Big oil needs to invest billions of dollars to maintain the cash flow and dividends its investors are accustomed to. The problem is that a significant portion of the world's reserves are controlled by state-run enterprises. There are some ways around this problem, however. The Russian government recently removed Gazprom's monopoly on Russian LNG exports. Now ExxonMobil (NYSE:XOM) and BP (NYSE:BP) are planning to create a new Asian LNG export facility.
The Russian situation
Russia is in a great place to meet Asia's energy needs with easy coastline access to major consumers. ExxonMobil and Rosneft have already awarded a contract for the initial front-end design and engineering of an LNG facility with five million metric tons per year of export capacity. The project's design is not expected to be finalized until the end of 2014, though. Seeing as BP owns 18.5% of Rosneft, the partnership is effectively an ExxonMobil-BP deal.
The bigger picture
LNG export terminals for the Asian market are not new. ExxonMobil owns 25% of Australia's Gorgon LNG project. Royal Dutch Shell (NYSE:RDS-A) owns 25%, and Chevron (NYSE:CVX) has the biggest interest at 47.3%. If investors can learn anything from Gorgon it is that massive LNG projects have the tendency to go over budget and suck up significant capex. Its original budget of $37 billion has already expanded by 41%. Even the smaller QCLNG project with an approved capacity of 7.8 million metric tons per year has seen its costs increase by 36%.
The LNG market is expected to grow 4% per year with China becoming one of the world's biggest natural gas consumers. Developing LNG export terminals is not cheap, but Shell is trying to keep a lid on costs with its floating LNG ship for use in Australia's Browse field.
What do these projects mean for investors?
The thought of billion-dollar cost overruns and multi-year construction periods does not elicit much love from short-term investors. On Wall Street, there is the tendency to focus solely on dividend increases and share buybacks. Investors willing to take a long-term perspective should be encouraged that the oil majors are putting their capital into big projects that will provide revenue for decades to come.
ExxonMobil saw its third quarter 2013 upstream volumes fall by 1.4% relative to the second quarter of 2013. The company has a very flexible balance sheet with a small total debt to equity ratio of 0.12. Instead of worrying about short-term dividend increases, investors should be worried about how the company will maintain its earnings growth until 2020. It would be easy to complain about ExxonMobil's falling share buybacks, but the firm is saving capital that it needs in order to maintain long-term cash flow.
Outside of Russia, BP's volumes have consistently fallen in 2013. The company has undergone a huge number of divestments recently, but its balance sheet still has a significant total debt to equity ratio of 0.39. Partnering with ExxonMobil on new LNG facilities through Rosneft is a good decision for BP. It will help supplement some of the income potential it lost through recent divestments.
Shell has seen its upstream volumes fall in 2013, though LNG volumes helped to stabilize earnings. On the positive side, Chevron saw its third quarter 2013 upstream volumes rise by 3,000 barrels of oil equivalent per day (mboepd) between the second and third quarters of 2013. This number is so small that it effectively means that Chevron's upstream production was flat. Shell, Chevron, and ExxonMobil will be quite happy when the Gorgon LNG project comes online in early 2015 and starts bringing in cash flow.
Chevron had upstream volumes of 2,582 mboepd in the second quarter of 2013, while Shell had comparable volumes of 3,026 mboepd. At first glance, it would be easy to compare Shell's profit margin of 4.6% against Chevron's profit margin of 10.6% and say that Chevron's management is superior. The problem is that Chevron is a smaller upstream producer, and its management has more flexibility in choosing upstream investments. Over the next decade, there is a good chance that Chevron will be forced into lower margin projects just like Shell.
The Asian LNG market is heating up. New Russian LNG facilities will help ExxonMobil and BP serve Japan, South Korea, and China with less exposure to Australia's cost inflation. Investors should be positive but cautiously remember the experience that ExxonMobil, Chevron, and Shell have with the Gorgon LNG project.