Shale Whale

Exxon Will Remake Shale Or Shale Will Remake Exxon

The major hopes to drive down costs in an infamously cash-burning business.
At Closing, April 23th
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From the moment it began, you could tell something was missing from Exxon Mobil Corp.'s first strategy presentation under its new CEO: Texan Rex Tillerson's usual jab at New York City, where the event is held.

His successor at the helm, Darren Woods, kept many other things the same. There was the usual emphasis on superior performance and the benefits of integration and a relatively humdrum Q&A session.

For all the continuity, though, Woods signaled some big shifts in where this supertanker is going.

First, although capital expenditure is set to increase this year, Exxon appears to have partly embraced the idea that big budget projections are taboo with investors these days, aiming to hold spending at around $25 billion a year through 2020. That's up from 2016's $19.3 billion -- which was very low -- but still notably below the $30 billion-plus levels of 2011 to 2014, which eroded Exxon's return on capital and dimmed its reputation for discipline.

Steady Course

Exxon's investment budget is rising but not to pre-crash levels

Source: The company

Note: Capital and exploration expenditures. Data for 2017 onward reflect company guidance, with figures for 2018 through 2020 representing the midpoint of the range.

Alongside this, Exxon spelled out a more laissez faire approach to production growth. When Tillerson gave his inaugural strategy presentation as CEO on a snowy New York morning in March 2007, Exxon was projecting its oil and gas output to be rising toward 5 million barrels of oil equivalent a day by 2011. With the aid of acquisitions, it did nudge 4.7 million a day that year. But further growth targets were missed, as Exxon's output has since fallen. And 2016 ended with the twin indignities of an asset impairment and debooking of reserves.

On Wednesday, Woods did raise Exxon's production guidance. But a range of 4 to 4.4 million barrels a day is only marginally higher than the previous one of 4 to 4.2 million, and the mid-point of 4.2 million is the same as last year's production. As if to de-emphasize the importance of growth as a target further, Woods said any production increases would be an outcome of Exxon's investment program -- the implication being it would not be a driver.

At the core of this more flexible approach is a more flexible set of resources: U.S. shale, especially the Permian position Exxon has been building, most notably via a multi-billion-dollar acquisition announced in January. Shale assets take a shorter time to develop than conventional fields. The recent crash and nascent recovery have shown drilling activity appears more responsive to movements in the oil price.

Exxon plans to devote about a third of this year's upstream budget to shale, rising to about half in the following three years. This is a very big deal. Spending this year alone will amount to $5.5 billion and will rise from there. Consider that EOG Resources Inc., one of the biggest E&P companies producing shale oil, laid out plans this week to spend up to $4.1 billion in 2017. Exxon, for long a global rover, has come home.

Hold off on the ticker-tape parade for now, though. Shale production is fundamentally different from the mega-projects for which Exxon is known; indeed, it was notable how little oxygen shale left in the room for previous mainstays of these presentations such as LNG.

In particular, shale is highly capital-intensive on an ongoing basis (whereas LNG and oil sands, for example, require huge upfront investment but minimal annual outlays thereafter). This is why E&P companies tend to outspend their cash flow from operations and are valued more on growth than returns. It was noted by one analyst at Wednesday's presentation that shale's characteristics could potentially weigh on Exxon's cherished financial metric of return on capital employed.

Exxon says its shale operations should generate cash quickly and not dilute returns. While this is unproven, Exxon can point to some advantages. Its integrated approach, encompassing production, logistics, refining and chemicals, does allow it to potentially capture more value from the same barrel than simply being a price taker at the wellhead.

It also has a well-established record of driving down costs and, notwithstanding recent success in Guyana, is known more for extracting value from discoveries than necessarily making them. In addition, even if the purchase of shale-gas pioneer XTO Energy Inc. in 2010 was poorly timed, it has given Exxon years to refine its approach to shale, while also (hopefully) learning from the successes and failures of others.

This will be important not just for its investors but also the wider industry. If Exxon can grow its shale production by 20 percent a year through 2025, as Woods suggested, and do so economically on its relatively exacting terms, then shale's impact on the global energy market could be even bigger and longer-lasting than it has been to date.

If not, though, shale will continue to muddy the waters when it comes to Exxon's plans for investing in traditional projects; Woods mused on Wednesday about shale's role in potentially dampening future oil-price cycles. It is telling that, even with ambitious targets for shale production and a $25 billion annual capex budget, there is barely any growth to speak of -- which is important to think about in the context of a large and growing dividend commitment that Exxon must bear but which smaller shale producers usually don't. The very fact that so much of Exxon's attention and spending, similar to Chevron Corp., is now targeting areas like the Permian basin sends an implicit signal that Big Oil's world is shifting beneath it.

Exxon's success, or lack of it, in applying the machinery of a major to shale may well be the defining narrative of Woods' tenure.

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

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    Liam Denning in New York at

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