Exxon Is Retrenching. A Top Executive Defends the Strategy. – Barron’s

Neil Chapman

Robert Seale

Exxon Mobil said late on Monday that it would write down the value of its natural gas assets by as much as $20 billion in the current quarter, among the largest impairments for any oil company in history.

Some of those assets were part of the $41 billion acquisition of XTO Energy that Exxon (ticker:XOM) made in 2010. The company is also reducing expectations for how much it will spend to grow production in the years ahead. Exxon’s stock has sunk 45% this year, and investors worry it may have to cut its dividend.

But the oil giant still sees enormous value in its portfolio and expects to be able to double its earnings by 2027 from 2017 levels.

Neil Chapman, who leads Exxon’s upstream division, overseeing the company’s oil and gas production, spoke with Barron’s about what the write-down means and how the company sees its future. The conversation has been edited for length and clarity.

Barron’s: Can you give us a little more insight into how you chose the assets that are going to be the focus for Exxon for the next several years? And then the ones that you’re planning to write down that don’t have as much value anymore?

Neil Chapman: I think you have to take one step back. There’s really two components. When we impair the assets, what we’ve done is we’ve taken them out of our development plan. First of all, Covid, like all of the majors, has impacted how much we’re spending, both on capital and operating expenses. We cut back our capital expenditures this year some 30%. And in the press release, we signaled that we were down further, to $16 billion to $19 billion next year.

What does that mean? That means we’ve pushed a lot of our development assets out, and we’re really focusing on the best of the best, high-grading our portfolio.

We have got the best set of development opportunities this corporation has had in two decades. Guyana, the U.S. Permian, Brazil, and then the two big LNG opportunities in Papua New Guinea and Mozambique. It’s the quality of those assets, which means we want to develop those first. Some of the dry gas assets [methane], we have pushed those further out in the development. In other words, they won’t attract capital as fast as the higher-quality or higher-return assets. And when it comes to a certain stage, when it’s multiple decades out into the future, we just take them out of our development plan, because it’s so far out. Taking them out of our development plan means we want to see if we can market those assets because they’re still valuable assets, they just won’t attract capital in our portfolio of opportunities.

Is this write-down an acknowledgment that the XTO acquisition was a mistake?

This is not XTO — some of the assets were in the XTO purchase, but a lot of them were not. So for instance, Colorado, Argentina, and Canada weren’t in the original acquisition. The XTO acquisition, if memory serves me right, was in 2010. A lot has happened since 2010. And a lot of what’s happened is the high quality of new assets that were brought into our portfolio.

I would tell you that if we had not gotten into XTO, we would not have the success we’re having in the Permian today. We have combined that with the scale of Exxon Mobil, the subsurface understanding of Exxon Mobil’s upstream organization, and the project development. So it’s a combination of all those things. This is about pushing dry gas assets out of our portfolio, some of which were in XTO, some of which were in other parts of the corporation.

Do you see the company’s margins rising considerably in the next couple of years? If you’re saying that these are particularly productive wells that you’re going to be focusing on — the best of the best — should investors expect a significant rise in free cash flow, particularly if people don’t want to wait until 2027 for earnings to double. And for those who are anxious about your dividend.

Let’s be clear on the doubling earnings. It’s really important to hear this: This is doubling earnings at a constant price versus 2017. What we’re really talking about is the earnings power of our businesses doubling. We don’t want to take any benefit from what may happen in the market. At constant prices and margins, we would double the earnings of the corporation, that’s what that refers to.

In terms of what actually happens in the market? I’d hate to predict what’s going to happen, because we always look at a range of scenarios. But if you go back in the history of this business, whether it’s on refining margins, or chemical margins, or the price of oil and the price of gas, it’s a commodity business. And when investment slows down or stops, then eventually the supply and demand starts to tighten. And then you see a price and margin spike. That’s what the history of this business has been. If you look at the amount of investment that’s been taken out of the business, particularly as a result of Covid, one would anticipate it will tighten up in the coming years. I absolutely cannot tell you when that will be. But I would say we look at it over a range of scenarios, our scenarios are typically in line with third-party ranges of prices and margins. Historically in this business, after prices get really, really low, sometime after it they tend to rebound. I can only imagine the same thing will happen here. I just can’t tell you when it will be.

Is your break-even price on oil going down? Can you give me a sense of whether free cash flow can be made at an oil price level under $40?

All the investments we’re making will deliver a double-digit return at less than $40 a barrel. So that includes Brazil, the Permian, and Guyana. Now, of course, it takes time to bring all of those assets online. We’re constantly upgrading our portfolio all the time, which means we’re lowering the break-even costs. But here’s what’s really important for Exxon Mobil, and it’s different versus the other integrated oil companies. We have a very large chemical company, by far the largest in this industry, we have a large refining company. And so when you look at Exxon Mobil, you can’t just look at the break-even on a barrel of oil, you’ve got to look at the refining and chemical margins, that’s critically important. And if you go back over the last decade, you will see that differentiated Exxon Mobil versus our competitors. Of course, in the current environment, with liquid transportation fuel demand being still down, refinery margins have been at record lows. And I will tell you chemicals are coming back. I think you’ve seen that.

