Energy

Liam Denning is a Bloomberg Gadfly columnist covering energy, mining and commodities. He previously was the editor of the Wall Street Journal's "Heard on the Street" column. Before that, he wrote for the Financial Times' Lex column. He has also worked as an investment banker and consultant.

Exxon Mobil, as you might expect, does capitulation a little differently from its peers. M&A bankers should be paying attention.

There is a lot of towel-throwing going on in oil earnings season so far. In October, BP said it was basing its plans on $60 oil. On Tuesday, reporting its worst annual loss in at least three decades, it spoke of preparing for sub-$60 levels -- a good thing, too, because Brent's recent Russia-inspired rally just fizzled out and it now trades at roughly half that level.

Meanwhile, Chevron Chief Executive Officer John Watson, who has long called for oil prices to rebound, spoke last week about protecting the dividend "regardless" of what prices do this year. At the smaller end of the scale, exploration and production companies are slashing investment budgets left and right; Anadarko Petroleum said on Tuesday that it planned to cut spending this year by almost half.

Exxon is also tightening its belt, cutting its budget this year by a quarter and suspending share buybacks. Par for the course -- except there is something wrong with this picture.

As usual, Exxon took the opportunity several times on Tuesday's conference call to trumpet its efficiency and portfolio of rich opportunities, enabling it to "invest through the cycle." But cutting investment when oil prices have plunged, taking down the cost of labor and rigs with it, looks more like investing with the cycle. The same goes for buybacks: If Exxon's stock was worth spending $3 billion on last year when it averaged about $83, surely it's even more of a bargain at less than $75?

Now You Stop Buying?
Source: Bloomberg

Part of the explanation is that even mighty Exxon isn't immune to what ails the oil majors. While Exxon's return on average capital employed held up better than its peers, it still shrank by more than half between 2008 and 2014, even before the worst of the current slump in oil prices took hold. The company's U.S. upstream business has lost money for four consecutive quarters. Likewise, even though net debt to capital remains comfortable at 16.7 percent, leverage rose by more than four percentage points in 2015.

Protecting balance sheets and sweating existing assets has become the way to win investors' hearts across the energy sector. It is no coincidence that Anadarko announced aggressive spending cuts Tuesday morning and is also the only stock in the Philadelphia Oil Exploration & Production index up the same day. Exxon's prudence can be taken as a sign that oil prices aren't likely to rebound quickly.

But another factor is also likely at play here: acquisitions. Exxon's head of investor relations was asked directly on Tuesday's call about whether the company was seeing bargains yet in the battered E&P sector. His carefully worded answer essentially boiled down to: not yet.

This, too, is a bearish signal for the sector's near-term prospects. Doug Terreson, an analyst at ISI Evercore, says that S&P exploration and production stocks are now priced at about $14 a barrel of oil equivalent of reserves, which is roughly half the average of what the biggest majors have spent on finding and developing their own oil and gas over the past three years. That even this disparity hasn't caused Exxon -- or most other majors -- to pounce suggests it expects further declines in the prices of potential targets.

In this, it is probably right: Oil inventories appear set to keep building at least through the summer, and testy negotiations between E&P companies and their lenders are expected this spring, putting further pressure on stock prices. Exxon's capitulation, conserving some firepower, may well be a sign that the industry's wider capitulation is just around the corner.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Liam Denning in San Francisco at ldenning1@bloomberg.net

To contact the editor responsible for this story:
Daniel Niemi at dniemi1@bloomberg.net