ExxonMobil: Going Drilling On Wall Street?

Summary

• Oil company stocks have been beaten down by a combination of market factors recently.
• One reason is that reserves have not been replaced over the past few years.
• In this article, we look at how XOM may respond.
• Current pricing represents an excellent entry point for this 4.12% dividend yield payer.
• This was shared previously with the members of The Daily Drilling Report Market Place community.

Introduction

Exxon Mobil (NYSE:XOM) traces its roots to the Standard Oil Trust which dominated the petroleum industry in the late 19th and early 20th centuries. Its dominance in that era was so profound that ultimately it was broken up into seven separate companies, some of whom became known as the "Seven Sisters," so named for their mid-twentieth century dominance.

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There has probably not been such a fabulous accumulation of wealth until the advent of the Internet companies. Some of which now face the same reactionary tide that Standard Oil faced a hundred years ago. The perception is they are just too powerful. Time will tell if the Internet titans ultimately meet Standard's fate. One thing only is certain, as with Standard, the owners will get richer still, as did John D. Rockefeller, the majority owner of the Standard Oil Trust.

Exxon Mobil, the major surviving company from the original seven, sets the standard for excellence among the Super-Major integrated oils, in every area but one. Reserves replacement. Its stock price has suffered as a result, and is currently about 8% below its 200-day moving average of $80.56/share.

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In an earlier article entitled, "The Return Of Deepwater Drilling...", I made the point that XOM needed to improve their performance in this area. Hence, their significant outlay in Brazil's Round 15 Deepwater auction. I don't think it will stop there, as this is long lead time stuff. If they wanted production now, which they do, they should have been drilling the last four or five years. I am not picking on them here, as there are obvious reasons why this hasn't happened. Still, things are what they are, and XOM needs some reserves.

XOM has had some hard knocks in the last few years. Write downs of its Canadian Oil Sands-Kearl River caused most of the reserves blip you see from 2015-6. Then having to write down some gas assets (discussed later herein), combined with the capital restraints of the last few years, have had their impact on reserves and share prices. XOM shares are essentially where they were ten years ago. Reserves, while rebounding in 2017, still show a 5-year decline.

I think soon, based on this company's history, XOM will make a significant acquisition. Whom they might go after may surprise you, and exploring this idea from a historical basis will be thesis of this article.

Exxon and Mobil become Exxon Mobil

In 1999, the year in which Exxon and Mobil finally merged (this was announced in 1998), oil prices were down, way down. Only bottoming at $8.03 in December of 1999, one month after Federal Trade Commission approval was received for the XOM merger. A fall of about 60% from a recent high of $21.76 set in January of 1997.

Several things drove this merger.

• Low oil prices made capital investment decisions hard and cut into reserves replacement. Exxon got 8-BBOE proven reserves with Mobil, for a cost of about $10 a barrel. A fairly low, risk free finding cost.
• BP (BP) (one of the original Seven Sisters) had been on an acquisition spree, gobbling up Amoco Oil (another sister) in 1998. It is conceivable that Exxon was concerned that if it didn't act soon, another company might.
• Economies of scale that could be realized when the two companies became one. Put simply, oil is cheap, revenues are down commensurately: cut costs.

The goals now are probably simpler and more fundamental, as the cost-cutting of the last three years has likely reached practical limits. What is needed is making a significant oil reserves addition... fast. Oil companies get measured by many standards. Of these, the biggie is years-supply of oil and oil equivalents. When you produce almost 4 mm bopd as XOM does, you go through the equivalent of two major oil fields of about a billion barrels, every s-i-n-g-l-e year. And, if in one year, or two years you don't replace that amount, then you're getting smaller, and may then become the target of a raiding company yourself.

This is not a place XOM ever wants to go. But it is getting tougher and tougher to replace fields of this size by drilling. A lot of the good stuff has been drilled up, and is on production. Not that it doesn't happen, as Bahrain's announcement earlier this week of a (potential) 80 billion barrel find within its borders, it's just getting harder to do.

So with the stock prices of many good sized oil companies depressed right now from a variety of market factors (volatility in the overall market, trade concerns, thermonuclear annihilation... you name it), the key conditions that stimulate mergers and acquisitions in the oilfield are similar to 1999.

• Oil demand is rising due to global market conditions, and oil prices are off about 50% of recent highs set in 2014.

Let's see, relatively low oil prices, cheap oil stock prices, rising oil demand... got it, time to go shopping for some oil!

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Oil demand is seen rising in the above chart, save for a brief interlude between 2007 and 2009. You may recall, the financial world melted down then, and the earth wobbled on its axis.

XOM buys XTO Energy in 2009

Now, let's look at the XTO Energy deal of 2009. As we flash forward ten years, unconventional - reservoirs not commonly tapped for hydrocarbons - resources are gaining traction in the U.S. And, one of the shining stars is XTO with its unconventionals expertise and gas reserves of 45 TCF.

Low carbon energy is all the rage in 2009. A newly elected president has proclaimed the future is solar and that "Clean Energy" will power the future. In the context of those remarks, can XOM be faulted for its bet on XTO? The future of clean energy was so bright...

