Is Exxon Mobil Heading for an Inflection Point in 2014?



In the general scheme of things, you have to spend money to make money — investments generate returns in proportion to the principal, compounding interest aside. Unless the investment is faulty, this means that the more you invest, the more benefit you ultimately receive. This is particularly true in the capital-intensive oil and gas industry, where every barrel of oil requires a tremendous amount of equipment, labor, and expertise to extract. (Fun fact: In 2009, the U.S. Energy Information Administration estimated average upstream costs of $33.76 per barrel of oil equivalent.)

So when Exxon Mobil (NYSE:XOM) announces that it’s reducing capital expenditures by 6.35 percent for the current year, some red flags go up on Wall Street. Reduced spending could translate into reduced production, and reduced production could translate into reduced earnings — that’s a lose-lose scenario for the company and its shareholders. The news put some selling pressure on the stock in early trading on Friday.

But shares had recovered by the time the market finished its first cup of coffee. In a press release explaining the capex changes, Exxon Mobil Chairman and CEO Rex Tillerson assured shareholders that reduced capex would not yield reduced production. In fact, he was expecting the opposite for 2014.

“We are adding new volumes that improve our profitability mix with higher liquids and liquids linked natural gas volumes. We’re also driving increased unit profitability through better fiscal terms and reducing low-margin barrel production,” said Tillerson. All told, Exxon Mobil is starting production at a record ten facilities in 2014 and adding new capacity of approximately 300,000 net oil equivalent barrels per day.

Profitable production growth is the ideal in the energy business, and it’s not always easy to obtain. Exxon Mobil has been able to obtain a large portfolio of about 120 high-quality projects through size, savvy, and sheer spending power. The company had record capital expenditures of $42.5 billion in 2013. Moreover, it can take time to realize the benefits of invested capital, and Exxon Mobil has been fighting production declines recently. The company reported a 1.8 percent year-over-year decline in fourth-quarter oil equivalent production.

Production declines were led by declines in entitlement volumes, but even excluding this, impact production was flat. Natural gas production fell by 654 million cubic feet per day (mcfd) to 11,887 mcfd. Excluding impacts from entitlement volumes, natural gas production volume fell 3.9 percent, “as field decline was partially offset by project ramp-up and increased demand.”

Exxon Mobil reported fourth-quarter upstream earnings of $6.79 billion, down about 12.6 percent on the year. Full-year upstream earnings of $26.84 billion were down about 10.2 percent on the year. This news sparked concerns about Exxon Mobil’s trajectory over the next few years: Does the company have enough high-quality projects coming online to profitably turn production growth around?

Tillers argues that the answer is yes. “We have financial flexibility to pursue potential strategic opportunities and maintain a disciplined and selective approach to capital that ensures any new investment will contribute to robust cash flow growth,” he said in the capex report, echoing a sentiment he expressed in the fourth-quarter earnings report. Moving forward, Exxon Mobil anticipates capital expenditures of less than $37 billion per year from 2015 to 2017.

In December, analysts at Goldman Sachs upgraded Exxon Mobil stock from Neutral to Buy, arguing that oil and gas super majors –a group of industry titans that includes Chevron (NYSE:CVX), Royal Dutch Shell (NYSE:RDSA)(NYSE:RDSB), BP (NYSE:BP), and Total SA (NYSE:TOT) — are headed for an inflection point in 2014. Production volume is expected to grow organically for the first time since 2006 at Exxon Mobil thanks to a “positive inflection in Exxon’s production profile,” the analyst wrote.