Exxon: Juggernaut or Dinosaur?

Like the ever-expanding universe, ExxonMobil (XOM) seems to know no bounds. Its $45 billion profit in 2008 was the biggest haul recorded by a public company in the history of the world. The runner up? Exxon, in 2007. No. 3? Exxon, in 2006.

Plunging oil prices are sure to devour some of those earnings this year. But even that presents opportunity, for Exxon, long the unchallenged exemplar of Big Oil, has an enormous stockpile of cash and shares with which to buy rivals. Indeed, it's difficult to imagine a scenario in which the company would soon be knocked from its perch. Even in the sharp recession, Exxon shares have held up, falling just 15% last year compared with a 22% decline by its rivals and 38% for the Standard & Poor's 500-stock index. "If one oil company is left standing, it will be Exxon," says Fadel Gheit, a long-time industry analyst for Oppenheimer & Co. (OPY)

Yet despite its seeming invincibility, Exxon is surprisingly vulnerable. Interviews with industry analysts, consultants, and current and former employees cast doubt on its strategy and growth prospects. Most immediately, Exxon's oil reserves and production are shrinking, and it is relying on less valuable natural gas to replenish them. Worse, it is getting much of that gas from a single country—Qatar—that could change the terms of their deal at any moment.

More broadly, Exxon seems overly wedded to a playbook drafted decades ago. The company's aversion to risk, a point of pride, has caused it to withdraw from lucrative exploration projects prematurely. And Exxon's perceived arrogance, reflected in its dismissal of alternative energy and its strained relations with foreign governments, has cost it business.

All of Big Oil faces the conundrum of size, but none more than Exxon. Its very bigness makes it hard to grow—or even sustain itself. Since the 1999 merger with Mobil, Exxon's total reserve base of oil and natural gas has barely budged, while production has fallen. Buying another oil company would add to its cash flow but wouldn't alter its inability to grow on its own.


Exxon's production numbers represent a failure. In 2001, former CEO Lee F. Raymond vowed to increase daily oil production to 5 million barrels by 2005, from 4.25 million. Instead, the tally fell. In 2006, with oil prices surging, daily production averaged 4.23 million barrels, and Exxon extended its 5 million goal to 2010. In 2007 it pumped just 4.18 million barrels. As prices soared in 2008 before crashing later in the year, production dropped to 3.92 million.

Exxon's performance raises a question once unimaginable: Has the company effectively reached the limits of its productive capabilities? Company spokesman Alan Jeffers brushes off such notions. He says Exxon never set specific production targets but rather "estimates of production capacity growth." Those estimates, he says, turned out wrong: "Plans are plans, and actual events may be different."

Not only is Exxon producing less oil but it's also having difficulty replacing the oil it pumps from the ground. In 2007 the company replenished just 76% of the approximately 1.52 billion barrels it produced that year, according to its Securities & Exchange Commission filing. The 2008 numbers, to be reported this month, seem certain to be worse. That's because the SEC considers only those reserves that are economically viable at the price of oil on the last day of the year. On Dec. 31, 2008, a barrel of crude sold for $44.60, less than half the 2007 yearend price of $95.98. The lower the price of oil, the lower the percentage of Exxon's reserves that would clear the hurdle.

This year may not be much better than last. After complaints by Exxon and other companies that the yearend measure is arbitrary, the SEC will allow the companies to start judging the commerciality of reserves at the average annual price. In 2008 it was about $100 a barrel, but according to most industry analysts the average will fall to $45 to $60 a barrel in 2009. If that proves accurate, Big Oil's reported 2009 reserves, Exxon's included, will be "grim," says Chris Ruppel, an analyst with Connecticut-based brokerage Execution. Exxon's Jeffers says the relevant reserve numbers are the ones the company calculates itself—and uses for making investment decisions.

With Exxon's capital and exploration budget up by 50% over the last five years, to about $25 billion in 2008, one might say the company is spending more and more to run in place.

By one important measure, Exxon is actually shrinking. According to analysts, since 2004 it has replaced more than 80% of the approximately 1.5 billion barrels of oil it sells each year with natural gas, which in the U.S. is worth barely half the price of oil. So when Exxon uses gas to replenish its 72-billion-barrel resource base, it erodes its own value. Oppenheimer & Co. has determined that Exxon's "proven reserves," when one takes into consideration the lower value of gas, are 17.9 million barrels, or 21% less than the amount the company reported in 2007.

There is nothing illegal or deceptive about replacing oil reserves with gas; Exxon's rivals, such as BP (BP) and Royal Dutch Shell (RDS), have done likewise to varying degrees in recent years. But Exxon has gotten most of its gas from a single country, Qatar. About 13% of Exxon's share price is attributable solely to Qatari natural gas, according to a January report by Deutsche Bank (DB). Relying on one country is risky. BP, for example, has lost enormous volumes of reserves in recent years in disputes with the Russian government and local partners. Exxon's Jeffers disputes the significance of the gas-for-oil issue. What is important, he says, is "the total value or return that a project could bring over a range of prices." Exxon's Qatari investment has such a high value because of a chain of projects starting with gas and going "through liquefaction, shipping, regasification terminals, and gas marketing," he says.


Exxon seems unperturbed by its production trends. It is one of the industry's most technologically advanced companies and earns among the highest profits per barrel. Indeed, two of the main traits at the core of Exxon's business model are a swaggering self-assurance and strict adherence to its playbook regardless of market conditions.

CEO Rex W. Tillerson, who took over in 2006, runs Exxon much the same way it has always been run. Tillerson is more polished and politically astute than his predecessor, Raymond, but the differences between the two are more stylistic than substantive.

Growing up in rural Texas, Tillerson was a second-generation Eagle Scout. (His father, Bob, even worked for the Boy Scouts of America.) While earning a degree in civil engineering from the University of Texas at Austin in 1975, Tillerson won a coveted position as percussion section leader for the Longhorn Band, for which he played bass drum. "You have 80,000 people screaming in the stadium, you count on the base drum to keep the band steady, and Rex was the guy," says Scott Harmon, who was drum major. "He was like a machine."

Quiet and intense, Tillerson was a perfect fit for Exxon. He joined the company straight out of college and rose swiftly through the ranks. During the 1990s, as a senior executive overseeing Exxon's business in the former Soviet Union region, he negotiated the acquisition of a 30% share of Sakhalin-I, a giant oil and natural gas field in Russia. Tillerson "had the kind of personality that the Russians respond to," says Eugene Lawson, at the time head of the U.S.-Russia Business Council. "He had a presence when he walked in. He looked you in the eye. He wanted to get down to business."

Today Tillerson manages Exxon from deep inside the company's Irving (Tex.) headquarters, a fortress that brings to mind the Central Intelligence Agency's command center in Virginia. Visitors must wait in their vehicles at the entrance while a tall, heavy metal gate retracts upward from the ground, then swings open. (By comparison, BP's glass-fronted headquarters sits on the bustling St. James's Square in London.)

Inside the compound, Exxon employees go through a grueling, years-long initiation. "Early on, you are taught a way to do things," says a company employee who spoke on condition of anonymity. "For anything I want to do, there is a document to give me guidance." The result is that employees "are machinelike in the way they function," says another employee. Greg Lamberson, a Tulsa-based consultant who worked with oil consortia in Chad, Cameroon, Russia, and Alaska, says the Exxon men stood out: They dressed more neatly than rivals, were more experienced in the field, and were more assertive. In a 2001 Alaska pipeline study in which Lamberson participated, BP was the manager, but the Exxon members of the group took charge. "You throw a bunch of guys together and a leader emerges, and generally that's the Exxon folks," Lamberson says.


Tillerson frequently touts Exxon's "discipline" in completing oil and gas projects on time and on budget. All the Big Oil companies claim to hew closely to their profit targets, unswayed by whether the price of oil happens to rise to $130 a barrel (making almost any deal attractive), or fall to $30 a barrel (killing the taste for a fresh prospect). But analysts say Exxon is the most ruthless, refusing in good times or bad to budge from its targets—even at the expense of growth.

Sometimes Exxon is cautious to a fault, walking away from promising projects that could help the company grow. Consider the story of Blackbeard West, a geological structure 28 miles off the coast of Louisiana in the Gulf of Mexico.

In February 2005, Exxon set out to drill the world's deepest oil well. The project was nervy, a plunge 32,000 feet—six miles—below the Gulf seabed. It was possibly dangerous because of the enormous pressure and heat at such depths, which could cause a gusher that would ruin the rig, put lives at risk, and create an ecological nightmare. Exxon and its partners proceeded because Blackbeard's geology resembled that of Gulf fields producing prolifically just 70 miles away. Data suggested the field could contain more than 1 billion barrels; if it did, Blackbeard would validate an entirely new oil frontier for Exxon and the opportunity-strapped industry as a whole. Some trade journals called it the world's most watched oil play.

After 18 months, the rig hands had reached 30,067 feet, just 2,000 feet from the target depth. And that is where Exxon halted. After spending an estimated $180 million, the company abandoned the field.

Exxon won't discuss what happened at Blackbeard, except to say the pressure rose too high. But analysts and others watching the project say Exxon became concerned when the pressure came close to the capacity of the equipment and drilling lubricants. Thomas M. Hamilton, a former Exxon executive and owner of a firm that was an original investor in Blackbeard, says he was told the pressure shook the drilling rig.

Just over a year later, drilling resumed under new management. James R. Moffett, co-chairman of the small Louisiana-based company McMoRan Exploration (MMR), said Exxon had misread the pressure equation: Because of a quirk of such deep geology, the pressure underneath Blackbeard would drop within a few more feet of drilling, and thus become less perilous. Moffett went to work on Blackbeard in March 2008. Sure enough, the pressure eased. Moffett drilled another 2,900 feet, and on Oct. 20—seven months after drilling restarted—declared that he may have found "between a half-billion and several billion barrels of oil."

"We'll see," says Exxon spokesman Kenneth Cohen. "I wish everybody well."

Even before Moffett's announcement, some analysts were disparaging Exxon. In this high-risk, high-reward industry, giant reservoirs go to those willing to gamble. "Exxon could have finished the well. They would have done fine," says oil analyst George Froley. "They just didn't have the guts."

Or perhaps the hunger. Exxon seems almost blasÉ about the future of energy. It is particularly out of step with its peers on the issue of alternative energy. Tillerson allows that a shift from fossil fuels is coming, but not for decades. Exxon forecasts that oil and gas will continue to supply 60% of the world's energy needs through 2030, and that a "game-changing" shift to alternatives will begin only after 2050.

On the other side of the debate are the other companies that comprise Big Oil, along with global carmakers, Silicon Valley, and most experts, who speak of a major transformation coming much sooner. With fewer giant oil fields around the world, project costs are rising significantly for the same volume of oil. Add to that climate change, which has created demand for cleaner energy, and you have a formula for an industry in turmoil.


Exxon's rivals are girding for what comes next. France's Total (TOT) says it's evolving into a "power company," touting expertise in building nuclear power plants. Chevron (CVX) is investing in algae. BP has plopped down $500 million to endow a biofuels-development center in California.

In contrast, Tillerson told reporters in January that Exxon isn't investing in existing alternative energy technology because "we think these technologies are old. If there is going to be a fundamental shift" away from fossil fuels, the technology "hasn't been discovered." The company is financing basic research, he said. It will spend $125 million over 10 years at the Global Climate & Energy Project, a Stanford University facility also funded by General Electric (GE), Toyota (TM), and Schlumberger (SLB).

Apart from that, Exxon is not a recognized player among the alternative-energy labs in and around Silicon Valley. Vinod Khosla, one of the world's most aggressive investors in alternative fuels, says he regularly meets representatives of Big Oil, though not Exxon, which "still lives in a different world." Jay D. Keasling, a professor at the University of California at Berkeley whose alternative-energy ideas have attracted about $1 billion in private investment, including $500 million from BP, says he has spoken to Exxon, but that "I think they are going to play a waiting game to see what the other companies do."

Exxon is also behind the times in its dealings with foreign governments. For years, Big Oil had been shut out of large parts of the world by a growing petro-nationalism among countries such as Russia, Brazil, and Venezuela. That is starting to change. BP has attempted—so far unsuccessfully—to form a global partnership with Russia's Gazprom, while Italy's Eni (E) has established friendships with national oil companies around the world. Venezuela, battered by the plunge in oil prices, has invited oil companies to increase their investment in the Orinoco Basin.

The invitation so far appears not to extend to Exxon, which is suing Venezuela. The dispute dates from 2007, when President Hugo Chávez told foreign oil companies they had to sell back a big slice of their holdings to the state. Chevron, BP, Total, and Norway's StatoilHydro (STO) went along with Chávez; later, Eni struck a separate, $10 billion investment deal in Orinoco. Exxon, along with ConocoPhillips (COP), refused, losing 40,000 to 50,000 barrels a day of production. A Venezuela deal would be a rare opportunity to get new oil onto Exxon's books. Merrill Lynch (MER) predicted in a January note to investors that the two sides would make up. Others consider that unlikely. "We worked hard to stay in Venezuela," says Exxon's Cohen. "When the terms became unreasonable, we were, in effect, expropriated."

With reserves and production flat and oil prices falling, Exxon indeed seems poised to make a major acquisition. In an October meeting with reporters in Chicago, Tillerson addressed the issue. Ever the disciplinarian, he suggested that potential sellers need to experience a bit more pain before they'll accept the kind of price he'd be willing to pay.

Sure, a major acquisition would make Exxon larger. But "bigger isn't necessarily better," says J. Robinson West, CEO of PFC Energy, a Washington consultancy. "You have to run faster and faster to stay in place." That is Exxon's big gamble: that running in place will be good enough.

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