Is Exxon Mobil Move Towards Natural Gas by Choice or by Necessity?
Exxon Mobil (NYSE:XOM) is the largest independent oil and gas exploration and production company in the world and competes with other major oil companies like BP (NYSE:BP), Chesapeake (NYSE:CHK), Anadarko (NYSE:APC) and Chevron (NYSE:CVX). We have a near $79 price estimate for the company. In its earnings announcement, the company highlighted its replacement rate for its oil and gas reserves.
What does the replacement rate signify?
Exxon Mobil produces almost 4 million barrels of oil-equivalents (BOE) daily, more than any other single entity in the world. The production and sale of oil and natural gas contributed to more than half of Exxon Mobil’s annual revenue. The importance of maintaining a steady source of these non-renewable sources of energy for Exxon Mobil cannot be over-emphasized. Because there is only a limited quantity of recoverable carbon fuel on earth, all oil & gas giants compete with each other to gain a larger share of any available source of oil. The extensive exploration costs incurred by these companies annually is targeted at ensuring enough reserve capacity to cater to the global fuel demand.
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The industry-standard metric used to determine the efficiency of an oil & gas company in replacing its reserves is the reserve replacement ratio (RRR). The RRR is the ratio of the amount of reserves added in a year divided by the amount extracted in that year. All companies try to maintain an RRR of more than 100%, as that indicates a stable supply of oil for them in the long run.
Understanding Exxon Mobil’s RRR trend
Exxon Mobil announced that its RRR for 2010 was about 210%, due to its addition of 3.5 billion oil-equivalent barrels in the year [1]. At the end of 2010, Exxon Mobil had a reserves base of 24.8 billion oil-equivalent barrels. This represents enough supply for the company to continue to current levels of production for 15 years.
Exxon Mobil announced that its 10-year average RRR was 121%, with liquids replacement at 95% and gas at 158%. This disclosure suggests a definite reduction in its crude oil reserves over the years. The substantial increase in natural gas reserves has been responsible for the high RRR.
The reduction in replacement of liquids can be attributed to the increasing difficulty for oil & gas companies to find sources of oil. In fact, it is also speculated that Exxon Mobil acquired the natural gas company XTO Energy in 2010 only to be able to show a decent RRR. [2]
See our full analysis for Exxon Mobil.
But should this be a concern for investors?
The declining trend in Exxon Mobil’s ability to acquire new sources of oil does raise a concern for investors as natural gas prices are considerably lower than that of oil on an equivalent basis. So even if Exxon Mobil continues to provide the same output in terms of oil-equivalent barrels for the years to come, it would have lower revenues from it.
Consider the scenario where Exxon Mobil’s oil production reduces from our current estimate of 1.8 million barrels per day to 1.6 million barrels per day by 2017. Then, as 1 barrel of oil-equivalent is roughly equal to 5,800 cubic feet of natural gas, Exxon Mobil will need to produce and sell an additional 1.16 billion cubic feet of natural gas by 2017. This will result in an almost 5% reduction in our estimated value of Exxon Mobil, bring its price below $75.
Notes:- Exxon Mobil Corporation Announces 2010 Reserve Replacement, BusinessWire, Feb 15 2011 [↩]
- Exxon Struggles To Find New Oil, Wall Street Journal, Feb 16 2011 [↩]