Exxon Mobil (NYSE:XOM) and state-owned Russian oil company Rosneft have announced the selection of Vostochniy Offshore Structures Construction Yard in order to test the feasibility and safety of the drilling platform they plan to use in the shallow waters of the Kara Sea. According to recent comments from Exxon Mobil CEO Rex Tillerson, the project has begun ahead of schedule and drilling is expected to commence in 2014-15. 
Joint Venture to Tap into Arctic Seas’ Vast Energy Reserves
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The two companies unveiled an offshore exploration partnership in April this year.  , Russia has the world’s second largest oil reserves, after Saudi Arabia, and is the world’s largest producer of oil and gas. Oil companies offer technological prowess and the ability to make long-term investments. The deal, which was endorsed by Russian Prime Minister Vladimir Putin, demonstrates the country’s eagerness to collaborate with them in a bid to develop its vast energy reserves in the Kara Sea and the Black Sea.
According to a study by the US Geological Survey in 2008, the Arctic may hold up to 90 billion barrels of oil, around 13% of the world’s total undiscovered reserves. Further, environmental factors could contribute to the decline in the level of ice in the Arctic, and recent climate models have predicted that the Arctic could be completely ice free by 2037.  This, along with rising oil prices, access to better technology, and the depletion of accessible reserves, presents a great opportunity for oil companies.
Substantial Capital Expenditures
In order for Exxon Mobil to make progress in its Arctic Sea projects, it must invest heavily in research, testing and construction of drilling platforms. The joint venture between the company and Rosneft estimates investments of up to $500 billion over the next several decades.  This would mean substantial capital expenditures going forward. We currently project upstream investment (measured as capital expenditures) to decline as a percentage of gross profits, primarily due to rising oil prices. Oil prices, however, depend on a multitude of factors, and there is no certainty in which direction prices may swing going forward.
For example, there is a possibility that oil companies will successfully gain access to undiscovered reserves such as those in the Arctic, which would lead to a large increase in supply. Demand growth, on the other hand, may slow down as the economic slowdown impacts emerging economies, and countries and corporations fulfill a greater part of their power requirements through alternative energy sources. This would result in a slower increase in oil prices, which would in turn lead to slower growth in gross profits and revenues, and larger capital expenditures as a percentage of gross profits.
We currently have a price estimate of $98 for ExxonMobil, which is almost 10% above the market price.Notes:
- Exxon sees Kara Sea exploration drilling in 2014-15, Reuters, September 2012 [↩]
- Rosneft and ExxonMobil Announce Progress in Strategic Cooperation Agreement, ExxonMobil Corporation, April 2012 [↩]
- The melting north, The Economist, June 2012 [↩]
- Exxon, Rosneft unveil $500 billion offshore venture, Reuters, April 2012 [↩]