ExxonMobil has a lot of things going for it when it comes to competitive advantages. Its massive size gives it the benefit of economy of scale. Its vertical integration across the oil and gas industry allows it to capture the value of these energy sources from the moment they are pulled from the well until they are used in our gas tanks or to heat our homes. And it just happens to be well positioned in a market where demand is pretty inelastic. This doesn't mean that the company is completely immune from a decline in share price. There are critical elements that could send shares of ExxonMobil in the wrong direction. Some of which are within its control, and some are not.
To help you better understand what an investment in ExxonMobil's shares could mean in the future, let's explore three things that could lead to a serious long-term decline in share value for ExxonMobil.
1. Rising production and development costs could eat into cash flow and earnings
Take a look at this image. This is pulled from one of ExxonMobil's investor presentations, highlighting where it expects to see profitable production growth over the next several years.
While there are loads and loads of different prospects in this graphic, there is one missing that the company has been working on for more than a decade: the Kashagan project in Kazakhstan. Perhaps it was simply a clerical error, but there could be another, more troubling reason for investors: It's something the company wants to forget about.
This project -- a joint venture between ExxonMobil, Royal Dutch Shell, Eni, Total, and the Kazakh national oil company -- has been close to an unmitigated disaster. Ever since the consortium was established, the project has gone $30 billion over budget thus far and has not yet become fully operational despite the original estimate for production in 2005. Thanks to these inflated costs, the final bill for the project could be as high as $187 billion, and ExxonMobil estimates that it will need to be involved in production from this field well beyond 2040 to make it a worthwhile investment.
This is an example of a major issue facing ExxonMobil and other oil and gas producers today. Many new sources of oil are in hard-to-reach places or complex geological formations, both of which lead to high costs for development. As ExxonMobil pursues more and more of these challenging projects in places such as the Arctic or far off the coast of Africa and the Gulf of Mexico, these costs have the potential to take away big chunks of earnings and cash flows. With more than 80% of ExxonMobil's earnings coming from oil and gas production, this is quite possibly the biggest long-term threat to ExxonMobil's future.
2. Exposure to social and geopolitical risk
If you could get ExxonMobil's management into a room for a couple questions, I'm pretty sure they would much rather have to deal with geological issues like the ones with Kashagan than with any of the social or political issues that arise from being an international oil company. With assets and operations in dozens of countries on all six of the habitable continents, ExxonMobil has to constantly deal with rising political situations that could significantly change its prospects. One great example was when Venezuela nationalized ExxonMobil's heavy oil assets in country. ExxonMobil estimates that this cost the company over $10 billion, but it was awarded only 1/10th of that in court arbitration.
Much of ExxonMobils's future today is invested in Russia. Its joint deals with Rosneft to explore the Arctic, the Black Sea, and major shale assets such as the Bazhenov shale represent a very large amount of oil and gas the company hopes to develop. The Arctic exploration project alone is expected to cost half a trillion dollars. If any of these assets were to become compromised because of geopolitical conflicts, Exxon will have a hard time replacing that potential.
3. The silent giant killer: Environmental disasters
The first company which will have a leak of oil [in the Arctic]... a drop, is a dead company. -- Christophe de Margerie, Total CEO
No matter how much we prepare and develop protocols and contingency plans, accidents happen. When they do, it can be extremely costly for oil companies and can wipe out years of returns for investors with almost no warning. If you need a reminder of this, just look at what happened to BP following the Macondo well blowout in 2010. Forget for a moment that the company has paid billions of dollars in cleanup costs or compensation to those affected or any legal fees over the past four years. Just look at what happened to the company's share price immediately following the accident.
In a matter of months, the company saw over $100 billion in market value get wiped out, and shares in BP have not seen prices equal to pre-Macondo days since.
Many places ExxonMobil plans to explore over the next several years -- the Arctic is just one example -- carry with them an elevated risk of costly cleanup and other expenses. This isn't a prediction that ExxonMobil will have a spill, but it isn't out of the realm of possibility, so investors shouldn't completely write it off.
What a Fool believes
One of the most challenging aspects of investing in a company like ExxonMobil is that it can take years to realize the benefits of owning the stock because you are betting on the long-term future of company and letting dividend payments compound over time. Unfortunately, things like spills and geopolitical events can send shares plummeting in a very short period without much warning. The one thing you can monitor as an investor here is development and production costs. If ExxonMobil's costs start to trend significantly higher than its peers, then shares may not perform as well as others, and it may be worth rethinking your investment thesis on the company.