Exxon Earnings Preview: Higher Commodity Prices, Better Volume Mix To Drive Growth

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Exxon Mobil (NYSE:XOM) is scheduled to announce its 2014 second quarter earnings on July 31. We expect the company to post modest earnings growth over the last year on higher commodity prices and improved liquids production, partly offset by lower overall production and thinner downstream margins. (See: Key Trends Impacting Global Refining Margins)

The average Europe Brent crude oil price was up by around 7% year-on-year during the second quarter and will positively impact the company’s crude oil revenues. On the other hand spot Henry Hub prices were up more than 15% y-o-y during the second quarter, primarily due to lower natural gas inventories compared to last year. This could be attributed to the unusually cold winter in the U.S., which forced consumers to use more heat and electricity this year. Since nearly 53% of the total natural gas produced by Exxon’s subsidiaries comes from the U.S., higher Henry Hub gas prices are expected to boost the company’s upstream earnings.

In addition to higher commodity prices, we expect Exxon’s earnings to also benefit from better production mix due to higher growth in liquids (crude oil, natural gas liquids, bitumen and synthetic oil) production during the quarter, primarily driven by the ramp up of its Kearl project in Canada and the unconventional plays in the U.S.

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During the second quarter earnings call, we will be looking for an update on Exxon’s ongoing new project development, specifically the Kearl expansion and the Hibernia Southern expansion projects in Canada, the Banyu Urip project in Indonesia and the Kashagan oil field in Kazakhstan.

Exxon is the world’s largest publicly traded international Oil and Gas Company. It generates annual sales revenue of more than $420 billion with a consolidated adjusted EBITDA margin of ~14.7% by our estimates. We currently have a $96/share price estimate for Exxon Mobil, which values it at around 11.9x our 2014 GAAP diluted EPS estimate of $8.05 for the company.

See Our Complete Analysis For Exxon Mobil

Lower Hydrocarbon Production

We expect Exxon to report a mixed set of second quarter numbers on the upstream side, as commodity prices were up during the period but the company’s production volume is expected to be lower, primarily due to the expiry of the Abu Dhabi onshore concession agreement. The company lost its 75-year rights to the emirate’s oldest producing fields this January, when the Second World War-era contract expired. These oilfields together account for around 50% of Abu Dhabi’s total oil output (almost 3 million barrels per day) and hold more than a 100 billion barrels of oil and oil equivalent. [1]

Until a new concession agreement is signed, Abu Dhabi National Oil Company (Adnoc) will be the sole-risk shareholder of the Abu Dhabi Company for Onshore Oil Operations (Adco), the current concession’s joint-venture operator. As a result, Exxon and other foreign oil companies, which were previously involved in the concession, will not be able to lift equity oil or book reserves from these oil fields. During the first quarter, Exxon’s average daily hydrocarbon production rate declined by around 1.5% y-o-y, primarily due to the expiry of the Abu Dhabi concession agreement, excluding which volumes actually increased 1.1% over last year. We expect to see a similar variance in volumes during the second quarter as well. [2]

Better Production 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 have generally become 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. Last year, liquids made up 52.7% of Exxon’s total hydrocarbon production, up from 51.5% in 2012. [3]

During the first quarter of 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 manifest itself in Exxon’s second quarter earnings as well. 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 is expected to drive better price realization per barrel and improve its unit profitability. [2]

Key Upstream Project Updates

During the second quarter earnings call, we will be looking forward to an update on Exxon’s Kearl expansion project in Canada. Located 70 kilometers north of Fort McMurray, the Kearl oil sands project holds an estimated 4.6 billion barrels of recoverable bitumen resource and is expected to remain in production for as long as 40 years. The production of mined diluted bitumen from first of the three froth treatment trains at the project began in April last year.

The initial development phase of the project is currently being ramped up and produced 66,000 barrels of bitumen per day during the first quarter, up from 47,000 barrels per day in the previous quarter. Exxon is also working on the expansion of the Kearl oil sands project, which is expected to boost its production capacity by a 100,000 barrels of gross production per day by next year. At the end of the last quarter, the project was more than 80% complete. Beyond the expansion phase, further debottlenecking of the Kearl oil sands project is expected to boost its total gross output to around 345,000 barrels per day. [2]

In addition to the Kearl oil sands project, we will also be looking for an update on 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 last earnings call that production from the project, which was ramped up to almost 80,000 barrels per day in September last year, continued 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. However, a recent report suggested that the project might not produce any oil until at least 2016. [4]

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: Kashagan To Continue To Weigh On Exxon’s Returns)

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Notes:
  1. Abu Dhabi to Run Onshore Oilfields as Foreign Tie-Ups End, bloomberg.com []
  2. First Quarter 2014 XOM Earnings Conference Call, exxonmobil.com [] [] []
  3. Exxon Mobil 10-K Filings, sec.gov []
  4. Production At Kazakhstan’s Kashagan Oil Field Halted Until 2016, wsj.com []