Oil Insight Article AMK

Second-quarter results for Exxon, which was the world's biggest company by market capitalization until Apple moved into No 1 slot, confirm a stack of trends in world energy and the global economy. Exxon Mobil is still the world’s biggest oil company by market value, even if its combined oil and gas reserves are now minuscule relative to those of a long list of both OPEC and NOPEC national oil companies. Like the other "historic oil majors" Exxon has shifted to the refining downstream, energy trading, non-energy activities - and gas production and the hunt for global natural gas resources - makes Exxon and the others highly vulnerable to the global economy's performance, and very vulnerable to falling oil prices.

Its second-quarter results show that Exxon earned a lot less than most analysts had expected. Reasons included the simple fact that global oil demand has stalled, led by stubborn shrinkage or at best "flat line demand" in the world’s largest economies. Exxon was also heavily penalized by the USA's incredibly low natural gas prices, which at around $3 per mln BTU price US gas at about $17.40 per barrel equivalent. This is a 45 percent decline on prices even 1 year ago, and 66 percent since 2006.

Exxon is above all realworld, these days. Like the other "historic oil majors" (which included Exxon, Mobil, Shell, BP, Chevron, Texaco, ARCO, Total, Gulf, ENI, and others) Exxon has downsized. Only a few figures are needed to show this: announcing the new and downsized earnings of Exxon, its CEO Rex Tillerson said his corporation plans to spend $37 billion in 2012 towards the goal of adding 1 million barrels equivalent per day of new oil production capacity by 2016. Not only the total cost of this downsized goal, but the time needed to achieve it are striking, even stunning. The keyword "equivalent" underlines that a part, probably most of this extra 1 Mbdoe of capacity by 2016 will come as natural gas liquids, even shale oil and condensed oil from natural gas production streams.

Until 2009, world oil demand growth attained about 0.8 - 1 Mbd every year, and in some years well above this: up to 2 - 2.25 Mbd extra demand in a single year but that was "another age", before 2009.

COMMODITY PRICES DONT HELP
Exxon's earnings fell short of analyst estimates for the second straight quarter, as the company's total production on an oil equivalent basis, with a fast-rising natural gas component and declining oil component struggled to achieve an average, in second quarter 2012, of 4.15 million barrels a day. This was Exxon's lowest quarterly average since 2010, when oil prices were still slowly recouping the losses made in 2008-2009. Current weak performance of Exxon, and other "historic majors", underlines a major and somber fact for global oil: below about $75 per barrel it is getting hard not only to produce more oil, but to maintain current production output.

Inside the US, what are suicidally low natural gas prices for producers un-surprisingly do not help "integrated energy companies", like Exxon which produce both gas and oil. It makes them hostage to high oil prices, depending on high oil prices to cross-subsidize their gas exploration, development and production. Otherwise, rather simply, they risk to run out of business.

Exxon's sales rose 1.5 percent to $127.4 billion. The company's initial claim that earnings based on this did not contain any special or one-time gains was quickly contradicted by the corporation itself: some $7.5 billion of earnings were due to asset sales-based gains, making up 47 percent of the per-share earnings. This came from asset sales. Asset sales and trading are now a normal part of Exxon's operations, shown by the role of asset sales in the company's apparently flourishing refining business.

Exxon's refining profit quadrupled in the second quarter to $6.65 billion, but $5.3 billion of this came from the company's one-off sale of a chunk of its Japanese refining business, to Tonen General Sekiyu.

Just as troubling for Exxon's real profitability and showing its total dependence on high oil prices, the corporation's earnings decline has almost exactly tracked oil prices. Brent crude futures, now the benchmark for over 60 percent of world oil trade, averaged $108.76 a barrel during the quarter, a 7 percent decline from a year earlier. Exxon's earnings fell by a little more than that amount.

PRAYING FOR HIGH OIL PRICES
The likelihood that Exxon CEO Tillerson will grab the microphone to say he wants and needs triple digit oil prices is of course low, but he needs them. For Exxon and any other integrated energy company producing both gas and oil the global economy and its oil demand trends are getting worse by the day. Oil demand in the U.S. and China, whose combined consumption of around 28.1 Mbd ranks at about 31 percent of world total oil demand, has now almost perfectly flat-lined for one year. The EU27 countries, in 2012, are in their sixth straight year of oil demand contraction.

Especially in the US, but this will progressively extend outside America in a predictable future hyper low gas prices are wreaking havoc on company profitability - even threatening their survival. Natural gas prices are, as shown by the company fortunes of gas-majority producers like Chesapeake and Exxon's gas subsidiary XTO, which cost Exxon nearly $40 billion to buy in 2009-2010, semi suicidal.

Gas futures in New York through the second quarter fell 46 percent compared to a year earlier, and averaged $2.35 per mln BTU. Ths was the lowest quarterly average in 13 years, since 1999. These price levels, earlier in 2012, prompted Exxon's Rex Tillerson to warn that Exxon and other US gas producers are “losing our shirts” amid a glut of North American shale gas supply. Outside the US the natural gas exists, for sure and certain and in staggeringly immense quantities - but developing and producing it is costly.

The gas glut most surely does not only affect Exxon. Royal Dutch Shell has also "gone for gas" and today produces about 55 / 45 of its total energy output as gas energy and oil energy. For the second quarter, Shell's earnings were also down, by about 13 percent at $5.7 bn, and like Exxon's earnings well below most analyst forecasts.

Consumers are already shifting away from oil to gas where they can. Gas is now the most-widely used US furnace fuel and the USA's second-largest generating source for electricity, but suicidally low gas prices make it a losing bet for energy explorers. In turn this makes oil the "only solution" for energy producers who intend to stay in integrated oil-and-gas production and the O&G downstream. To be sure: this means expensive oil, because low-priced oil will be as lethal to company fortunes as bargain basement priced natural gas.

What this means is that if a serious slump happens in world oil prices - this will bring dangerous times for the "historic majors", and others. Their corporate strategies will be an analyst's feast, predicting which one will break ranks first and sell more oil - despite falling prices.

Already today, analysts criticize Exxon's acquisition of XTO Energy, ranking Exxon the largest US gas producer, in front of Chesapeake Energy Corp. The Chesapeake story or saga is well known today, prompting analysts who in 2010 thought Exxon's buy out of XTO was a great move, to say that today almost any other major oil company except Exxon, with less exposure to US gas, is a more compelling investment and trading play, under current and likely emerging conditions.

KEEPING OIL PRICES HIGH
The oil-and-gas producers have already had to abandon all hopes of keeping natural gas prices high - which 5 years ago could attain over $12.50 per mln BTU in the USA. They have been forced to accept that natural gas prices, in the US, have already fallen about 66 percent in 5 years - making their last, best hope "triple digit" oil prices
.
On the world scene, not only the "historic majors" but also once-powerful, recently-powerful players as big as Gazprom of Russia are being forced to contemplate an ever approaching and large cut in their earnings on gas production and exports. Quite soon, Gazprom will be forced to abandon "oil indexed" gas pricing, and the results will be terrible for Gazprom.

The upsetting and transforming role of surging gas finds, production and supply has now created a context where companies as big as Exxon, BP, Shell, Total, ENI, and the gas majors are trapped in a hole where the only way out is through "triple digit" oil prices. How these players strive to keep oil prices high will be an interesting scene to observe and analyze, but under real and current oil market conditions, even $75 per barrel is cloud cuckoo and massively overpriced!