U.S. Sanctions On Russia Weigh On Exxon’s Arctic Exploration Program

Exxon Mobil (NYSE:XOM) recently announced that it is winding down its drilling operations in the Kara Sea (a part of the Arctic Ocean north of Siberia) in order to comply with the latest U.S. sanctions on Russia. The company also noted that it has received a license from the U.S. Treasury Department allowing a slippage beyond the sanctions’ deadline to enable a safe and responsible wind down of exploration activities. Although the near-term financial impact of this particular event on Exxon would be limited, prolonged restrictions on drilling activities in the Arctic Ocean could significantly impact the company’s long-term growth potential. ^[1]

Exxon Mobil 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 $107/share price estimate for Exxon Mobil, which values it at around 13.4x our 2014 GAAP diluted EPS estimate of $7.96 for the company.

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Earlier this month, the U.S. government extended sanctions on Russia over the Ukrainian crisis. The previous round of sanctions only restricted the export of U.S. technology for Arctic and shale exploration, which did not prevent Exxon and Rosneft from starting to drill an exploratory well in the Arctic Kara Sea. However, the new measures that are specifically targeted towards crippling the cooperation between Western and Russian energy companies in Arctic and tight oil exploration require the removal of U.S. workers on these projects by September 26th. ^[2]

Exxon and Rosneft expanded their 2011 strategic cooperation agreement last year to include seven new blocks in the Russian Arctic in the Chukchi Sea, Laptev Sea and Kara Sea, spanning 600,000 sq. km. With this, both the companies agreed to cooperate in exploring and developing new hydrocarbon reserves in an area almost 190 million acres in size stretching almost halfway across the Arctic shoreline. 2D and 3D seismic surveys along with other data collection activities in the Kara Sea had been going on since then. The companies finally began drilling the first exploratory well in the multi-billion barrel University prospect last month. However, drilling operations on the giant prospect will now be put on indefinite hold as a result of the new U.S. sanctions on Russia making Exxon’s $700 million exploration project in the Arctic Ocean one of the biggest corporate casualty of these sanctions so far. ^[3]

Exploration for new hydrocarbon reserves is a critical and capital-intensive function of all oil and gas companies. It takes years for these companies to conduct initial geological surveys and following exploratory and appraisal drilling activities before the actual development of oil and gas fields begins. Therefore, the immediate financial impact of fresh U.S. sanctions on Exxon would be limited. However, prolonged restrictions on exploration activities in the Arctic could prove detrimental to the company’s long-term growth prospects. At the end of last year, Exxon’s total proved hydrocarbon reserves stood at 25.2 billion barrels of oil equivalent, which is to say that the company held enough reserves to produce oil and gas for the next 16 and a half years at 2013 production rates. ^[4]

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1. Exxon Mobil Statement On Treasury Department Sanctions On Russia, exxonmobil.com [↩]
2. Exxon Winds Down Russian Drilling, wsj.com [↩]
3. Exxon Mobil 2014 Analyst Meeting, exxonmobil.com [↩]
4. Exxon Mobil 2013 10-K SEC Filing, sec.gov [↩]