- While Exxon is not facing environmentalist pressures as severe as its European peers, such as Shell, it is not immune to it either, due to recent elections to its board.
- Shell and others have a secondary reason for being more responsive to environmentalist pressures, namely dwindling upstream reserves, which are less of an issue for Exxon.
- Exxon's response to environmentalist pressures is of a dual nature. One is addressing emissions from existing projects, second is to put a pause on new projects.
- If Exxon can resist the pressure to shelve new projects and mostly focus on reducing emissions from existing projects, it can outperform most of its Western oil major peers this decade.
Investment thesis: European oil majors tend to be the main subjects of debate when we discuss the effect that the green lobby may have on Western oil majors. The likes of Exxon (NYSE:XOM) are often perceived as being safe havens, almost immune to what has arguably become an effort to kill the Western oil industry before global oil & gas demand declines. Exxon is in fact far from safe in this regard. It may not be faced with imminent court action like Shell (RDS.A) (RDS.B) found itself facing in the Netherlands. It is however facing internal pressures as well as external pressures via very strong lobby organizations, that are in large part finding a great deal of media support. Exxon is responding to those pressures and it is set to potentially greatly affect its upstream sector, while demands to cut emissions from its operations may overburden its downstream sector profitability this decade. At the same time, unlike some of the European oil majors, it may lack the government support that EU operations of European oil majors are getting for their green investments. Exxon may in fact find itself getting the worst of both worlds. On the other hand, it could resist environmentalist pressures to some extent, in order to prevent the worst of the possible outcomes from coming to fruition. Its comparatively superior upstream reserves situation has the potential to make it one of the few Western oil majors who can win the decade if it also navigates through the environmentalist pressures prudently until we achieve a return to some basic common sense.
Exxon is going into this decade of transformation with ample oil & gas reserves in its portfolio.
Shell may have a secondary reason for embracing the green transformation agenda, namely the sorry state of its oil & gas reserves. It struggled in the past decades to maintain its reserve life ratio. Recent global oil & gas discovery data suggests that things are looking even more bleak going forward. Fewer discoveries mean that there is less oil & gas replacement through discoveries throughout the industry, and there is also less to go around in terms of acquisition opportunities. One of the factors that have been responsible for Shell's reserve decline is the fact that it shunned reserves with low profitability prospects.
Exxon does have ample reserves of oil and gas on the books. It however contrasts with Shell in that it did not shy away from booking some reserves with more questionable economic potential, like its US upstream assets. Oil majors have been finding it much harder to squeeze profits out of their US upstream operations than they do from their international projects. For instance, Exxon's third quarter results show upstream earnings of $869 million in the US, while internationally it achieved net earnings of $3.1 billion in its upstream sector. In other words, 22% of its upstream profits came from the US. Compared with capital spending, where 34% of upstream capital costs are incurred in the US, it is clear that returns on spending are much lower in the US compared with its worldwide upstream activities.
Exxon's upstream production seems to be solidly stable, underpinned by a solid reserve base.
Data source: Statista.
While reserve volumes can fluctuate wildly together with the volatile price of oil & gas, Exxon clearly has a stable reserve situation as long as the price of oil remains over $60/barrel. In terms of reserve life, it does not help to look at 2020 reserve data, given the unusually low price of oil. Looking at a more normal year, like 2018, versus recent average production in the 3.7 mb/d equivalent range, we can estimate Exxon's reserves to last it for 18 years at current rates of production. By comparison, Shell's reserve life is currently estimated to be down to only about 8 years.
So clearly Exxon is faced with a very different set of circumstances compared with Shell when it comes to its green strategy. Shell might as well embrace a non-hydrocarbon future since it has barely any reserves left anyway. Exxon can continue to produce oil and gas at levels similar to this year for a prolonged period if it so chooses.
Investor activism is pushing Exxon hard from within.
Recent comments coming from Christopher Ailman, CIO of The California State Teacher's Retirement System, that voice a point of view that compares Exxon's need to adapt to the green transition, or face a similar fate to Kodak are emblematic of the extreme and in my view highly mistaken viewpoints that are gaining traction within the investment community. It is extreme and mistaken because it fails to take into account the fact that global demand for oil & gas continues to expand, while such activism is pushing Western oil majors in particular to abandon their global leadership in projects that can supply that growing global appetite for these hydrocarbons.
