Exxon’s Kearl Expansion Startup To Boost Its Upstream Production and Profitability

ExxonMobil (NYSE:XOM) recently announced first production from the Kearl oil sands expansion project in Alberta, Canada. The project started ahead of schedule and is expected to double the overall production capacity of the Kearl oil sands project. Production from the expansion project will be ramped up in the coming months and is expected to reach approximately 110,000 barrels of bitumen per day at its peak. The expansion project consists of three additional trains that use the paraffinic froth treatment technology, which is both an energy and capital efficient process for bitumen production. Here’s why we believe that the project start up will improve the prospects of Exxon’s exploration and production (E&P) segment in the long run. ^[1]

• Increased Marketability of a Huge Base of Proved Reserves: The Kearl Oil Sands project, located 70 kilometers north of Fort McMurray, is a joint venture between Imperial Oil, which holds a 70.96% stake in the project, and Exxon Mobil Canada, a wholly owned subsidiary of Exxon Mobil, that holds the remaining 29%. Since Exxon also holds a majority (69.6%) stake in Imperial Oil, its net share of diluted bitumen from the Kearl project stands at over 78%. The project has an estimated 4.6 billion barrels of recoverable bitumen resource, and is expected to remain in production for as much as 40 years. Upstream projects with a longer plateau-production profile yield higher returns for exploration and production companies in the long run, as marginal production costs diminish over time. ^[2]
• Higher Net Production: Exxon expects to ramp up its net upstream production to approximately 4.3 million barrels of oil equivalent per day (MMBOED) by 2017 as it progresses on its plan to add roughly 0.8 MMBOED (assuming an average 4% natural decline in production every year) of new production between 2014 and 2017. ^[3] Last year, Exxon’s average net production from the Kearl oil sands project stood at 66,000 barrels per day. However, the recent startup of the expansion project has increased its gross production capacity to around 220,000 barrels of bitumen per day. Therefore, according to our estimates, the ramp up of production from the Kearl oil sands project is expected to contribute more than 13% to the company’s short to medium term production growth target. ^[4]
• Better Mix and Thicker Margins: Exxon’s hydrocarbon production can be broadly split into two categories – liquids (crude oil, natural gas liquids, bitumen, and synthetic crude oil) and natural gas. Liquids are generally more profitable to produce than natural gas because of higher price realizations. The proportion of liquids in its net production is therefore a key driving factor for the cash margin earned by an exploration and production company per barrel of oil equivalent. In 2014, liquids made up 53.2% of Exxon’s total net hydrocarbon production, up from 51.5% in 2012. Increased bitumen production from the Kearl oil sands expansion project will further improve Exxon’s production mix, as its natural gas production is expected to decline around 2% y-o-y this year. This is expected to drive Exxon’s cash margin per barrel of oil equivalent produced (adjusted for the change in price realizations) higher, compared to last year. ^[4]

Despite these positives, if benchmark crude oil prices do not recover significantly from current levels in the long run, returns from the project might not be as lucrative as originally projected, because firstly, bitumen production is a costly process, compared to production from a conventional oil field, and bitumen also trades at a discount to lighter grades of crude oil, because of higher refining costs.

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1. ExxonMobil Announces Kearl Expansion Project Starts Production Ahead of Schedule, exxonmobil.com [↩]
2. Kearl Oil Sands Project, exxonmobil.com [↩]
3. Exxon Mobil Corporation 2015 Analyst Meeting, exxonmobil.com [↩]
4. ExxonMobil 2014 10-K Filing, sec.gov [↩] [↩]