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Why Do Investors Put Up With Oil and Gas Madness?

Sara Murphy
February 2, 2014

Royal Dutch Shell (NYSE: RDS-A) just announced that it had a terrible 2013, but management wants to assure you that this year will be better. ExxonMobil (NYSE: XOM) and Chevron (NYSE: CVX) had disappointing results, too, but they are full of confidence in their strategies for the future. Why on earth do investors believe that the same factors that were responsible for past failures will suddenly drive success going forward?

High capex costs, tight margins, bad Juju
The fundamental problem here is that oil and gas firms are spending more and more to get their hands on the same commodity. The times when you could scoop oil up with a pail are behind us. Now you have to jump through all kinds of crazy hoops to get at diminishing hydrocarbon reserves. Arctic drilling and oil sands exploration don't just anger environmentalists: they're horrendously expensive, and so far, they're not paying off at all.

The payoff may never come. After dropping all that dough on these projects, Shell, ExxonMobil, and Chevron may never be able to burn a fair amount of what they extract. The mainstream is increasingly becoming aware of the potential for a carbon bubble, which could strand hydrocarbon assets.

Just look at how things went at the recent World Economic Forum in Davos. The CEOs of major blue-chip companies were practically begging for climate change regulation. If regulators pursue some of the widely proposed measures -- such as putting a price on carbon -- the breakeven point on any extraction project changes dramatically. Then it becomes all about the cost curve, and the most expensive exploration projects will be the first to fall to the inexorable power of economics.

A little credit
But first, let's give credit where it's due. Shell announced that it was backing away from its absurd plans to return to Alaska's Chukchi Sea to revive its Arctic drilling activities. That's good, because watching Shell try to get back to the Chukchi was like watching a train wreck in slow motion. It was a comedy of errors, and cutting its losses was the only possible call for Shell to make.

Ben Van Beuren, Shell's new CEO, said the company planned in 2014 to focus more on profitability, rather than on increasing oil and gas output. That's welcome news, especially since Shell had a reserve replacement ratio of 131% in 2013, which means the company has a strong asset base to support it. Van Beuren said that Shell would work to enhance capital efficiency in 2014, with "hard choices on new projects, reduced growth investment, and more asset sales."

Define insanity
That's where the good news ends. While Shell is at least facing its maker a little bit, Chevron and ExxonMobil blithely shrugged off their 2013 income losses, chalking it up to the usual commodity-price volatility. ExxonMobil released a statement saying that the company had "strong business results in 2013" characterized by "disciplined use of capital, project execution, and asset management."

Maybe ExxonMobil thinks that its late-2013 output rebound justifies such claims. The problem is that much of that uptick comes from a Canadian oil sands project, the cost of which ballooned well past budget, and which could come under immediate threat if carbon ever gets priced. It seems a fragile basket into which to put one's eggs.

Meanwhile, Chevron is spending like a drunken sailor. Last year, Chevron pumped a stunning $42 billion into oil and gas projects and intends to up that by an additional $40 billion in 2014. This cash gusher was enough to freak out SEC regulators, who have demanded that Chevron explain why it thinks costs won't balloon even further, and why the company thinks its liquidity won't be compromised. Chevron says it'll get back to the SEC.

All three companies are pushing ahead with other megaprojects that smack of desperation. Here's a little taste:

  • The Gorgon: If you're picturing some freaky, snake-headed sisters turning onlookers to stone, well, that wouldn't be far off. The Gorgon is a 15 million-ton-per-year liquefied natural gas plant on Australia's Barrow Island. Chevron owns 47%, and Shell and ExxonMobil own about a quarter each. Its cost overruns are the stuff of nightmares. The project is 75% completed, and more than 45% over budget.
  • Caspian Islands: Exxon and Shell are part of a consortium that aims to pump oil from man-made islands in the Caspian Sea. The project could cost $40 billion, where it was originally budgeted for $10 billion.

The bird's-eye view
This situation is screaming for a little perspective. Let's follow the thread.

1. In 2013, Shell, ExxonMobil, and Chevron together spent more than $120 billion to soup up their oil and gas output. The Wall Street Journal points out that in today's dollars, that's what it cost us to put a man on the moon.

2. The companies have yet to see a payoff, and they may never if the carbon bubble s