- The public hates the free market when oil and gas prices are high.
- The time to solve potentially high prices is when prices hit record lows.
- Economists give us informed advice. But that is not the same as perfect knowledge.
- We are adding refining capacity, with Exxon Mobil probably adding the most capacity.
- Exxon Mobil is one of the few that has been growing these past years.
(Note: This was in the newsletter July 9, 2022).
So many times, Exxon Mobil Corporation ( XOM ), like much of the industry, makes the front pages when people get irritated. It would appear that voters love the free market when prices are low. But something has to be better when prices climb. I do not think that anyone has ever found a better solution than the marketplace, despite all the perceived problems. I also think we have moved beyond the solutions of price controls that were implemented when I grew up.
But as irritating as the current situation is, the fact remains that the solution to high prices is high prices. The corollary to that is that the solution to low prices is low prices. Therefore, if low prices are wanted in the future, then any government intervention for that outcome was likely needed when oil prices went negative. Back then, really no one said a word about the consequences of those low oil prices (let alone a solution for what was about to follow).
Exxon Mobil and the industry are likely to survive the current public outcry because many of the leaders know that the free market provides the best solution. We as a country have a lot of history trying other methods. Even though President Harry Truman stated that he went looking for one-armed economists, so they could not state "on the other hand," economists are still our best guide to the future. But that does not make the advice perfect. It only makes it the best advice we can get.
Refining Capacity
But what is also needed is what the economists call "perfect information." The press did not qualify for anything close to that when I was in college, and I doubt that the situation changed.
In Exxon Mobil management's response to President Biden, the company has expanded refining capacity. The industry regularly cuts unprofitable capacity during times of lower demand while building modern capacity during times of increased demand. Cenovus Energy ( CVE ), for example, is bringing on the brand-new Superior Refinery online after the original burnt to the ground. That replacement project was several years in the making.
Various reports figure that the refining industry will add the capacity of at least a couple of moderately sized new refineries through modifications and additions in the current year. This fulfills the adage above that the cure for high prices is "high prices" (in this case refining margins).
The fact that the supply additions did not exactly match demand increases should surprise no one because no one knew exactly what would happen after the coronavirus demand destruction. A recovery like that had never been experienced before. It was essentially new territory, so the economists that were advising both parties were essentially hoping that they picked a conservative pathway.
Upstream Oil Production
Similarly, Exxon Mobil was farsighted enough to continue to invest during the downturn in some long-term projects that will add production. One of the things taught in business school is that the lowest cost time to increase production is during a downturn. This company has the breakeven points to actually take a risk that a recovery will follow that downturn.
The pressure comes from shareholders (as shown by all the articles here and elsewhere) telling management to not add debt during a cyclical downturn. Many managements give-in to that pressure. This management did not. Some of the results of management actions follow:
Exxon Mobil Permian Basin Development Plans (Exxon Mobil Investor Day Presentation 2022.)
Exxon Mobil is one of the few companies planning to increase production in the Permian since the start of the fiscal year. Now, since they also grew production in a dismal year like fiscal year 2020 in the Permian, they are growing production. This is different from much of the industry that is merely recovering lost production because oil prices were too low to justify drilling.
As management noted, in fiscal year 2020, they also lost money and borrowed money even with a lot of investors loudly opposing such a plan. Yet, the investments made in that fiscal year were done with costs that have created a competitive advantage for those projects that will last for years because the costs were so low.
International Projects
Similarly, the company has also been growing production internationally.
Exxon Mobil Guyana Project Overview (Exxon Mobil Investor Day Presentation 2022)
We as consumers are told that there is a large shortage because demand is several million barrels higher that supply. Yet here is a company with a solution that is likely to add millions of barrels over time.
It makes zero sense to limit profits through a "windfall profits tax" when a fair amount of that money is going to head to a project like this that will help to put an end to high prices. Followers of the company know that management has been adding drill ships as cash flow has increased.
Similarly, Exxon Mobil acquired InterOil with the supposed intention of taking Papua New Guinea from essentially zero upstream production to a top 5 natural gas exporter. This company is actually doing quite a bit to put an end to high energy prices. That is how the free market should work, and frankly, it is working.
Conclusion
Back in 2018, there was the tweetstorm that caused a lot of people in the industry to wonder if anyone wanted the industry to earn profits. No one complained about all the industry losses in the 2015 to 2020 time period.
We have plenty of examples that other forms of economic administration just do not work. That includes our own experimentation with pricing controls.
Yet there is always a seemingly large part of the voting electorate that does not want free markets at a time like the current. The only President I can remember that opened up new areas to exploration during a time of high prices was President Bush in the 2000s. The current administration is cautiously considering such an action. Obviously, it faces political headwinds doing so.
But the current difference between twenty years ago and now is that much of the unconventional reserves (most estimates are well past 90%) are on private land, and they are many times the size of previous conventional opportunities. Now the industry can expand production no matter what the government does.
What needs to change in general is a deeper understanding of the free market and all its messy steps. Large projects, like the one in Guyana take years. Refining capacity will decline in the next cyclical downturn, and it will head up in the next recovery.
Most importantly, the market stopped waiting for that "pot of gold at the end of the rainbow" and began demanding responsible capital allocation with a decent return to shareholders. The bond market soon followed with more stringent lending guidelines than has been the case in the past.
So, we will get to where we need to be. But it will be with unsynchronized steps between demand and supply that will continue to try the patience of voters. In the meantime, Exxon Mobil is poised to profitably deliver the oil investors need during a period of countercyclical growth that few in the industry had the nerve to execute. That is going to prove to be a boon to the dividend in the future as well as an uncharacteristic period of growth for the current decade. That implies a lot of very good news for shareholders.
For further details see:
Exxon Mobil: Execution Does Not Match Press Coverage