Exxon’s Earnings Decline On Lower Volumes, Thinner Margins

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Exxon Mobil (NYSE:XOM) reported lower fourth quarter earnings on slimmer refining margins and lower production output. The company’s 2013 full-year earnings per share (EPS) of $7.37 declined by 24% y-o-y. However, EPS adjusted for gains realized by the company from divestments in 2012 declined by around 6% y-o-y. Exxon also announced that the liquefied natural gas (LNG) project in Papua New Guinea (PNG) is on-track for its first shipment by the end of the third quarter of 2014. [1]

We currently have a $96 price estimate for Exxon Mobil, which will soon be updated based on the recent earnings announcement.

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Thinner Downstream Margins

Almost 80% of the year-on-year decline in Exxon’s 2013 full-year operating earnings (earnings adjusted for divestment gains in 2012) can be attributed to thinner downstream margins. This has been more of an industry-wide trend during 2013 as global overcapacity amid sluggish demand and higher crude oil prices squeezed operating margins for refiners. There have been certain bright spots as well, such as refineries in the Midwest U.S. that have gained from lower crude oil prices due to the fast-growing supply from unconventional plays in the U.S. and a lack of midstream infrastructure. However, the sharp decline in international crack spreads more than offset this advantage for Exxon. [2]

Going forward, we expect the global refining margins to continue to remain under pressure due to industry overcapacity, which stems from the fact that governments in different parts of the world are willing to run uncompetitive crude refineries at very low or no returns to sustain employment and reduce their reliance on imported fuels. [3]

Exxon Mobil has been investing heavily in ramping up its capacity for ULSD or ultra-low sulfur diesel (a diesel fuel with sulfur content as low as 10 parts per million), which is a high value product with better margins. Demand for ULSD is expected to rise sharply in the coming years as countries all over the world try to reduce particulate emissions from diesel engines. As of 2006, almost all of the petroleum-based diesel fuel available in the U.K., Europe and North America is of ULSD type.

Exxon recently commissioned a new hydrotreater unit at its Singapore refinery, which increased its ULSD capacity by 57,000 barrels per day. The company has so far invested almost $3 billion in upgrading several refineries around the world for higher ULSD production. This is expected to slightly offset the impact of global overcapacity on its operating margins. [4]

Lower Production, But Improving Mix

Exxon’s 2013 full-year upstream earnings declined by over $3 billion or ~10% y-o-y on lower production volume. However, most of the decline in production came from natural gas, as the production of liquids (crude oil, natural gas liquids, bitumen and synthetic oil) actually grew by ~1% y-o-y. In the U.S., where natural gas prices are heavily depressed compared to international markets due to a glut of supply, the company’s natural gas production fell the most (down more than 7% y-o-y).

This was more or less in line with what the company had guided for during the analyst meeting last year. Although liquids production did not grow as fast as anticipated due to slower than expected ramp up of the Kearl project in Canada and the ongoing production halt at Kashagan, the company’s volume-mix clearly improved in 2013. Liquids contributed 52.75% to Exxon’s total production volume last year, compared with 51.25% in 2012.

Higher liquids production boosts operating margins for oil companies as they earn more revenues per barrel of oil equivalent (BOE) on selling liquids rather than natural gas. Exxon’s consolidated subsidiaries sold liquids at an average price of over $100 per barrel in 2012, while the company realized average price of just over $23 per BOE of natural gas. [5] We therefore expect better volume mix to boost Exxon’s upstream operating margins going forward.

Major Project Updates

During the 2013 fourth quarter earnings call, Exxon officials announced that the PNG LNG is on track to deliver its first LNG cargo in the third quarter of 2014. The company holds a 33% operating stake in the $19 billion project. Scalability, lower costs and proximity to Asian markets that are expected to drive most of the growth in global energy demand over the coming years are some of the key aspects of this project. The project is also crucial to Exxon Mobil’s plans of boosting the proportion of liquids and liquids-linked products in its portfolio. (See: Exxon’s Papua New Guinea LNG Project Is On Track For Its First Delivery)

On the other hand, delays continue to overshadow the giant Kashagan project, which is also expected to play a crucial role in Exxon’s future production ramp-up plans. The company officials announced during the earnings call that production from the project, which was ramped up to ~80,000 barrels per day in September 2013, continues to remain shut due to leakage in a gas pipeline connecting one of the drilling islands to the onshore processing facility. The officials declined to provide a timeline for the restart of production from Kashagan, as the operator is currently investigating the issue. [6]

The mega oil project located in Kazakhstan’s zone of the Caspian Sea has already been plagued by significant delays and cost overruns due to several technical issues. This has also delayed returns from the project, thereby increasing the amount of time that participating oil companies such as Exxon Mobil will have to wait in order to generate a desired rate of return upon their investments. (See: Exxon Readies First Shipment From Huge Kazakhstan Oil Field After Costly Delays)

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Notes:
  1. Exxon Mobil Corporation 4Q13 Press Release, exxonmobil.com []
  2. Crude-by-rail profits fall as WTI-Brent narrows, financialpost.com []
  3. Global overcapacity to squeeze oil refining margins: Campbell, reuters.com []
  4. ExxonMobil’s New Singapore Hydrotreater Begins Operation, exxonmobil.com []
  5. Exxon SEC Filings, sec.gov []
  6. Exxon Mobil Corporation 4Q13 Earnings Presentation, exxonmobil.com []