Exxon Mobil's (NYSE:XOM) announcement of its 2016 proven reserves status earlier today had news outlets scurrying to release one scary headline after another. Bloomberg's "Exxon Caves to Oil Crash With Historic Global Reserves Cut" is interesting as it seems to suggest that Exxon Mobil became affected by the fall in oil prices only today as it finally "caves in," while the use of "historic" definitely catches attention. Financial Times was less dramatic with its "Exxon Mobil forced to make cuts to reported oil and gas reserves," which clearly stated the fact without exaggeration though the use of "forced" still leaves much to be desired. When oil prices recover back to above $100/bbl, would any headline say that Exxon Mobil is "forced" to make upward revisions to its reserves? "Adjustment" would be a more neutral word to use, but I suppose that would not entice many to click on the news link to read further. BNN's headline, "Exxon slices reserve estimates, largely in Northern Alberta," reflects the reserve cut more accurately in context, as it clearly states a location where readers familiar with the oil story recognize as having the highest cost crude oil. Fortune has the most optimistic header thus far, based on my extensive sleuthing of related news on this topic. Its subject header "Exxon's Big Oil Sands Write-Off Could Help It Dodge SEC Troubles" lacks the grandiloquent description of the announcement but brings out four key points: i) there's a write-off, ii) the oil sands are being written off, iii) the write-off is substantial, and lastly, iv) the positive in the filing comes in the form of a potential avoidance of deeper implications of a Securities and Exchange Commission (SEC) investigation. In September last year, the U.S. SEC was reported to have doubts about whether Exxon Mobil has appropriately valued its energy reserves, given the plunge in crude oil prices and potential curbs on carbon emissions.
What's the Real Implication of the Reserve Cut Announcement?
So, for the same announcement, different news agencies have reported differently. The most glaring piece of information is the "net reduction of 3.3 billion oil-equivalent barrels from 2015." The reduction was predominantly contributed by the "entire 3.5 billion barrels of bitumen" at Kearl in Alberta, Canada, which is better known as the Kearl oil sands project. The remainder came from the 800 million oil-equivalent barrels in an unspecified location in North America. The 3.3 billion net reduction is significant, no doubt, given that the resultant 19% decline in total reserves represents the largest annual cut since at least Exxon's 1999 merger with Mobil. However, this being an annual exercise where the energy prices used are based on the average of the applicable market price prevailing on the first day of each calendar month during the year, the depressed prices in 2016 inevitably result in the reserves' valuation taking a haircut across the board. Crude oil prices have been on the decline since the second half of 2014. Prices bottomed in the first quarter of the year and staged a rebound thereafter but remained lower than the highs of 2015. The average Brent price for 2016 at $45/bbl was $9, or 17%, lower than the year before, and less than half the average for 2014, which itself was lower than the recent peak achieved in 2012.
Despite the official downward revisions, the reduction itself is not expected to "affect the operation of the underlying projects or to alter the company's outlook for future production volumes." That is a strong indication that the reduction is more of a compliance exercise than a realization that the projects such as the Kearl Oil Sands would never be profitable at some time in the future. The company acknowledges such a thought in the same announcement. Just as reserves need to be adjusted downwards in line with a decline in market prices, when there is a recovery like what we have seen in the past months, there would similarly be an adjustment upwards. Furthermore, the company pointed out that "a further decline in costs, and / or operating efficiencies" would also be a consideration in adding the booted out projects back, as even at the same energy price, lower costs could result in the projects becoming profitable. This is highly probable as we have already seen production costs declining and breakeven costs continuing to get lower with advancement in technology and improvement in facilities such as pipelines.
Looking at the oil supply break-even cost curve (below), it becomes obvious that as of December 2015, the oil sands were clearly the highest-cost crude oil supply source globally. At an average breakeven price at $74/bbl, it was a whopping $12/bbl higher than the average breakeven for North American Shale plays which held the runner-up title, and 2.6x more than the average Onshore Middle East assets. With both the key oil price benchmarks, Brent and WTI, at below $60/bbl for the entire 2016, it is no wonder that much OF the oil sands plays were deemed to be unprofitable and had to be removed from the reserves.
Illustrative Oil Supply "Break-even" Cost Curve as of December 2015
(Source: Rystad Energy)
IRPC (OTC:IRPTF) (OTCPK:IRPSY), a refining and petrochemical company in Thailand, collated several predictions on the crude oil price based on Reuters reports in a chart, which clearly demonstrates projected uptrend in prices. While the crude oil price in 2017 ($52-57/bbl) would still apparently be insufficient for the majority of crude oil prices to turn profitable, the forecasted range for 2018 at $63-77/bbl brings hope that at some point in the year, much more oil sands projects would be above the average break-even point at $74/bbl. With another two to three years till the oil prices hitting above $70/bbl, the technology advancements and operational efficiency improvements could also bring the breakeven costs lower than the December 2015-estimated $74/bbl. This meant that by 2019, Exxon Mobil could be adding some, if not all, of its reserves for the Kearl Oil Sands project back.
(Source: Reuters, compiled by IRPC)
As mentioned in the introduction, the headlines of many news articles appear to suggest the reserve cut implies the termination of certain projects. From the cost-curve chart shown above, the oil sands block sits on the right most side. However, this does not mean a total abandonment of oil sands projects. A Wood Mackenzie and Deloitte analysis forecasted continued, albeit reduced, development spending on oil sands by supermajors which naturally include Exxon Mobil. This is a further indication that despite having the highest breakeven cost which is below the prevailing market prices, there is the acknowledgment that there would still be ongoing development of oil sands.
(Source: Wood Mackenzie and Deloitte)
For the unnamed North American projects that were part of the 800 million oil-equivalent barrels being taken out of the 2016 reserves, the probability of those being added back by 2019 could be even higher. Among the U.S. shale plays, there is a wide range of wellhead breakeven costs, with Cana / SCOOP at below $40/bbl on the low end and Granite Wash above $80/bbl on the other end. Since Exxon Mobil did not disclose exactly the location or the project, we can only guess that the affected names belong to the high end of the breakeven costs. Nevertheless, even for the highest cost Granite Wash, with the holding power of Exxon Mobil, it could become profitable when the crude oil price goes above $90/bbl at some time in the future.
The headlines from many news agencies and commentators appear to be quite bearish and sensational. The net liquids and gases reserve cut by Exxon Mobil is more of a reflection of the steep price drop last year, continuing on the plunge which began in the second half of 2014. Furthermore, the company had already prepared the market for the cut in the earnings report in October. With energy prices recovering and projected to continue heading upwards in the next few years, it is possible that Exxon Mobil will add back the very same barrels back to the reserves. Investors should not be worried about this announcement. Likewise, the impairments made by the company in the last results announcement should not be a concern for the long-term prospects of Exxon Mobil.
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