Exxon Mobil's Three Crises: 'It Never Rains But It Pours'
- Coronavirus, Brent crude chaos and a not so pretty climate beauty competition means the stock is down dramatically.
- COVID-19 starts to bite and Brent crude tanks due to Russia, Saudi Arabia disagreement.
- Things heat up on emissions reductions as Exxon Mobil CEO Darren Woods taunts European rivals.
- Exxon Mobil acknowledges that its dividend is not covered by earnings, instead asserts that debt is cheap and so the dividend is not under threat. Recent developments may have changed that.
- Lots of articles on Seeking Alpha saying “buy” XOM; these rely on all of this being “just” a cyclical issue. Long-term structural issues still ignored.
You know that something is up when the Exxon Mobil (NYSE:NYSE:XOM) CEO Darren Woods taunts his rivals that he isn’t going to participate in a beauty competition. This happens all of the time in the school yard, but within a group of the global oil and gas majors? Be in no doubt, this is deadly serious as Darren Woods reveals his dismissal of the need to rapidly decarbonise, while his European counterparts Royal Dutch Shell (NYSE:RDS.A) (NYSE:RDS.B) and BP (NYSE:BP) announce their intention to get serious about rapid decarbonisation. The share price of XOM fell by ~9% to $47.69 after Darren Woods statement, and while COVID-19 fears are biting, my take is that dismissing climate issues is a serious misunderstanding by him concerning his role in the fossil fuel industry. And then came disaster with the stability of oil pricing going out the window, with XOM share price down a further 12% to $41.86! Yesterday the market recovered somewhat, with XOM rising 3.7% to close at $43.41. It might be noteworthy that both BP (closed at $26.79, up 5.97%) and Shell (closed at RDS.A :$36.96 up 6.57%/RDS.B : $36.03 up 4.68%) showed stronger gains than XOM. Investors who have XOM in their portfolio, or those contemplating investing as XOM touches unprecedented lows might reflect on where the XOM share price and indeed the company is headed. Here I make some comments about how the different issues raised by oil pricing havoc, COVID-19 and finally climate change are going to impact XOM. The apocryphal statement “it never rains but it pours” is apposite for Exxon Mobil currently.
Russia, Saudi Arabia throw away the rules as COVID-19 affects demand
In some respects the current chaos in setting a price for oil, while bringing to head a number of simmering issues, is sort of business as usual. Just about every happy Exxon Mobil investor sees the company as among the best able to cope with this kind of situation. I don’t claim to be expert about the ins and outs of the current manoeuvrings, but a dramatic fall in the price of Brent Crude to the mid-thirties is very serious.
Exxon Mobil CEO Darren Woods claims that XOM’s investments are robust even below $40 per barrel of Brent Crude. The question is how XOM would fare for a sustained period with the price at $30, or even maybe $20? Darren Woods clearly has an oil price in the range $50-$70 in mind as he steers the good ship XOM.
Vladimir Zernov presents a fascinating case as to why Russia declined to cut production and he shows how the US is a target. He considers the politics and suggests that Russia won’t be surprised about the strong pushback by Saudi Arabia, which is effectively opening the floodgates on an already oversupplied oil market. This has lots of intrigue as big players clash. I’ve mused for some time what Saudi Arabia has to lose if it does what it has just done. Its cost of production is very low and I think it knows that the climate emergency means that oil exploitation has to stop soon (see below). So why not sell as much of its reserves as it can before it has to stop?
Of course stabilising oil pricing is well within the ability of humans to fix, but whether there are enough cool heads around to make that happen quickly is a big question. If Vladimir’s arguments hold, don’t expect a quick resolution, especially when national pride is in the mix.
Where is the COVID-19 pandemic heading?
My core training is in biology/biotechnology, so I have some sense of what a pandemic means. While it is laudable that people are cautious about where this is headed, anyone who thinks that this can be limited to Q1 2020, doesn’t understand what is likely to happen when a highly infectious virus enters the human population which has no immunity to it. The good news is that it seems to be dangerous to just a limited group of people, mostly the elderly who have health problems. However the whole population is susceptible, so the elderly everywhere are at risk. Even if the overall fatality rate is just 1%, tens of millions of people worldwide could have a life threatening illness. This will mean that even the most advanced health systems will be challenged. And so already we are seeing extraordinary efforts to contain infections (Italy quarantined, school closures etc). All of these things threaten the global economy and of course the resulting effects on manufacturing supply chains are going to be very serious.
So the outcomes of COVID-19 are much more uncertain than the oil pricing shenanigans, because we don’t know how fast this will progress, nor the overall extent of the pandemic, nor what will happen if/when health systems get overrun. Health authorities are pretty clear that there is a pandemic and that it is to a large extent unstoppable.
Of course XOM is not alone in being impacted by COVID-19.
Is reducing CO2 emissions merely a beauty competition that won’t impact on climate change?