These comments are important because Christopher Ailman has been instrumental in packing Exxon's board with members that sympathize with an accelerated transition of the company away from hydrocarbons production. Ironically, he was quoted as being unsatisfied with Exxon's response to these pressures thus far, even as Exxon is in fact taking action meant to make it less reliant on fossil fuels and more green, with new projects meant to push Exxon into the renewable energy space. Exxon was reported to be debating the scrapping of major upstream & LNG projects. Exxon is also reportedly seeking to reach net-zero emissions in its Permian operations by 2030, among other things. One of the ways to get it done is to replace hydrocarbon-based power sources with renewables on its drilling sites. It remains to be seen how much of a cost increase it will incur as a result. As I already pointed out, Exxon's North American upstream is already suffering from a lack of profitability compared with its international upstream operations, when looking at the capital spending to profits ratio.
Putting aside the cost of the $15 billion in green initiatives that Exxon wants to implement in the next six years, most of which will be money spent to reduce emissions with little or no financial gain to be had on the capital investment, there is the fact that Exxon is contemplating divestments that are likely to greatly diminish its role in the hydrocarbon industry. The proposed cancelation of the $30 billion LNG project in Mozambique would be a great blow to Exxon's future prospects. LNG is set to be a very important product within the context of natural gas demand rising across the world, in response to climate change worries, which are prompting governments and companies to replace dirtier coal use with cleaner-burning natural gas. Natural gas is seen as an energy source that can be a bridge between the renewable energy economy and the current world of deep reliance on more polluting coal and oil.
Growing global reliance on natural gas does need more flexible supply chains, which can only be achieved by connecting the global supply of natural gas through LNG supplies that can help to shift resources around the world, beyond what can be done through pipeline systems. It was one of the main reasons why I stayed invested in Shell for many years. Shell controls about 20% of LNG delivery, which is reason to be bullish on Shell. Unfortunately, all the other factors, including the steady dwindling of its reserves as well as the green pressures it is faced with, more than offset the positive of its LNG prospects. Exxon has an opportunity to gain a strong foothold in the increasingly lucrative LNG industry, while still maintaining a superior position in the upstream sector compared with many of its Western oil major peers many of which are seeing their reserves dwindle. It will be a shame if the growing pressures of green lobbies will derail those prospects.
Exxon should resist the green pressures, and wait out the current environmentalist pressures.
Contrary to statements floating around, comparing oil companies, or technologies that use oil to Kodak, oil demand seems here to stay. ESG investing, and other forms of pressure being put on Western oil majors will perhaps lead to a decline in oil & gas demand. After all, if there will be less oil & gas to go around, demand destruction is set to occur. Unfortunately, it is not the healthy kind of demand destruction that many envision or hope to see. It does not involve a sudden shift from ICE-powered cars to EVs or giving up on gas-fired power plants for wind turbines. It involves industries shutting down as they find it impossible to operate under high energy input burdens like we are seeing in Europe. As I pointed out in a recent article, in the past few months, industrial establishments ranging from ceramics producers to fertilizers and metallurgy works centers are reducing their activities or outright ceasing production in Europe, mostly because of the high cost of natural gas and electricity.
At some point, there will be public as well as an elite-level backlash against the negative effects that the green lobby and activism are having on the Western World's economy. As I pointed out in regards to Europe, the net effect is not just a decline in oil & gas production supplied to the market by Western oil majors. It can undermine a broad range of industrial activities. If Exxon can successfully avoid the worst of the potential policy measures it is considering in order to appease environmentalist activism, it can become a market favorite in the longer term among its peers. It has the upstream reserves to maintain production, it also has some strategically important projects in the pipeline, such as its LNG capacity expansion plans. What it needs now is a strategy to address green concerns, without endangering a lucrative future in hydrocarbons production, transport, sale, and value-added activities. If Exxon can implement a green strategy that mostly focuses on reducing emissions from existing projects, rather than forcing the termination of projects, it can become one of the few Western oil majors that will still be standing strong beyond the middle of this decade. It can become a viable long-term investment bet.
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