Other large oil companies like BP and Royal Dutch Shell are transitioning to invest more in alternative energy. Why isn’t that the next move for Exxon? Why don’t you invest more in alternative energy?

There’s a long answer to this question. But I would say in simple terms, we see the demand for crude oil or gas, for refined products and petrochemicals, being there for a long time into the future. You know, all the drivers that have driven this business for many, many years are still there. And it’s not just a question of the demand for crude oil, it’s the depletion you have to replace all the time. So we believe the demand will be there, someone will need to supply it. And if you’re the best of the best at supplying it, that’s a good foundation to build your business on for the future.

When we look at renewables, we look at what value can we bring? Let’s just take the wind and solar. What value would that be to the shareholders? Do we have any competitive advantage that others don’t have? And we start from that. What we believe we can bring to the whole energy discussion is our knowledge of the energy systems. We produce our Energy Outlook every year, we produce our Energy and Carbon Summary every year, which gives our perspective on that whole energy demand. We think that’s important. We spent a lot of effort into reducing the emissions from our own footprint. We targeted to reduce our flaring by 25% by 2020. We’ve exceeded that. And 15% methane reductions. And we’ve exceeded that.

So looking after our own footprint is really, really important. We produce products which significantly reduce the emissions of society. And I think people forget that — just the fact we’ve been talking about gas, and gas replacing coal, that is a significant component of reducing the carbon footprint.

We produce chemicals. We’re the largest chemical producer. I’ll just use one simple example for you, which is an automobile. About 50% of the volume of a car today is plastics, elastomers and rubber. But it’s only 10% of the weight. Those plastics and rubbers come from Exxon Mobil. And that’s why cars run for more miles per gallon than they could historically, that’s why electric vehicles can run with a battery that has increasing mileage. We produce those products and we believe we’re contributing in those ways.

The third area where we believe we can bring capability to the whole energy discussion is around where there are technology gaps today. So for example: jet fuel, diesel to supply commercial vehicles and heavy goods vehicles — there is no battery solution to replace those products. What we’re working on is how can we replace those products. We’ve been working on biofuels — algae. If you grow algae, you take carbon out of the atmosphere. Effectively you can put algae into a refinery and produce distillate or jet fuel, and you put the carbon back into the atmosphere. We’re working on carbon capture and sequestration. I think most people realize we’ll have to, as a society, take carbon out of the atmosphere.

It’s a massive technology challenge, but it plays to the strengths of Exxon Mobil. We do things at scale. We’re spending a lot of money on technologies to improve the ways of capturing carbon from the atmosphere. And so these are technology gaps today that renewables will not solve. We’re looking for ways we can bring value both to the shareholders and to society and to the U.S. For us, wind and solar don’t fit either of those categories.

Does Exxon support a carbon tax in the U.S.?

We’ve always said that we support a carbon tax. I would say a tax-neutral carbon tax. We’re not in support of taxes, but I think to tax carbon is a very simple way of achieving the objectives the world wants to achieve. And it is easy to implement.

Obviously, everyone’s plans have changed to some degree because of Covid. But how would you answer investors who are frustrated that they haven’t received the returns they expected, who see you change your plans dramatically.

I don’t think our plans have changed dramatically. The plans that we laid out, which was an aggressive organic investment program, was built on the most-advantageous investment opportunities in the industry, and that’s in upstream, downstream, and chemicals. We laid that out in 2018. What’s happened as a result of Covid, is that endpoint will be pushed out to 2027, two years. So we’re on the same path. It’s just delayed a little bit. But Covid, as you know, it has had an unprecedented impact on the industry. And so I think the fact that we can deliver what we deliver just with a two-year delay is, frankly, quite remarkable.

Historically, Exxon has been the 800-pound gorilla in the room in energy. Does this mark a change in that? Your capital budget next year is going to be maybe half what it would have been. You’ve had operations all over the world, and now you’ll be in a few select places. How should people view the company now, with a smaller market cap? What is the role of Exxon going forward?

If you look at where we started — yes, we’re responding to the current environment, and we’re cutting back capital expenditures. But also I think in the release we talked about our midterm capital expenditures in the range of $20 billion to $25 billion. I think you’ll find that right up there with the very largest investment of any integrated oil company in the world. So it’s not changed. I don’t feel it has changed at all. I think what has changed versus the last five to 10 years is we’ve dramatically improved the quality of our investment opportunities, and significantly higher value opportunities.

Thanks, Neil.

Write to Avi Salzman at avi.salzman@barrons.com

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