- Oil supply is tight for the rest of 2022, which means uncertainty about short-term share price.
- High oil & gas prices emphasise that fossil fuel is a cyclical industry; renewables are different and that is being noticed, especially in Europe.
- XOM continues to argue that oil consumption is set to expand substantially even while renewables grow and transport gets electrified. This expansion, especially in Guyana, is now in the spotlight.
- Energy is no longer accurately defined by oil, gas and coal. This has big implications for XOM’s future.
- XOM management continues to ignore the changes that are obvious today; investors need to pay attention.
It is a surreal time. There is chaos in the fossil fuel energy markets, increasingly confronting news about climate emergencies, and yet humankind is blindly marching into disaster with little progress in decarbonizing global economies. BP’s ( BP ) just out “ Statistical Review of World Energy” makes for a confronting snapshot. While the COVID pandemic gave a glimpse of reducing emissions, since then the rise of fossil fuels has once again commenced. We seem to be in a cycle where leaders with short term horizons ignore the evidence for climate change and the fossil fuel industry just keeps pushing on. I’m beginning to think that the thing that will lead to change is the cyclical nature of the fossil fuel industry, which means times like now, when prices go silly. Exxon Mobil ( XOM ) is a company that is spearheading the push to destroy any hope of achieving the ambitions of the Paris Climate goals. This is demonstrated in a recent CNBC hour long documentary on XOM . The take home message is that XOM is going to have to change its business, but the hour long documentary made clear that Darren Woods is not on board with this view. Nevertheless XOM is hoarding cash with a goal of having $20-$30 billion cash by the end of next year. Investors need to ask why (hint, dividends cost the company $15 billion annually). Here I provide some context that might help.
Oil prices are up but what about the rest of 2022?
Art Berman has supplied interesting analysis of recent data and projections from the EIA and OPEC about current global oil supply/demand. His perspective about the actual global supply/demand equation indicates an excess of 0.5 to 0.7 million barrels/day in the second half of 2022. An extended interview with Art is worth watching. Of course this is but one view in a cacophony of opinions about oil prices. There are so many factors impacting oil prices that who knows what tomorrow will bring?
Oil doesn’t equate to energy, there are other energy sources
XOM management equates energy with oil and gas (maybe coal). XOM CEO Darren Woods thinks that this means expansion of oil & gas exploration. He barely mentions that energy is more than coal, oil and gas and that we are entering a time where the traditional cyclic energy pricing due to supply/demand mistiming will no longer be the core feature of energy pricing. The supply/demand issue for fossil fuels results from the long delays between finding an oil/gas reserve and exploiting it. The huge cost of exploration and developments means that mostly oil & gas companies are cautious of investing until they are sure that they will be able to make money from their investments.
Renewable energy is different because once you build the infrastructure (equivalent for example to building an oil rig) the ongoing energy production has minimal cost. For fossil fuels there are huge ongoing costs to harvest the oil or gas, transport it and refine it.
We are entering a different age for energy when it becomes essentially free. This is why I see energy investing becoming fundamentally different. It does mean a change in focus and a different grid structure that involves managing intermittency. This is reflected in solar and wind projects now mostly having a companion big battery or pumped hydro capacity.
If I am correct, then the demand for oil & gas is very vulnerable to falling dramatically. Is there any evidence for this? I think there is .
Oil is rapidly ceasing to be a substitute for energy
Oil is becoming an ever more expensive commodity. In the early days harvesting oil involved drilling a hole and enjoying the gusher. Today oil & gas projects often involve deep water harvesting (eg XOM’s Guyana operations ).
This has profound implications for XOM because it means a dramatic change in how energy is envisaged. I suspect that we are about to enter an age where energy will be very cheap and not subject to cyclic swings caused by the difficulty of managing supply/demand and the time taken in a fossil fuel world to balance supply/demand. Of course this view is not shared by oil & gas executives (eg Darren Woods) who dismiss renewables without even addressing the characteristics of a huge number of major renewables projects.
Oil consumption due to transport
There are several timing issues in relation to oil consumption in transport. In the US currently, light transport accounts for 45% of oil use. Hence electrification of transport is a big threat to almost half of oil consumption. The switch to BEV (Battery Electric Vehicles) is now a reality due to effectively all major car manufacturers (except Toyota, which is still heavily focused on hybrids which have an ICE (Internal Combustion Engine)) have plans to exit manufacture of the Internal Combustion Engine and switch to BEV production.
In 2019 XOM CEO Darren Woods asked what is the point of electric vehicles if they will be charged using electricity made from coal. The point is that renewables are increasingly being implemented for power generation because they are the cheapest source of power. A new renewables project means that coal and natural gas are threatened.
The climate emergency is driving the urgency of this switch, with a need to reduce global emissions by ~50% by 2030 to have a chance of safely addressing the increasing climate issues.
Note that plans to end the manufacture of ICE will impact biodiesel. XOM makes a big deal of renewable diesel projects, but these projects for heavy transport rely on continued use of the internal combustion engine, at a time when road transport is switching to electrification.
