Exxon Mobil (NYSE:XOM) management has stated that they are not interested in Hess (HES). Even though that statement gives me visions of a bridge in the desert that someone wants to sell, it is actually quite possible. The main area of contention is Guyana. That is actually by far the lowest cost producing asset that Hess possesses and is likely a major reason for the Chevron (CVX) acquisition for Hess followed by the Exxon Mobil request for arbitration. Shareholders may find out in the process what some very capable industry insiders believe that Guyana is worth.
Hess and other Bakken producers have long held that the Bakken breaks even in the $40's WTI range. But Exxon Mobil appears to be able to do better than that with the projects its finds. The company therefore would have no interest in the rest of Hess.
Low-Cost Assets
Exxon Mobil touches on the low cost of recent projects compared to projects in the portfolio. This is one way to reduce the corporate breakeven cost.
Management is going out of their way to find projects that have a competitive advantage. That likely translates into a lower corporate breakeven if the company finds enough of these projects (as they clearly intend to do).
This management generally goes further than most by then (as the CEO discussed during the conference call question and answer) looking at "bottlenecks" to get still more profitability out of these projects.
For investors, this is often the difference between average management and superior management. Any project usually has the greatest profitability in the beginning. Keeping the project very profitable well into the production lifecycle takes a fair amount of detail-oriented management because very few upstream wells (for example) maintain that superior profitability for a long period of time.
The reason for upstream wells in particular is that unconventional has a fairly steam decline curve in the beginning. Meanwhile production costs are often fixed because the well cost a certain amount as did the pipeline. Therefore, those assets producer a declining amount of production (rapidly declining in the first couple of years).
Allocating the cost does help disguise the rising costs somewhat as fixed costs are often allocated based upon the reserve report. However, maintenance is often expensed, and maintenance rises as wells and the equipment ages. At a certain point, there is often no cash flow and then the well gets plugged and abandoned. But this management is focused on keeping costs as low as possible until that final production day arrives.
A previous article discussed how Exxon Mobil planned to not only increase current cost advantages in the Permian (for example). But management also wants to triple recoveries in the future to maximize the Pioneer (PXD) acquisition. It will likely take some time for that to happen, and success is not assured. But this is how some managements continually achieve above-average profitability and lower breakeven costs when compared to the competition.
Raising The Bar
One thing that Darren Woods, CEO has emphasized repeatedly is that when "the goal" has been reached early, the bar should then be raised whenever possible. As a result, what was a $9 billion cost reduction goal in earlier articles now has become a $15 billion dollar goal.
The new item with this campaign is that there is a good possibility that earnings on an "apples to apples" basis may well triple in the time period shown above. This is because every dollar saved goes "straight to the bottom line" with very minimal deductions. Since the bottom line is a small percentage of revenues, savings like that can (and evidently well) have a big impact on the bottom line.
The cost reductions mean two things to investors besides increasing profitability of the company at various pricing levels. The first thing that happens is that there is more Tier 1 acreage because of these cost reductions. That often means the reserve report keeps showing higher reserves over time despite the fact that wells eventually will deplete. Instead of running out of acreage to drill for great results, the industry overall will show more possibilities over time.
Secondly, if the whole industry decreases costs at a fast enough rate, that might encourage higher production to bring about a period of lower oil and gas pricing. Right now, the industry is not responding to higher prices because the market is demanding a return of capital while the debt market wants far better debt ratios. But the return of capital requirement could change over time if above average profitability happens for a long enough period of time. Exxon Mobil is positioning itself to show above average profitability until the industry is ready to respond to higher prices by increasing production. That could last some years.
Technology Company
Darren Woods, CEO and Chairman, mentioned that Exxon Mobil can be thought of as a technology company. This is because the company transforms molecules.
The oil and gas industry makes a lot of raw materials for the "green revolution". Some, like hydrogen, are mentioned in the slide above. This is definitely not the last stop in the green revolution. But it is the next logical step for a lot of the products made.
