When oil prices get volatile, oil producers' success or failure depends in part on how they've balanced their focus between high-margin upstream projects and cash-flow-rich downstream ones. Now, with oil prices subject to unreliable swings as demand drops and Russia and OPEC cut back supply, let's take a closer look at why ExxonMobil (NYSE:XOM) might be uniquely positioned in the industry to ride out these ups and downs.
A battle of two business segments
Like most integrated energy producers, Exxon structures its businesses into upstream (getting oil and gas out of the ground), downstream (turning raw fossil fuels into finished products), and chemical (lubricants and specialty products) segments.
Upstream business segments not only provide higher margins (while commodity prices are high), but also fuel downstream business segments. Downstream business segments include processing facilities such as plastics plants and refineries. These investments provide a steady stream of cash flow which helps to soften the blow when the price of the crude oil that feeds them gets volatile.
In 2013, when the price of oil was coasting above $100 per barrel and the gettin' was good, it was not unusual to see companies take on huge sums of debt to dive headfirst into the upstream market. When oil prices plummeted in 2016, these decisions led a lot of non-integrated solely upstream companies to go bankrupt seemingly overnight.
Production costs vary in the upstream industry, but investors can generally assume that the higher the price per barrel of oil, the more profits an upstream producer can make. The same can't be said for the downstream industry. While downstream assets are also exposed to commodity price volatility, companies welcome lower input costs at the downstream level, provided that demand for their finished products stays level. Level or increased demand for the finished downstream products would allow those producers to enjoy steady pricing power. In a perfect world, refineries would want cheaper crude oil, because it basically lowers the cost of the primary inputs.
Downstream assets such as refineries, plastics plants, and LNG facilities require a decades-long investment commitment, but reliably produce similar margins throughout the life of the asset. Downstream processing facilities such as refineries deliver these reliable revenue streams and margins because they sell their customers long-term contracts on their capacity to refine oil.
Upstream companies merely have to find refineries to sell oil to with every well that's tapped -- a much quicker process. This can make the cycle of investment for these projects less than a year, meaning contracts to sell oil to refineries can come up for renewal real quick. And if contracts come up for renewal when oil prices are low -- maybe even below what it costs to get that oil out of the ground -- upstream producers may rethink renewing that contract, or just suck it up and take the hit so that production can keep going and you can make some amount of revenue. Sometimes, something is better than nothing, even if you're operating at a loss.
How diversified is ExxonMobil?
To understand how diversified ExxonMobil is between upstream and downstream businesses, it helps to understand how much of the company's revenue is attributable to upstream and downstream assets. This also helps you understand how much of the company's revenue is exposed to fluctuations in commodity prices.
In 2013, when oil was trading above $100 per barrel, , a scant 9.3% of ExxonMobil's revenue came from its upstream business. Downstream revenue made up about 81.4% of ExxonMobil's revenue for the same year. The remainder was attributable to the company's chemical segment.
In its most recent annual earnings release Exxon attributed 9.1% of total revenue to upstream operations, where revenue from downstream operations made up 80.2% of total revenue for the quarter.
These similarities in proportions of revenue suggest that Exxon's kept its asset mix between upstream and downstream somewhat level throughout that time span. Exxon either thoughtfully maintains this asset mix because it wants to keep the diversification at a target level, or it needs to produce the same general proportion of crude oil in order to keep its refineries running at the levels it wants.
How does this stack up to other major oil producers?
To figure out how Exxon's revenue split compares to what's typical in the energy industry, it helps to look into companies that similarly include downstream and upstream revenue-generating assets. BP (NYSE:BP), Shell Oil (NYSE:RDS.B) (NYSE:RDS.A), and Chevron (NYSE:CVX) each have a sizable stake in both downstream and upstream assets, but each differs from each other in the proportions of revenue those segments produce:
|Revenue Distribution||BP||SHELL (RDS.A & RDS.B)||CHEVRON (CVX)|
|% Attributable to Upstream||9.87%||2.89%||21.64%|
|% Attributable to Downstream||89.77%||85.11%||73.65%|
This table shows each company's upstream and downstream revenue as a percentage of all its revenue for 2019. (To make those proportions more accurate, we're leaving out any revenue a company gained from sales between its own business units. And if those numbers don't add up to 100%, remember that we're also overlooking each company's chemical operations.)
Of these four companies, Exxon is the second least exposed to upstream price volatility, which gives it a strong footing to outlast these depressions in commodity prices for its upstream segment.
Reviewing where a company's income stream comes should be high on an investor's list when researching an investment. For integrated oil producers, the breakdown between upstream and downstream may also give an indication of what risks the company is taking with investors' capital. And in this case, investors who value a well-diversified asset base and limited exposure to volatility in commodity prices may find Exxon just the right bet.