XOM management has complicated views about the BEV. On XOM’s website there is acknowledgement that the world is switching to an electrified fleet that may have as many as 400 million vehicles. This section of the website, which focuses on reduced emissions starts off with a focus on enhanced biofuels, which of course presumes transport powered by an ICE. But scroll down and there is acknowledgement that by 2040 there may be as many as 420 million electric cars in the global fleet. Yet there is a claim that there will be increased demand for energy, which seems to be equated with oil demand.
Since light vehicles consume 45% of US oil, I find it hard to see that oil consumption can continue to grow as the transport fleet becomes electrified. Something doesn’t add up.
An aside on electric vehicles
I have a different view about the electrification of transport. Tesla has driven the change in how cars (and trucks) are viewed. A car is a mobile computer with many changes resulting from that, including autonomous driving. The assumption that ICE cars will continue to be used fails to recognise how technology change works. When the iPhone was released it changed the nature of the phone and almost overnight the concept of a phone was changed from being a device for conversation to being much more. I’m pretty sure that this is going to happen with the transition from ICE to BEV. This means that oil consumption will fall in parallel with this process. I’m betting with my investments that the change is going to be fast and that it will be accelerated by the need to reduce emissions due to climate change. Governments will get involved/are now involved with speeding not only the adoption of BEVs but also decommissioning cars with an ICE.
Straws in the wind
Last year the small San Francisco Bay area city of Petaluma banned new gas stations, which some might have thought of as a Californian curiosity. Today’s news is that Los Angeles is considering banning new gas stations. As the signature US city for car transport, this grabs one’s attention. But this is not just a Californian eccentricity, with reports about curtailing new fossil fuel infrastructure elsewhere in the US and Canada. Along with these moves goes the buildout of infrastructure focusing on electrified transport.
XOM’s business model is fossil fuels forever
A surprising thing about XOM CEO Darren Wood’s position is that it is now a lonely one with the oil & gas majors now acknowledging that we are entering the beginning of the end of the fossil fuel industry. Many Seeking Alpha investors see a Europe (eg BP, Shell ( SHEL ) TotalEnergies ( TTE ))/US (eg XOM, Chevron ( CVX )) divide and focus on US companies XOM and CVX as the oil & gas companies who are in the business for the long term. It is evident from the way XOM and CVX present themselves that they intend to continue to be oil & gas providers and talk of decarbonizing focuses on doubtful “solutions” such as renewable fuels and carbon capture to manage emissions.
No doubt Darren Woods gets comfort from the IEA projections about oil & gas consumption out to 2050, but the devil is in the detail of the IEA projections. Using “business as usual” projections is not a safe position in a time of dramatic change. For a pretty complete view of a big variety of energy predictions for 2050, a lot of data is summarised in Resources for the Future’s Global Energy Outlook . An example of the kind of data presented in this report is given below.
Global electricity 2050 (Resources for the Future, Global Energy Outlook)
The above shows the global electricity mix from Global Energy Outlook which orders 2050 electricity production from highest to lowest levels of fossil fuel electricity generation. None of the studies shown on the Figure reflect the prominence of fossil fuels in 2050 imagined by Darren Woods.
Politics
I’m aware that Seeking Alpha doesn’t like to get into political discussions, but in the case of the oil & gas industry I think the time has long past when political considerations can be ignored. The reality is that governments have huge influence and in many places the fossil fuel industry largely calls the shots with government. My take is that the seriousness of the climate issues are such that governments can’t ignore them anymore. Of course almost no articles on this site even mention the looming climate crisis.
There are some straws in the wind and I think investors need to take them seriously. There is a lot of pent up change and you can see how this is starting to play out in Australia, where there has just been a change of government from a party with a fossil fuel oriented/anti-renewables stance to a new renewables-focused and emissions reduction stance. Overnight Australia’s standing in the world is shifting and climate is at the core of this change. The change in investment towards this shift from fossil fuels to renewables is already becoming apparent.
The situation in the US is pretty deadlocked with the Biden administration seeking to take urgent action on climate, while the Republican Party in the Senate and the Supreme Court have major blocking actions currently. The recent Supreme Court decision about EPA powers to regulate coal fired power plants clearly limits the Biden Administration’s powers to address emissions reductions. Whether this will change in the near term is anyone’s guess, but the January 6 US House Select Committee hearings might bring some of the issues to a head soon.
XOM is being scrutinized
Australia has just had an east coast power crisis caused by a series of coal fired power plants breaking down and the natural gas industry limiting local supply amid huge price spikes. A back story to this crisis is that Western Australia has not had surging power prices or a problem with natural gas supply. The reason for that has become public. When the big West Australian gas projects were being developed, senior executives from XOM met with the then West Australian premier with a proposal to develop the projects, but in it they demanded rights to export all of the gas. The West Australian premier said “no deal” and XOM left in a huff, to return within 24 hours agreeing to set aside 15% of production for local consumption. This is a rare example of politicians standing up to bullying by the oil & gas industry. The consequence is there for all to see in the contrasting Australian east and west coast gas situation.
