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There have been a lot of changes in the oil market since the emergence of the U.S. shale industry, which has changed the price structure of oil, forcing majors with high-cost offshore assets, like Exxon Mobil (NYSE:XOM), to adjust their long-term strategies.
It has also changed the way companies look at reserves, which, in the case of Exxon, has dropped to 13 years after it wrote down its Canadian sands assets. That's the lowest level its reserves have fallen to in 20 years.
What needs to be understood is whether this is a long-term threat to the company or a reflection of the variables now part of the energy market that weren't there a couple of decades ago.
Before we examine that, we'll look at what it is that shareholders and investors are looking for with Exxon Mobil and other majors.
Investors want this
With the belief that the price of oil could be lower for much longer than previously believed, investors have taken a much shorter time frame in regard to major oil producers. What they're now looking for is the company to be able to maintain its dividends and, ultimately, even to survive.
Its survival isn't an imminent threat, but the potential cutting of dividends is. After all, why invest in an oil major if the dividend isn't in place? If the company is considered close to being as risky as smaller but faster-growing shale producers and the dividend is cut, it would make more sense to invest in a growth company rather than the slower-moving majors like Exxon Mobil.
The two things most investors want to see is that all energy companies are cutting costs and lowering their breakeven points, while at the same time operating within cash flows. Contrary to the past, reserves are no longer the main issue for shareholders and potential investors.
Cutting costs, in the case of Exxon Mobil, isn't only a matter of improving existing costs at its offshore assets - it's a matter of finding ways to offset the higher costs using other means as well. That's why Exxon recently acquired more shale acreage. The company can quickly boost production and lower its costs basis across its entire upstream portfolio, while increasing revenue.
In other words, there are limitations on how much costs it can take out of existing offshore operations and how long it'll take. Shale production guarantees an immediate impact on the average cost of producing a barrel of oil for Exxon.
A lot has been made of the alleged risk renewables represent to the fossil fuel industry. I'm of the camp that believes it's still decades away before that makes a difference. The reason why is, even if it has an impact on developed nations, energy demand will continue to grow far beyond the ability of renewables to meet the need. That means oil and gas will remain a major energy source for at least another two to three decades.
The most probable future is energy demand will grow to such high levels that fossil fuels won't be able to meet the needs, and renewables will be the energy source that grows quickly because of that.
I don't really see renewables as competition in the way many in the market consider them to be. I see energy demand raising all energy ships, with all sources needed to meet the needs of people and nations far into the future. In other words, some day in the years ahead, it will appear oil specifically will lose market share because its percentage as part of the overall energy market will decline. The truth is, this won't mean supply or demand is declining, but that it can only meet a portion of it.
Also important to note with oil is that it's not only used for gasoline. Many investors look at this when thinking of the possible disruption renewables will have on oil. Oil is also used in a lot of products, and as emerging nations' demand for those products grows, that part of the oil market will remain robust.
Interestingly, many decades from now, we may see the auto market dominated by electric cars but the oil market driven by petroleum-based products.
That said, I still don't see renewables in regard to transportation as being a significant negative catalyst in the near future for oil or Exxon.
Reserves will be treated differently
To me, what's driving the change in how majors are treating reserves is more from a cost perspective rather than renewables. As mentioned, investors are pressing for lower costs and producers operating within cash flow. That really isn't a negative for companies in relationship to tightening reserves.
The reason for that is there are a lot of known reserves in the world, and a lot of oil left for exploration in the years ahead. Even in the U.S., it appears federal lands will be opened for exploration, which should yield an increase in reserves.
Large producers have been buying up more acreage or fields with prices low at this time. For example, BP Plc (NYSE:BP) acquired Zohr from Eni, and Total S.A. (NYSE:TOT) acquired acreage in Uganda and Brazil for exploration purposes.
These types of moves confirm the larger producers aren't thinking in terms of oil demand dropping to the degree they don't need to prepare for the long term. The difference is they don't have to necessarily have reserves all proved and in the ground as they had in the past. Many countries lacking capital will also be more than willing to strike deals with majors to develop known reserves. The companies no longer have to have them under the corporate umbrella to grow reserves in the future.
A lot has been made of the decline in reserves at Exxon Mobil, but I really don't see it meaning a lot. I also don't see renewables being the catalyst behind lower reserves, but rather it being driven by market forces which have put downward pressure on the price of oil because of excessive demand.
Investors, in my view, aren't pressuring for lower reserves because of a threat from renewables, but because they don't want capital locked up in the ground or under the ocean floor.
In the case of Exxon, shareholders want it to protect the dividend. That means finding ways to lower costs. I don't see it as being any more complicated than that.
What is likely to happen in the future is Exxon will lower its average production cost per barrel of oil and operate within cash flow. Once the market rebalances, the price of oil will start to climb, providing better margins, earnings, and cash flow. That will provide the cash to acquire more assets that can grow its reserve base without going heavily into debt.
Exxon Mobil isn't in any danger because of its reserves. It will be able to add to them at the right time and market conditions, and should be able to maintain and grow its dividend for a long time into the future.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.