ExxonMobil's Supreme Test in the Current Global Environment

Borrowing a phrase from Chief Executive Rex Tillerson of buy-recommended ExxonMobil (XOM), the current global financial situation is not only a “supreme test” of the company’s business model, but also of every person’s investment strategy. Even before long-term strategic considerations, the first concern is, “Where is the cash?” In an 18-month effort, XOM has reduced its vulnerability to Wall Street, bank, vendor or borrower failure to “very, very low exposure”. Also holding an analyst meeting last week, hold-rated Encore Acquisition Company (EAC) cashed in its oil price insurance citing counterparty risk, i.e. EAC might not get paid.

Turning back to long-term opportunity, XOM is guided by its energy outlook. We notice a reduced share for coal in the formal forecast the company discloses annually and Mr. Tillerson confirms “natural gas will grow much faster than oil or coal”. XOM does not invest in renewable energy beyond a vigorous research effort because it has been conditioned to believe the government would make the largest oil company ineligible for the subsidies without which wind and solar is uneconomic.

Moreover, even after achieving President Obama’s goal of doubling wind and solar by 2012, the popular palliatives would still contribute less than 1% of total energy. Instead, XOM is increasing its spending on dependable oil and gas in a year when others are cutting back. We like to think of our recommended investment strategy in the same terms. After securing the cash, invest for the long-term upside.

U.S. Stocks May be Suffering from Tax Concerns

XOM has fallen sharply along with most stocks since the inauguration of a new U.S. President, perhaps along with concerns of rising taxation. The XOM chief declares that changes being debated are not positive for U.S. companies, particularly changes to the foreign tax system that would put U.S. companies at a competitive advantage. Indeed, we notice that Russian, Brazilian, Chinese, European and Canadian stocks in our coverage seem to be outperforming U.S. stocks lately. As a result, much of the damage in the U.S has already been done to stocks. At the same time, the actual implementation of onerous taxes in a weak economic and stock market environment may not happen as it could be politically ruinous to those who would do so.

Brazil is Nothing Like Ghawar

Pleased to have a promising position in Pre-Salt oil discoveries offshore Brazil, Mr. Tillerson thinks a comparison to Saudi Arabia may be mischaracterized. Ghawar, the largest oil field in the world, is comparatively easy and inexpensive to develop. The XOM CEO says the Brazilian discoveries require technological improvements, even breakthroughs, potentially, as well as a different approach to operating in such large volume, so far offshore and in water so deep. We like the prospects for Petrobras (PBR), the dominant player in the Pre-Salt, and are waiting for the opportunity to initiate a rating on the stock.

Russia Sorting out Latest Events like Everyone Else

XOM is proceeding in normal fashion with its project at Sakhalin in the Russian Far East. In Mr. Tillerson’s view, the government of the resource-rich country has known its conventional oil and gas production would be declining by now, but has been caught by surprise by the global financial crisis. He thinks it is still early to say how new policies to encourage investment and attract new capital will evolve. With a little extra courage we remain interested in buy-recommended Gazprom (OGZPY.PK), believing the value of the company’s natural gas resources outweighs the political risk.

Qatar an Example of Producing Country/Private Country Partnership

For an indication of the kind of deal XOM would like to do with other countries, Mr. Tillerson points to the Middle East nation, Qatar, owner of half of the world’s largest natural gas field. XOM and Qatar are developing the world’s largest liquefied natural gas (LNG) export project in a joint venture where the host government and the oil company have a common interest in long-term profits. We might add that just in case any pirate wants to raid the small emirate, the U.S. military has its giant regional headquarters nearby.

Share Buybacks a Flywheel

In mechanical devices like the farm tractors of our youth, the spinning of a heavy flywheel smoothed the pulsations of an internal combustion engine power source. In using the analogy, Mr. Tillerson may have in mind that commodity price, energy demand and myriad other factors contribute to a pulsating cash flow. After predictable dividends and programmed capital expenditures are covered, the remaining pulsations in cash flow are smoothed by the share buyback flywheel. Repurchasing shares is an automatic reinvestment in all of the company’s projects on efficient terms. As we see it, the buyback flywheel allows a company that long ago reached the conventional limits of size and profit to continue to deliver per share results like those of a long-term growth investment.

Oil and Gas Price Diverging Near-Term

Our weekly chart illustrates a divergence as Six-Year and One-Year Futures for oil tip up in the past week while those for natural gas tip down. In fact the trend of near-month crude oil currently quoted above a rising 50-day average is more positive than any stock price trend. Oil oriented stocks like hold-rated Suncor (SU), buy-recommended Canadian Oil Sands Trust (COSWF.PK), hold-rated Lukoil (LUKOY.PK) and unrated Petrobras are the few in our large cap coverage priced above their 50-day averages.

Originally published on March 10, 2009.

Comments

[searcher:]

"..has been conditioned to believe the government would make the largest oil company ineligible for the subsidies without which wind and solar is uneconomic." Such a belief is likely warranted. Yet XOM has been castigated for not 'investing' in alternative energy when their expertise and assets are in petrochemicals. These same parties would 'view with alarm' any deployment of resources by the company as an attempt to 'strangle' the nascent industries.

Please call to mind the nonesense that was spouted at the time of their quixotic acquisition of Reliance Electric at the start of the 80's, also a time of energy anxiety. The 'breakthru' in motor control was as ultimately illusory as much of what now passes for alternative energy potential.

Mar 30 01:28 PM

[Lamont B Du...:]

I think they may have already passed the test. They based their E&P budgeting on where prices are now, even when they were at $147. They knew that the price spike was not supported by market fundamentals. Now they are the only major I'm aware of that hasn't scaled back E&P for 2009.

BP & Chevron are spending tip money on alternatives, solely for the advertizing value. They won't come up with "the answer".

When they came up with their game-changers, Thomas Edison was not funded by the whale oil industry; Henry Ford was not working for the Baltimore & Ohio Railroad; Bill Gates was not working for IBM. Anyone who thinks large, established corporations are able to function as disruptive start-ups is going to be disappointed.

Mar 30 07:04 PM

[Alan von Al...:]

A couple quibbles. Edison was funded by railroads and bankers, the very largest enterprises of the Gilded Age. Edison's "game changers" were mostly misfires that others (Tesla, Westinghouse, Bell, etc) improved or developed concurrently. Gates built nothing and could not have succeeded without IBM. See inventors.about.com/li...

If we're talking about a breakthrough energy invention or process that will be cheaper, just as efficient and as flexible as oil power, it's science fiction. I don't care what happens in solar. You're not going to power aircraft with it.

Mar 30 10:17 PM

[WayneS:]

Exxon also spent a lot of time and money on "alternative energy" in the 80's besides Reliance Electric.
Solar power, wind power, hybrid cars, electric cars, using ethanol in vehicles, hydrogen motors, motors running on water, coal gasification, coal liquification, etc, etc. These things are re-invented every 20 years.
Efficiency is the only answer. We waste the majority of the energy we use.

Mar 31 12:45 PM

[bindlepete:]

XOM will continue in the liquids fuels business long after petroleum has been effectively been depleted. Like the Chinese they will likely go into the long suppresssed methanol and dimethyl ether business. Feedstocks either gas or coal.

If the latter is used the size of the units will make carbon dioxide sequestration reasonable, as in the Bullah ND coal based plant. This will make everyone happy except the petroleum based refieries will close up shop.

Liquid fuels have great advantages in energy density, flexibility of transport, storage and use.

Apr 01 11:47 AM