In today’s world, Guyana and XOM are in the news concerning XOM’s tactics to tilt the Guyanese development in their direction. The difference between today in Guyana and the above West Australian story is that the Guyana story has been widely publicised and the World Bank has weighed in. In a nutshell the World Bank is claiming that Guyana has been shortchanged by XOM’s negotiating tactics with a relatively unsophisticated Guyanese government.
As an example, here's the thing. There have been concerns about future decommissioning costs (current estimate $17 billion) for Exxon’s Guyanese operation recently. The VP and Business Services Manager for ExxonMobil Guyana, Phillip Rietema, was recently reported as stating that all associated costs will be the Exxon consortium’s responsibility .
This sounds fine, but in the fine print it is also stated that all of the costs are recoverable as a permitted expense under the petroleum agreement with the Guyanese Government.
Here is what Exxon’s Phillip Rietema said : “ Decommissioning is permitted expenses under the petroleum agreement and it is put into the cost bank and is cost recovered over time. The funds are then used in the future for the decommissioning expenses when they come to do. The decommissioning liability is the liability of the contracting group and we are responsible for those. There is no debt or responsibility of the people of Guyana or the government ”.
The point is that Exxon recovers the costs along the way … so the Guyanese Government pays through less rewards along the way. But here is a reason for concern. While Exxon subtracts the decommissioning costs along the way, currently it has no specific fund which identifies the money being set aside for decommissioning. From Exxon: While provisions are made for decommissioning in the company’s statement of financial position, there is no specific fund set aside currently, and negotiations with government on how that will be catered for is not expected to begin for another decade.
The above is one reason for concern, but a second reason is that the decommissioning planned seems to be less than a full decommissioning. Exxon phrases this in terms of leaving the ocean in a condition that avoids harm to the environment (i.e., a focus on escaped oil and gas). Exxon plans to leave a lot of gear (risers, pipelines, umbilicals and subsea equipment) behind on the ocean floor. While engineers may not care about this approach, environmentalists are asking about whether there is any basis (eg marine studies) for saying that this isn’t a problem.
A more immediate issue is gas flaring, which has become a big deal and XOM makes much of its reduction in flaring . Leaving control of documenting emissions to XOM seems less than a perfect solution.
IEEFA explores the issues between XOM and the Guyanese Government in a recent article. While the IEEFA article mostly addresses Guyanese Government inadequacies, the point is that there are big problems because a very sophisticated group has been largely in control of the negotiations against an unsophisticated government.
The times when big oil & gas producers were fully in control are fading. Investors need to take this new situation into account when considering investment.
What the analysts say
I’m accustomed to being the contrarian amongst SA authors, but the sentiment is changing. Of 18 authors in the last 30 days there are four strong buys, six buy, four hold and now four sell recommendations on Exxon Mobil. Wall Street Analysts are much more on the fence with 15 of 27 analysts in the past 90 days giving a “hold” recommendation. There are still a lot of buy (6) and strong buy (5) recommendations and just one sell.
The above SA author sentiments may be influenced by the fall in share price by 14.4% over the past month and down almost 20% since June 8. The ephemeral nature of XOM share price is clear when one considers the one-year gain of 38.2% in comparison with the 5-year performance of being up 5.9%. The current XOM share price is almost exactly where it was 10 years ago (up 0.01%)!
Conclusion
Last month XOM CEO Darren Woods claimed that his views about the world’s insatiable appetite for oil are being confirmed and that this demand growth is going to last for at least the next 3-5 years. In recent weeks the XOM share price has retreated from a 52-week high of $105.57 to the current price of $84.81. It is too early to know whether this is the start of a longer term correction in XOM’s share price, but the issues that I raise in this article are cause for caution about the performance of XOM in both the short and longer term. A number of core issues that XOM CEO Darren Woods continues to emphasise may be less certain than he claims. Firstly, there is no clear evidence of demand beyond the levels of demand prior to the commencement of the COVID pandemic, while at least for the next six months it is possible that supply might even exceed demand. If this is the case, then the exuberance about XOM share price rise may be misplaced. In the longer term two core tenets claimed by XOM seem questionable. Firstly, it is no longer appropriate to equate energy with oil, because renewables have clearly arrived to make assessment of energy more complex. Secondly even XOM is acknowledging that electrification of transport is happening, although this is not reflected in the company’s estimate of oil consumption in the future. Investment is about the future. I suggest that investors need to be cautious about a company whose senior management is having trouble acknowledging that its industry is facing decline.
I am not a financial advisor but I do follow closely the dramatic changes happening in the energy and transport space as the world acknowledges the need to exit fossil fuel exploitation. I hope that my perspective on XOM’s prospects helps you and your financial advisor in making decisions about investment in XOM.
For further details see:
Exxon Mobil Stock: What's The Outlook For The Rest Of 2022?