Oil and gas companies blamed lower commodity prices for their poor fourth-quarter performance. WTI crude oil price averaged around $57 per barrel in 2019.
With oil prices in the low $30s, the oil majors are surely going to face heat. For instance, ExxonMobil's (XOM 0.03%) projections for the next five years assuming $60 per barrel Brent price fall flat at current oil prices. So, what does this mean for investors?
Impact on ExxonMobil's earnings
Lower oil prices will negatively affect ExxonMobil's upstream earnings, though its downstream earnings may benefit slightly from lower prices. However, the negative impact on upstream earnings may far outweigh downstream gains. In the longer term, sustained low prices will very likely force ExxonMobil to cut on its investment plans.
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However, Exxon has since realized the importance of low-cost supply. So, it has been divesting assets with higher per barrel production costs. At the same time, it is investing in assets with much lower costs of supply. The company's key growth projects, including in the Permian Basin and Guyana, are expected to generate double-digit returns at $40 per barrel Brent price. That's not so far away from where prices stand currently.
Additionally, the company plans to raise production in the Permian Basin at a rate such that it achieves around 10% returns at $35 per barrel Brent prices. That cost of supply may set ExxonMobil for sustained growth in the longer term.
Similarly, ExxonMobil's break-even rates at Guyana are far below $40 Brent. Exxon plans to develop the resource in phases, which will add incrementally to the company's production. Guyana production is expected to reach more than 750,000 barrels per day by 2025.
The low-cost production should help Exxon stay profitable when oil prices are low. Of course, Exxon's transition into a low-cost producer won't happen in a day, but the company is working on it.
Tough times ahead
While Exxon's latest investments can produce oil much cheaper, the same can't be said for its existing assets. The company may have to increase its asset sales significantly from here on. For one, it can't keep producing oil at rates no one is buying. Secondly, it will need liquidity to fund its growth projects and other requirements.
ExxonMobil's free cash flow for 2019 didn't cover its dividends, though it generated impressive cash from operating activities. The company generated $29.7 billion in cash from operating activities in 2019. It spent $26.8 billion in property, plant, and equipment additions and net investments and advances and generated $3.7 billion in proceeds from asset sales. So, ExxonMobil generated free cash flows of $6.6 billion in 2019. It paid $14.6 billion in dividends for the year.
As operating cash flows dwindle due to lower prices, Exxon will have to sell more assets, reduce spending, or ultimately cut dividends in order to maintain leverage.
Energy companies took years to adjust to around $50 per barrel of oil prices. It may take a few more years, at a minimum, for companies to reposition themselves in the changed scenario.
It will likely be a long wait -- which may chase away another chunk of investors from energy stocks, including Exxon. A likely positive for ExxonMobil is that oil in the low $30s might not last for years, helping the company in its transition.
