The Oil and the Glory
Why we care about Exxon’s identity crisis
ExxonMobil is experiencing an identity crisis. For a century and a half — ever since John D. Rockefeller switched from the produce business to oil in Cleveland, and created the precursor to Exxon along with the entire petroleum industry as we know it — this company has been synonymous with the distinctive personality of oil. ...
ExxonMobil is experiencing an identity crisis. For a century and a half — ever since John D. Rockefeller switched from the produce business to oil in Cleveland, and created the precursor to Exxon along with the entire petroleum industry as we know it — this company has been synonymous with the distinctive personality of oil. But as we learned yesterday, Exxon is now mostly a natural gas company. Is that anything to boast about? Probably not — Daniel Day-Lewis, for instance, would likely get little traction as a natural gas man, armed with a deadly bowling pin, shouting, "I drink your milkshake." In fact, Upton Sinclair would never have written the book. Take a look yourself:
Is Exxon’s shift — its proven reserves are now 53 percent gas, and just 47 percent oil — important? It is most certainly in a financial sense to the company’s options-laden Exxon executives and their shareholders, but we’ll get to that below.
But it is also significant geopolitically, and for the average driver, because it’s emblematic of a big shakeup in power. Industry and motorists around the world are increasingly relying for their fuel not on publicly traded companies like Exxon, based solely on the profit motive, but on state-owned oil firms with a complex range of incentives and abilities. Multinationals like Exxon are becoming gigantic gas companies because they are being turned away by the petro-states of the world, which want to produce their own oil.
That matters less when we are talking about Saudi Aramco, whose objectives are pretty well aligned with the market, business and motorists — the Saudis want you to keep using good-old oil and not be incentivized to shift to an electric car, so they do what they can to more or less contain prices.
Not so much Russia’s Gazprom Neft and Rosneft, which have been vehicles of official Russian foreign policy. Even if Gazprom and Rosneft were totally market-driven, would they be able and willing to produce every barrel of oil they could in order to supply the growing market? The answer is no — Russia lost its best producer with the 2003 imprisonment of oligarch Mikhail Khodorkovsky; other middling producers include the Chinese, the Venezuelans and the Mexicans.
This shift to petro-state production of oil — underscored by Big Oil’s embrace of natural gas as a substitute — is exacerbating the tightening of the global oil supply that we are going to witness in the coming four or so years. It will drive prices up.
Returning to shareholders, Exxon isn’t the only company shifting to natural gas — all of Big Oil is doing so. But Exxon merits special attention because of its ultra-boastful personality. As it has for the previous 16 years, Exxon bragged yesterday that it managed to add more oil to its reserve base than it produced and sold. This is called "reserve replacement," and it’s a metric watched closely because it’s a signal of an oil company’s robustness. If it’s failing to refill its reserve banks, it’s considered to be cannibalizing itself – basically, eating its own seed corn.
What Exxon announced yesterday was that, in 2010, it produced and sold about 1.6 billion barrels of oil equivalent, but drilled and acquired 3.5 billion barrels, resulting in a super-impressive 209 percent reserve replacement. Yet analysts and writers are spilling much ink raining on Exxon’s parade – they say that the main part of that increase is not because of Exxon’s Daniel Day Lewis-like prowess in the oilfield, meaning finding its own oil, but through the purchase of a Daniel Day Lewis-like natural gas company called XTO last year. That delivered Exxon the natural gas equivalent of 2.8 billion barrels of oil. Hence, in terms of genuine oilman bragging rights — drilling its own oil — Exxon added only about 700,000 barrels of oil equivalent, for a 45 percent reserve replacement ratio.
I actually haven’t understood the focus on organic-versus-acquisition as a growth metric. If a company can get more value out of the assets of a company than the current management, then that’s a net plus, and Exxon is famous for doing that.
Yet the XTO deal is important. The reason is how it illustrates Exxon’s record of account massaging. Exxon seems incapable of simply stating, "We did not replace all our reserves this year, but we have a heckofalot of reserves anyway, and we convert them into cash at a more efficient and consistent rate than any of our competitors." Nope, it has to say that it’s replaced its reserves for 17 years straight when, legally speaking, it hasn’t. How many consecutive years has Exxon replaced 100 percent or more of its production? Two, and six of the last 11.
How is it that Exxon can get away with saying the number is 17? Because it doesn’t — not in the legal Securities and Exchange Commission document (the 10-K) where it matters. Instead, as it did yesterday, it issues a press release to the media and to Wall Street analysts providing its own notion of reserve replacement; then, a month later, when these parties have moved on to other subjects, it files its 10-K — the document that, if it is fiddled with, can result in a criminal offense — with the numbers broken down and dropped into various categories.
As I’ve written previously, when you get out your calculator and add up the numbers from the 10-K, you get the more realistic picture of Exxon’s performance. I documented Exxon’s reserves for the years 1999 to 2008, and found that it had exceeded 100 percent reserve replacement in four of the years, and failed to in five. That’s a record pretty much in line with the best of its competitors.
The difference comes in Exxon’s holdings of oil sands in Alberta, Canada. Until 2009, the SEC didn’t permit the 10-K to comingle oil sands (which you mine like a mineral) with conventional liquid oil that you drill from a well. So in the 10-Ks, Exxon didn’t do so. But Exxon thought that the SEC was mistaken to exclude those sands — something the company has argued in various forums for years — so in its press releases, it included the sands. From 1999 to 2008, that provided the margin for yet more winning years. The last year it did that was for 2008 reserve replacement.
Exxon treats the reserve figures with grave seriousness. To make them last year, it again relied on the oil sands, this time in line with new SEC rules. This year, it was the XTO deal.
There is more to the story though, and here is where there is a real impact on Exxon executives and shareholders. Exxon continues to be rightly regarded as the best-run big oil company in the world by far, but its asset base is gradually becoming less valuable. What ultimately gives the reserves replacement story importance is that every time Exxon – or any of the other oil companies – replaces the oil it’s produced with natural gas, the company becomes less valuable.
Here is why. For ease of apple-to-apple comparison, oil companies convert natural gas to BOEs, or "barrels of oil equivalent." Except that natural gas isn’t equivalent to oil. Today, for instance, a boe of natural gas sells for about $24 in the United States, while a barrel of real crude oil will fetch you about $85, or three and a half times the sum. You can get more if you sell your stuff in the form of liquefied natural gas to Japan — about $64 or so. But that’s still about a third more if you are selling oil to the same Japanese buyer.
So the doubt cast on Exxon’s new 2.8 billion barrels of oil equivalent is not just notional — it’s not just because Exxon didn’t drill to get them. It’s because they aren’t oil. It’s because Exxon is becoming a gas company.