The difficulties that XOM has concerning action on climate change are very much of XOM’s making. The point about the climate is that the oil and gas industry needs to be wound down by 2050 and emissions reduced ~50% by 2030, although you won’t hear Darren Woods acknowledging this.
The premise that drives the CEOs of two US oil and gas majors, XOM and Chevron (NYSE:CVX), is that they are the best in the industry at discovering and exploiting oil and gas reserves and that oil and gas is going to expand for a long time (at least through 2040), so it is pointless seeking to change their business models to acquire skills in low carbon energy generation that others are perfecting. This includes BP and Shell who acknowledge that the world is changing and that emissions need to be reduced urgently.
CEO Darren Woods relies on the Paris Agreement to be comfortable that oil and gas consumption will keep expanding, while not acknowledging that the Paris Agreement target is not 2C warming, which is widely seen by the scientists as dangerous, but 1.5C warming, which is a much tougher goal to achieve and will require dramatic reductions in emissions (eg 7.6% annually until 2030). This is a very tough target which not only can’t countenance increased emissions, but instead needs emissions reductions by ~50% by 2030.
CEO Darren Woods uses the lame excuse that if XOM cuts output, others will take up the slack… His assumption is that there is no alternative to oil and gas, at a time when there clearly is. Continually stating that solar PV and wind can’t cope doesn’t make that statement true. It just reflects an unwillingness to acknowledge what is happening in the world currently.
Factors that are putting pressure on oil and gas
As renewables combined with energy storage (batteries, pumped hydro) start to outcompete coal and gas for power generation, it is inevitable that other sources of emissions will get targeted. This is becoming an issue in the UK, where coal has almost been removed from the electricity generation system (coal now just 2%, with 54% of electricity generation from low carbon sources of which 37% came from renewables, with wind contributing 20%).
The Table below shows that in the past decade coal has accounted for 80% of the CO2 emissions reductions achieved in the UK, with minor (6%) reduced emissions from oil and 20% reduction from gas. These emissions reductions mean that the UK has achieved 29% CO2 emissions reductions in the past decade. The challenge now is that to achieve Paris targets the UK needs a further 31% decrease in CO2 emissions by 2030, which is a similar amount to that achieved over the past decade. The problem is that current Government projections suggest that emissions reductions will slow so that only 10% CO2 emissions reductions will be achieved in the next decade.
Source : CarbonBrief
So there is an increasing focus on other fossil fuel reductions. The next areas for emissions reductions are transport (largely oil-based) and heating (a lot of gas). Obvious programs to address these issues are electrification of transport with Battery Electric Vehicles and energy efficiency and heat pumps for heating and cooling using electricity and reduced consumption. The emergence of low carbon competition for an oil and gas producer’s products represents a fourth emerging crisis for XOM.
The dividend is safe because XOM has access to cheap debt
If XOM had not been paying the dividend based on asset sales and debt for a decade, the above flippant comment might satisfy investors that there is nothing to worry about. The reality is that from 2010 through Q3 2019 XOM's free cash flow has been $137.8 billion, while dividends and buybacks have cost $202.3 billion. This leaves a $64.5 billion deficit. At some stage this is going to have to stop.
There are the first signs of facing reality as XOM plans to reduce its Permian expansion slightly this year. Watch this space, as the three disasters converging will force change amongst even the oil and gas majors.
The dividend issue is perhaps the most challenging for many investors and this is well articulated by the recent heartfelt article by Seeking Alpha superstar Regarded Solutions. In his article he makes the point that management has made a public promise to continue the dividend and that debt is so cheap that it makes sense to borrow to fund the dividend. Regarded Solutions also puts a big emphasis on long-term investing. It is not clear to me that he is aware of the existential threat that the oil and gas industry is facing as urgent action on climate change begins to bite.
A lot of retirees are likely to get hurt if they buy XOM now.
A lot is going on in the oil and gas industry in general and XOM in particular, with battles about production and resulting slide in oil prices, a looming pandemic emergency and finally the ever present climate emergency, which requires dramatic emissions reductions. It takes a certain kind of Chutzpah to deliberately taunt your competition with questionable arguments about the climate emergency. This is curious because XOM is a member of the Oil and Gas Climate Initiative which has a goal of zero emissions in the second half of this century. I’ve been arguing for some time that XOM doesn’t accept the need for urgent action on climate change and now we have clear rejection from the CEO. Since the share price of XOM has fallen so dramatically, my take is that, in addition to fears about COVID-19 and OPEC oil pricing, investors are cautious about XOM’s business model. As I’ve said previously, historically low share prices do not necessarily mean a “buy” signal. When I wrote Seeking Alpha article Exxon Mobil 10-year Low Is Not An Investment Signal on January 31 2020 the XOM share price was $64.11. Less than 2 months later, the share price is now $43.41. Think about this as you review your XOM investment.
Author's note: I am not a financial advisor but I do follow closely the dramatic changes happening as the world begins to exit use of fossil fuels for energy and transport. If my commentary on Exxon Mobil helps influence the investment decisions of you and your financial advisor, please consider following me.
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