Nearly every company develops a reputation. Sometimes it helps the company, and sometimes it hurts. When that reputation comes into question, though, it can fundamentally change the investment thesis on a company. Exxonmobil (XOM 0.78%) takes great pride in one element of its business, but it could potentially be at risk, Let's take a look at this prideful point Exxon claims and see what could keep it from holding this crown.
You're the Best, Around
Exxon is the largest publicly traded oil company, but that isn't anything that excites its shareholders. What it really wants people to know about it is that the company is a top-notch capital allocator. Its better than 25% return on capital employed is the best among its peers in the integrated oil and gas space, and the company goes out of its way to tell you.
Source: Exxon Investor Presentation
Thing is, in the oil and gas space, it's not as though Exxon can demand a big price premium on final products over Chevron (CVX +0.28%). Instead, it involves picking the right projects that will be able to capture value better than others and get those projects online in a timely, cost-efficient manner. A company can control a large part of that situation, but occasionally a project or two will not go as expected. In the case of Exxon, there are a couple projects recently that haven't turned out the way it had originally hoped, and it could put a bit of a dent in that industry leading figure.
"I have made a huge mistake"
Lets not kid ourselves. Exxon may be an integrated oil company with millions of barrels in refinery capacity and multiple chemical plants, but it's pretty much all about the upstream side. If we adjust Exxon's 2012's earnings for the $5.9 billion it gained from selling off its Japanese downstream operations to a subsidiary, then about 77% of the company's earnings came from exploration and production. This is where it starts to get problematic. Some of the major projects that Exxon has taken on in the past couple years are just not turning out the way they should be; most notably the Kashagan field and its dive into American shale oil and gas through the XTO Energy acquisition.
Kashagan--the megaoil project 7 years late and $24 billion over budget-- has just barely started to produce. For the project to reach its potential peak production of 1.5 million barrels per day, though, it will take at least another $100 billion from the consortium of companies working on the project. With so much capital tied up in a project that will only add 63,000 barrels per day, it will take a very long time before it generates a return on the project. Both Exxon and Royal Dutch Shell (NYSE: RDS-A) estimate that the two companies will need to be involved in the project beyond 2040 to realize a desireable rate of return on the project.
While Kashagan has not been the brightest spot in the comapny's international operations, it still looks like a shining star when compared to Exxon's returns in the US. Just look at the returns since 2009.
| Return on Capital Employed for Exxon's U.S. Upstream Operations | |||
| 2009 | 2010 | 2011 | 2012 |
| 18.2% | 12.2% | 9.3% | 6.8% |
Source: Exxon 10-Ks
The biggest reason we have seen a major slump in return is because of the $41 billion it spent on the XTO deal back in 2010. XTO was a very natural gas heavy company, and it has caused a major production shift for Exxon in the US.
| Exxon's Production mix in US Operations | 2009 | 2012 |
| OIl (thousand barrels per day) | 384 | 418 |
| Natural gas (thousand barrels oil equivalent per day) | 229 | 680 |
| % liquids production | 62.6% | 37% |
Source: Exxon's 10-Ks
With natural gas prices half of what they were back in 2009, it shouldn't come as a surprise that Exxon's returns post-XTO have dropped 63%. Luckily for Exxon natural gas prices are slowly creeping back up from the epic lows of 2012, so that plus Exxon's shift away from shale gas to focus on tight oil should boost returns here in the US.
Still, shale drilling has not created amazing returns, either. EOG Resources (EOG +1.33%) had 86% liquids production in 2012 in some of the most attractive acreages in the Eagle Ford and Bakken formation. yet the company's return on capital employed for the year was only 9.4%. It will be awfully difficult for Exxon to maintain that reputation as a top capital allocator with returns like that.
What a Fool Believes
For a company in the oil business to continually crank out a 25% ROCE, it takes some very smart business decisions, but it also takes a little bit of luck for the projects to go off without a hitch. Exxon has hit a couple bumps in the road with Kashagan and XTO, but its other projects like Kearl oil sands and the Julia field in the Gulf of Mexico should boost those returns, but with costs for megaprojects increasing around the world, it will become more and more difficult for Exxon to maintain this pace.
