Last Thursday, Exxon Mobil (XOM) reported first-quarter earnings of $9.5 billion dollars, slightly higher than first-quarter 2012 earnings of $9.45 billion. However, the stock price fell about 2% as traders were unhappy with a decline in production. Oil equivalent production fell 3.5% from the first quarter of 2012 and fell 1.2% if you eliminate all the various quotas and divestment that occurred. Oppenheimer analyst Fadel Gheit, unimpressed with the report stated.
"It's going to be a very rough ride for the majors. If oil prices go down from here, no major integrated oil company will beat the S&P"
Brian Youngberg, an analyst at Edward Jones said
"This company has been very growth-challenged for some time, "If they can get to the point they could keep (production) flat investors would look very positively at that" he also added "Lower production at Exxon is an ongoing trend, they need so many projects to come online to offset field decline"
Concerns were also raised about XOM's reduced share buyback, which will decrease from the $5 billion it has been for a number of quarters to $4 billion in the second quarter. Several questions during the Q&A of the conference call were about the drop in share buybacks. Credit Suisse had concerns about the quarter and characterized the quarter as a "weak beat."
I think many analysts are overly concerned with the declining production as the decline rates are only temporary. Unable to look beyond tomorrow, or looking out the rear-view mirror, they fail to see the future for Exxon Mobil is very bright.
Let's start by looking at historical production numbers. The chart below shows daily production going back 10 years. All numbers were taken from Exxon Mobil Annual Reports.
As you can see, production has been relatively steady, with the exception of a couple years. Production in 2012 was affected by the following issues.
- Asset sales - when fields get old and production starts to fall, the major oil companies will sell the field to smaller oil companies that specialize in getting the most out of old fields using CO2 flooding or other means.
- Entitlement limits - countries often place a limit on how much oil/natural gas energy companies can pump out of the ground on a yearly basis. These limits are often based on monetary benchmarks and with oil prices high, less oil can be pumped out in a given year.
- Mature fields - some of XOM's fields are mature and the production is in decline.
Exxon Mobil is so large that maintaining production at current levels is not an easy issue to resolve. It must find very large projects with production that will last for years. Competition for those types of fields is intense and acquiring them requires a great deal of money. Despite these difficulties, XOM has replaced all of its lost reserves for 19 consecutive years.
Not only has XOM replaced all of its lost reserves, it has been adding liquids, a higher margin reserve, at a fast pace. In 2012, XOM replaced 115% of reserves and in 2011 XOM replaced 116% of reserves. However, a deeper look reveals an even brighter picture. At the end of 2012, XOM's proved reserves totaled 25.2 billion oil-equivalent barrels, which was made up of 51% liquids and 49% natural gas, an improvement over the 2011 reserve breakdown of 49% liquids and 51% gas. Liquid additions during 2012 totaled 1.4 billion barrels (174%) of production and natural gas additions totaled over 400 million oil equivalent barrels, or 56% of production.
Production Will Increase Not Decrease
At the 2013 analyst meeting, XOM management stated that by 2017, production will increase by 1 million barrels a day. Here is what XOM CEO Rex Tillerson had to say about production at the 2013 analyst meeting.
"The continued development of our resource base, will deliver additions of over 1 million net barrel of production per day by 2017. Most notably, we are growing liquids production and liquids-linked gas volumes."
"We anticipate volumes will grow 2% to 3% per year from 2013 through 2017 with significant contributions from liquids."
XOM has approximately 30 projects set for start-up between 2013 and 2017, many of which are long-lived projects.
Looking beyond tomorrow, it is clear to me that XOM's production levels are just fine and there is no reason for concern. In fact, a 1 million barrel-a-day increase in production is approximately a 23% increase from 2012 production levels, which is pretty impressive.
Increased Production Leads to Increased Profit
Energy company profits are strongly tied to energy prices, higher oil and natural gas prices usually leads to higher profits. I have no idea what energy prices will be next year or in 2017. But, I do know XOM will be increasing production, which should lead to increased profits. At the 2013 analyst meeting, XOM management stated the 2012 earnings per barrel of production was $19.27. That profit level occurred in spite of record-low North American natural gas prices.
If you do the math, you will see that a 1 million barrel-a-day increase in production, assuming the same $19.27 per barrel of earning, equals over $7 billion in additional earnings (1,000,000 x $19.27 X 365 = 7,033,550,000).
What XOM's actual increased profit level will look like in 2017, I do not know. But, I do know that with rising production comes rising profits. I also expect North American natural gas prices to be higher in 2017 and would not be surprised to see higher oil prices in 2017. I think it is a fair assumption that XOM's earnings will be higher as production grows.
Own More Barrels For Each Share
Exxon Mobil has proved reserves of 25.2 billion and has approximately 4.4 billion shares outstanding. That means each share of XOM owns approximately 5.7 barrels of reserve. As XOM continues to build its reserves, it is also shrinking its share count. In 2012, XOM bought back shares worth approximately $20 billion dollars. In the first quarter 2013, XOM bought back shares worth over $5 billion and intends to buy back $4 billion in the second quarter.
Although nothing is guaranteed, let's assume XOM continues to buy back between $5 billion and $4 billion dollars' worth of shares a quarter. At an average share price of around $90.00, that is approximately 200 million shares a year. Let's also assume XOM maintains the same reserve level it had in 2012, in my opinion, the reserves will be higher, but let's be conservative and say it remains the same. As you see, a share that owns 5.7 barrels in 2012 will own 7.2 barrels in 2017, a 26% increase.
|Year||Share Count||Share Buyback||Remaining Shares||Barrels of reserve per Share|
What I See Looking Beyond Tomorrow
Reading analyst reports and Internet articles a common theme is concern over XOM's falling production. What the analyst and authors miss, is that the slight decline in production is a temporary problem, not a long-term issue and has been fully communicated by management. Here is another quote from Rex Tillerson at the 2013 analyst meeting.
"Overall, liquids and liquids-linked volumes are projected to be up 3% to 4% per year during the period. Total production will decline about 1% this year in 2013 versus last year. The projection for 2013 is lower than presented last year due in part to lower anticipated dry gas volumes in North America as well as some minor slippage to start up with two projects' timing this year."
The period he is referring to is the 2013 through 2017 period. Due to minor delays in two projects, one of which is the Kearl Oil Sands project, production was down. Kearl was started this week so that anticipated production has begun. Why analysts and writers cannot see that the production issue is short-lived is beyond me. They see an issue, but I see opportunity.
I see a company that is buying back $4 to $5 billion dollars of shares a quarter.
I see a company that according to David Fish's excellent Drip Investor Resource Center has increased its dividend for 30 straight years and has averaged a 9.7% annual dividend increase over the last five years.
I see a company that will grow its production by 1-million barrels a day over the next five years.
I see a company that will increase shareholder ownership of oil equivalent barrels over the next five years.
I see a company that is the best managed integrated oil company in the world with an asset base that will continue to grow.
I see a company that has a product the world must have and will need more of far into the future.
I see a company that is cheap at 9 times earnings.
I see a company that should be bought and held for a very long time.