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Maybe. It turns out that XOM was a little early with this purchase, as in the next few years with the explosion of unconventional drilling that took place, so much gas was found that prices languished, dropping from about $13 MCF to about $3.50 MCF.

To the point that a year and half ago XOM was forced to take a 2-billion dollar charge writing down the value of some of the reserves it gained in the XTO deal. Things that work at $13 MCF may not at a fifth of that price. Early is often wrong in this business, and picking winners based on the political preferences of presidents is often fraught with peril.

Nonetheless, early doesn't necessarily mean wrong... forever. More on this in a minute.

Let's see what XOM is telling us about what it sees in the future

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The graphic above shows that gas will play an increasing role in power generation over the next twenty years. It also tells us that oil will still be the dominant fuel for transportation. And, finally it says that renewables will play a slightly larger, but still minor role in overall energy needs.

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Even with electric vehicles factored in, XOM is telling us that fossil fuels will still play a dominant role in personal and commercial transportation. On the right side of the graphic, we see XOM's prognostication of gas demand for electricity generation in BCFD.

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If we do nothing, oil supply falls far short of demand in 2040, highlighting perhaps the danger of listening too carefully to the most rabid of the alternate energy soothsayers.

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A shortfall in gas is also projected. Not as severe as that for oil in the average demand case. But, when has energy demand ever been average?

So where does XOM go in search of reserves if this thesis is correct?

First, I think they are telling us pretty strongly that gas is the low-carbon electricity generation fuel of the not-too-distant future. And, where are the low cost reserves of natural gas found? Right here in the U.S.A.

For that reason and others, I don't see XOM going after BP (this has been long rumored, but shot down many times) or Shell (RDS.A) (RDS.B); or any of the other supermajor international oil companies (IOCs). The hill of (rising) nationalism would just be too high to climb, and lot of time would be wasted pursuing them.

Rather, I see companies like Pioneer Exploration (PXD), or Diamondback Energy (FANG) as being vulnerable to an XOM raid. Let's look quickly at PXD.

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Pioneer is pretty gassy as you can see. Half of its approximately 1-billion bbl of reserves are in gas to the tune of about 17 TCF. XOM just spent 6.6 billion to add the 250K Bass Permian (Delaware basin) acreage portfolio to its inventory, showing a propensity already to shop on Wall Street and adding 3.0 billion bbls roughly to its reserves base for 2017 (that was the 2017 jump you saw).

XOM currently has about 55 TCF of gas reserves booked globally, with only about a third of that in the U.S.

Through its XTO subsidiary, XOM is a Permian wells factory. They know how to produce these resources cheaply and have a track record of doing so. It has an acreage position of over 750K acres, and are currently developing it at a 20% CAGR.

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The two areas are in separate basins, but with each about an hour's drive from Midland, not too far to be managed from a central office. I see this being reasonably in-keeping with XOM's 'bolt-on' approach to acquisitions. That being they like there to be a synergistic effect to current assets.

PXD is also a 'wells factory' that has XOM like thinking already, as can be seen below.

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This discussion of PXD is a bit of whimsy on my part, and PXD might not be a perfect fit. PXD's stock price of +/- $177.00 share (up $8.00 a share today) might also put it beyond the pale financially.

Still, if XOM is looking to acquire acreage in the Permian, PXD has three times the position they acquired from the Basses. They paid the Bass Brothers of Fort Worth, $6.6 billion for 250K acres last year. Paying $30 billion for a juggernaut like PXD is not too far out of bounds for a hungry tiger.

Summary and your takeaway

XOM has shown mixed performance in market timing for acquisitions. Mobil was a fait accompli. Billions of dollars were saved in synergies between the two companies that paved the way for today's dominance. Oil reserves were increased 40% for a very nominal price as compared with E&P risk. In that scenario, maybe you spend a bunch of money and come away with nothing. And, of course, their position as the world's largest public energy company was cemented for all time.

By contrast, XTO Energy was bought at near market tops for both oil and stock prices. XOM was guilty of thinking $100 oil and $15.00 gas were the new normals.

With a net debt to capital ratio of 16.8%, as of their year-end report, XOM is in pretty good financial position to look at an acquisition in the $30 to 50 billion range. There are a lot of companies at the depressed prices of today for those sums.

XOM is back to generating loads of free cash flow, nearly $15 billion as of their latest report. So, in theory, an acquisition could be paid for fairly quickly if circumstances warranted. And, of course, there is always the possibility (likelihood) that the new company would be accretive to earnings right off the bat.

Their dividend is also well covered with free cash now, and the yield at this price is over 4%. XOM yields at this level are very rare.

In short, XOM is in a great position to go on the prowl - remember their corporate symbol is a tiger!

Disclaimer and Final Request

I am not an accountant or CFA. This article is intended to provide information to interested parties. As I have no knowledge of individual investor circumstances, goals, and/or portfolio concentration or diversification, readers are expected to complete their own due diligence before purchasing any stocks mentioned or recommended.

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Analyst’s 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.