recent presidential debate, as the Democratic party nominee clarified his comments about a “transition away from oil” by saying this would not happen before 2050.

Yet while Exxon plots more fossil fuel production it is also ploughing money into research on biofuels and carbon capture techniques, believing it can bridge a “technology gap” to solve the conundrum of delivering more energy to more people at lower cost and less emissions.

“That’s where we focus our research,” says Vijay Swarup, head of research and development at Exxon. “How do you provide the energy that the developing nations want to grow their prosperity, and continue to meet the demands of the developed nations, but to do that, with lower emissions?”

Kearl, a huge bitumen mining project in northern Canada run by Exxon affiliate Imperial Oil © Imperial Oil

It marks a break from the past, when Exxon executives such as Mr Raymond would regularly question climate science, or when Mr Tillerson dismissed biofuels as “moonshine” in 2007.

But scepticism among some Exxon investors and analysts persists. “ExxonMobil has failed to produce any advanced technologies at commercial scale,” says Ms Jaffe.

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Despite a company pledge to reduce its own greenhouse gas emissions, they remained about 124m tonnes a year between 2009 and 2018, a volume greater than Belgium’s.

Its large retail investor base means it does not face as much institutional pressure as some of its rivals, says one company adviser. But the lingering perception of some in the market is that the company’s devotion to oil is a source of Exxon’s current failings.

Line chart of Dividend yield (%) showing ExxonMobil's cost of capital has soared

“They have a general macro view [of oil demand] that served them well for several decades,” says Tom Sanzillo, analyst at the Institute for Energy Economics and Financial Analysis. “The broader vision doesn’t work any more, and the business model that flows from it doesn’t work any more.”

It has exasperated some institutional shareholders. An executive at one Exxon-investing fund was blunt: “I know they don’t believe in transition. But the market does.”

Meeting higher demand

But what if Exxon turns out to be right about oil demand? The bullish thesis for the company’s stock is that this year’s vast cuts to global upstream capex will lead to a drop in supply by mid-decade — by which time oil demand will have recovered.

Exxon is pledging to increase oil and gas production by more than 1m b/d by 2025. Rivals such as Chevron also plot growth but not of the same scale — and some expect to reduce production or hold it flat. Exxon’s bet is that its output surge will hit its peak just as the market tightens. “Exxon has growth projects, BP and Shell don’t,” says Mr Leggate. “Is their pivot to green energy partly because they underinvested [in oil] in the past five years?”

In his message to staff, Mr Woods said: “Irrespective of short-term volatility, we must stay safe, maintain the integrity of our operations, drive efficiencies and continue investing.”

Darren Woods, ExxonMobil CEO, The company estimates that oil demand will reach 111m b/d in 2040, compared with about 100m in 2019 © Lexey Swall/FT

The upstream centrepieces are US shale — where Exxon holds a commanding position — and deepwater oilfields off Guyana, where the company estimates its production will reach 750,000 b/d by 2025. Brazilian oil will flow later, according to the plan, while a Mozambique liquefied natural gas project will offer a “highway to India” and its fast-rising economy, says a company adviser.

In the Permian, the prolific shale oilfield of west Texas and southeastern New Mexico, Exxon says oil and gas production will rise from around 300,000 b/d in the second quarter to around 1m b/d by 2024.

Shale is now a crucial part of the company’s portfolio because it offers the ability to rapidly dial up or down output, according to oil price changes. Thus, as Exxon slashed its planned capex this year to around $20bn, it was able to slow its Permian development, allowing it to speed up later.

The company may even join a wave of consolidation under way in the US oil sector. Hess, a partner in Guyana that also holds US shale assets, could be a good fit, believe some analysts. Pioneer Natural Resources, another Permian producer, is considered a plausible target as well.

Previous failures to deliver growth leave investors sceptical. But Mr Leggate says the market is “missing the woods for the trees” by discounting the only supermajor that will have capacity to increase production when oil prices recover.

Yet, as investors focus on the climate impact of their companies, it is not obvious that Exxon’s huge new bet on oil will be rewarded.

“The Exxon brand is so broken in the mind of the market,” says Mr Sankey. “The next generation don’t want to own environmental public enemy number one.”

Via Financial Times