There is also the management announcement about venturing into the lithium business because lithium is needed for the latest generation of batteries and because Exxon Mobil has the technology from its current business to be competitive in producing and selling lithium.
There are many more chemicals that are used by "green products" that do not yet have the potential just yet like hydrogen and lithium. But are profitable markets currently.
Followup On Impairments And Maintenance
Earlier in the month, in a previous article, management took some impairment charges. But the stock really did not respond to those impairment charges as one would have expected.
The reason is now a little more obvious with the earnings report out. Even during a time of relatively weak prices compared with the previous year, the company earns at least an adequate return on the capital employed. If the return on assets is decent during times like current industry conditions, then when commodity prices inevitably rise, this company will be the equivalent of a "license to print money".
The market often prices cyclical stocks in relation to perceived average profitability. With the success of the cost reduction projects, there is a good chance that the market perceives better profitability in the future than was the case in the past. Therefore, the stock has been awarded a premium compared with the competition that is likely deserved.
Guyana
The Guyana project is the first one in the country to produce cash flow. When combined with the activities in Suriname, this area appears to have a significant effect on Exxon Mobil's future. It is one of the "cost advantaged" projects that management previously discussed.
My Hess (HES) articles have far more details on this. The project receives Brent pricing. These FPSO projects are breaking even in the $30 range and sometimes lower. As this production replaces higher cost production, this is one of the ways that Exxon Mobil will lower its corporate breakeven through the use of "cost advantaged projects".
More importantly, so far only one lease has production and cash flow. But Exxon Mobil has several lease interests in both Suriname and Guyana. By at least a few estimates, the production in this area of the world could be as high as one-third of the company's total production by the end of the decade if the current rate of growth is maintained. If more discoveries and leases cash flow, that forecast could prove conservative.
The Main Idea
The last article highlighted the announcements of impairments and routine maintenance (big routine maintenance) costs that would adversely affect the first quarter results.
But the stock did not really respond as expected to that announcement because the market looks forward to better times and commodity prices have been rising throughout the quarter.
Now, the quarterly report itself turns out to have been more than reasonable.
Probably the key idea would be that Exxon Mobil handled a perceived "industry low" with some very reasonable results. With more cost cutting planned in the future, the weaker commodity price environment should result in better corporate performance along with a long-term better stock price throughout the industry cycle.
Risks
Despite the cost cutting guidance, there could be nowhere to reasonably cut costs in the future starting "tomorrow". Sometimes these projects go too far and actually hurt the business.
Management has mentioned "advantaged products". Guyana and the value-added chemicals business would be two examples of the business that have above average profitability. But this business depends upon finding those constantly to maintain that competitive advantage. There can be no assurance that will happen in the future.
Similarly, management has plans to increase the production of the Pioneer acreage. There is no assurance that will happen although with the record of this management it is highly likely.
The dependence upon low visibility commodity prices for guidance means that the guidance is really only good for as long as the underlying assumptions last. In this industry, that can be very short-term.
The loss of key personnel is not the issue with Exxon Mobil that it is with smaller companies. But sometimes a key person makes a big difference in the company progress.
Finally
Exxon Mobil remains a strong buy as management appears to be accelerating earnings growth first by increasing company profitability and later through growth projects that should raise production growth to the upper single digits for the long-term.
Management has made both the Denbury and Pioneer acquisitions which should provide a temporary bump in that long-term forecast. Time will tell if opportunistic acquisitions become a significant part of the growth picture.
In the meantime, the company appears to be transitioning to a growth and income play. That is rare for a company of this stature to be able to do something like that long term.
Long Player believes oil and gas is a boom-bust, cyclical industry. It takes patience, and it certainly helps to have experience. He has been focusing on this industry for years. He is a retired CPA, and holds an MBA and MA. He leads the investing group . He looks for under-followed oil companies and out-of-favor midstream companies that offer compelling opportunities. The group includes an active chat room in which Oil & Gas investors discuss recent information and share ideas. Learn more.
