Exxon 2Q Preview: Lower Oil Prices To Outweigh Higher Production, Better Mix

Exxon Mobil (NYSE:XOM) is scheduled to announce its 2015 second-quarter earnings on July 31. ^[1] We expect lower crude oil prices to weigh significantly on the company’s upstream earnings. Benchmark crude oil prices have fallen sharply over the past 12 months on rising supplies amid slower demand growth. The average Brent crude oil spot price declined by more than $48 per barrel, or almost 44% year-on-year, during the second quarter. According to the company’s latest annual SEC filing, a $1 per barrel fall in the annual weighted average price of crude oil reduces its total full-year after-tax upstream earnings (from both consolidated companies as well as equity affiliates) by approximately $350 million. Therefore, we can expect the company’s second-quarter oil and gas exploration and production earnings to be around $4.2 billion less than the year-ago quarter, just because of the decline in oil prices. Lower average Henry Hub natural gas prices in the U.S. will further eat into the company’s upstream earnings for the three-month period ending June 30, 2015. Overall, we expect lower price realizations to result in a decline of approximately $5 billion or $1.20 per share in Exxon’s second quarter upstream earnings, compared to the year-ago quarter. However, better upstream volume-mix, due to a higher growth in the production of liquids (crude oil, natural gas liquids, bitumen, and synthetic oil), primarily driven by the ramp up of the Kearl project in Canada, and the development of unconventional plays in the U.S., coupled with thicker downstream margins, is expected to partially offset the impact of lower oil prices on Exxon’s overall performance. During the earnings conference call, we will be looking for an update on Exxon’s ongoing new project development as well as its operating strategy under the changed crude oil price environment. ^[2]

Exxon Mobil is the world’s largest publicly traded international Oil and Gas Company. It generates annual sales revenue of more than $390 billion with a consolidated adjusted EBITDA margin of ~18.6% by our estimates. We currently have a $81/share price estimate for Exxon Mobil, which values it at around 18.7x our 2015 full-year diluted EPS estimate of $4.32 for the company.

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Higher Production

Exxon’s net upstream (oil and gas) production has been relatively flat over the past decade. It actually declined slightly from over 4.21 million barrels of oil equivalent per day (MMBOED) in 2004 to 3.97 MMBOED in 2014. This has also been the 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. However, going forward, Exxon expects to ramp up its net upstream production to approximately 4.3 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. The company is banking on a number of new project start-ups to achieve this target. Most of these projects, including the liquefied natural gas (LNG) project in Papua New Guinea, the Kearl oil sands and the Cold Lake Nabiye expansion projects in Canada, and the development of Sakhalin-1′s Arkutun-Dagi field in the Arctic, have either come online recently, and are currently in the ramp-up stage, or are scheduled to start-up in the near future. On the back of these new upstream projects, Exxon plans to grow its net upstream production by around 2% y-o-y this year. ^[3]

In addition to new projects, we expect Exxon’s second quarter net upstream production to also increase as a result of higher entitlements from projects under production-sharing agreements (PSA). A PSA is an arrangement through which an oil company bears the risks and costs of exploration, development, and production. In return, if exploration is successful, the oil company receives entitlement to variable physical volumes of hydrocarbons, representing recovery of the costs incurred and a stipulated share of the production remaining after such cost recovery. Therefore, under such agreements, the production volume entitled to an oil company increases during the period of lower oil prices. Exxon derives a significant amount of its total net hydrocarbon production from production-sharing agreements, and its upstream cash profits are therefore relatively less exposed to the volatility in crude oil prices.

Better Mix

Exxon’s hydrocarbon production can be broadly split into two categories – liquids and natural gas. Liquids are generally more profitable to produce than natural gas because of higher price realizations. In 2014, Exxon sold liquids at an average price of around $85.40 per barrel, compared to just around $39.80 realized per barrel of oil equivalent (BOE) of natural gas. 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. Therefore, over the last few years, Exxon has been trying to improve the proportion of liquids in its upstream production mix by slowing down its shale gas development program in the U.S. and focusing more on growing liquids production. In 2014, liquids made up 53.2% of Exxon’s total net hydrocarbon production, up from 51.5% in 2012. We expect the company’s volume-mix to improve further this year, as it expects to grow liquids production by around 7%, while natural gas production is expected to decline 2% year-on-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. ^[3]

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1. Quarterly Earnings, exxonmobil.com [↩]
2. ExxonMobil 2014 10-K Filing, sec.gov [↩]
3. Exxon Mobil Corporation 2015 Analyst Meeting, exxonmobil.com [↩] [↩]