Hydrocarbon production is getting increasingly difficult and expensive. This is a key trend underlying the performance of all major oil and gas companies, and Exxon Mobil (NYSE:XOM) is not an exception. The company’s net rate of production has remained essentially flat since 2005, while its average production cost per barrel of oil equivalent (BOE) has almost tripled over the same period. The only way left for the company to push its upstream earnings higher is through better price realizations, which depends on global commodity prices that are not under its control. Therefore, Exxon plans to grow its average price realization by improving its sales volume-mix, or selling more liquids than gas. Here, we take a closer look at how the company plans to go around this. 
We have revised our price estimate for Exxon Mobil to $96/share, which values it at around 11.9x our 2014 GAAP diluted EPS estimate of $8.05 for the company.
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Flat Upstream Production
Exxon’s upstream production has been relatively flat over the past decade. It declined slightly from over 4.21 million barrels of oil equivalent per day (MMBOED) in 2004 to 4.17 MMBOED in 2013. This has also been a case with most of the other large integrated oil and gas players, as they have been unable to add enough new production to more than offset natural field declines. This could partly be attributed to the shear size of these firms, which is making and developing large lucrative hydrocarbon reserves, more and more difficult. Just to give some perspective, global liquids production has grown just by around 4 million barrels per day or 5% since 2005, and most of this growth (~50%) has come from unconventional sources in North America, predominantly U.S. shale oil, where large oil companies such as Exxon have not done so well. 
However, Exxon plans to ramp up its net hydrocarbon production to around 4.5 MMBOED over the next 3-4 years. The company is banking on a number of new project start-ups to achieve this target. As many as ten of these projects are scheduled to start-up this year itself, including the liquefied natural gas (LNG) project in Papua New Guinea, which started producing recently, first oil from the Arkutun-Dagi field offshore Russia’s Sakhalin island and the Cold Lake Nabiye expansion project in Canada. 
Despite this, Exxon expects its net hydrocarbon production to remain relatively flat this year, as these new project are not expected to ramp-up substantially until next year. Beyond 2014, the company expects its upstream production to grow at 2-3% CAGR till 2017. We believe that even if the company is able to achieve this target, a 7-8% cumulative sales volume growth in 3-4 years is not going to be a huge growth lever for its upstream earnings. Therefore, Exxon’s future growth largely depends on higher price realizations, which it expects to drive from better volume-mix. 
Exxon’s total hydrocarbon production can be broadly split into two categories – liquids, which include crude oil, natural gas liquids, bitumen and synthetic oil, and natural gas. Liquids made up more than 60% of Exxon’s total hydrocarbon production in 2009. However, its percentage contribution declined significantly after the company acquired XTO for $41 billion in 2010, which increased its natural gas production by 31% y-o-y that year. More importantly, most of the increase came from the U.S., where natural gas prices have been significantly depressed by international standards due to a sharp rise in production from unconventional sources. (See: Key Trends Impacting Natural Gas Prices In The U.S.)
Liquids are generally more profitable to produce than natural gas because of higher price realizations. Last year, Exxon sold liquids at an average price of around $95 per barrel, compared to just around $41 realized per barrel of oil equivalent (BOE) of natural gas. This is the reason why the company has been trying to improve the proportion of liquids in its production mix over the last couple of years. In 2013, liquids made up 52.7% of Exxon’s total hydrocarbon production, up from 51.5% in 2012. 
During the first quarter this year, Exxon’s total liquids production increased by 73,000 barrels of oil equivalent per day, or ~3.3% y-o-y, excluding the impact of Abu Dhabi onshore concession expiry. On the other hand, its natural gas production declined by 1.2 billion cubic feet per day, or more than 9% y-o-y. Although, lower weather-related demand in Europe exaggerated the decline in natural gas production during the first quarter, we expect the overall trend of improving volume-mix to continue for the rest of the year. The company expects its liquids production to grow by ~2% y-o-y and natural gas production to decline by around 3% for the full year. This would drive better price realization per barrel and improve its unit profitability. We currently expect Exxon’s adjusted upstream EBITDA margins to expand from around 54.5% in 2013 to 58% in the long run, primarily driven by better volume mix. Notes: