Market outlook: ExxonMobil pushes upstream and chemicals

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ExxonMobil leads peers in return on average capital employed (ROACE) for upstream, downstream and chemicals

ExxonMobil oil and gas executives are keenly eyeing the Wolfcamp shale formation in the Midland Basin, not too far from its corporate headquarters in Irving, Texas. The young petroleum play lies within the sandy West Texas acreage of the United States’ oil-rich Permian Basin. Sporadic tufts of green along with rusty pumpjacks relieve the semi-arid monotony of the landscape. Nearby, towns of Odessa and Midland function as headquarters for oil and gas extraction. Even as far back as ten years ago, the Permian Basin was struggling to find workers to fill the 2,000 odd jobs it had open. People began to move in by the droves.

Wolfcamp is the new, and popular, kid in the Midland town thanks to hybrid technology. Oil companies made the organic, rich shale formation popular among American job seekers by erecting active rigs to drill horizontal wells. They then used hydraulic fracturing to irrevocably blast the hitherto resistant unconventional oil and natural gas out of the ground.

Surprisingly, the Permian Basin is one of the few that haven’t disappointed post the 2014 oil price crash. It has higher productivity per well. Besides, its chief operators happen to have better access to cash. Turf wars are on for mergers and acquisitions after the land piqued shareholder curiosity last year for its market resilience. Wood Mackenzie estimates the Permian Basin has attracted 14% of global deal flow in 2016.

Stepping into this scenario, ExxonMobil has slowly but surely carved out a chunk of the fields for itself through carefully crafted contracts. Beginning in 2014, the company signed five agreements that just about doubled its operations in Wolfcamp. Late in 2016, it created a crude oil logistics joint venture with Sunoco, called the Permian Express Partners, to effectively expand pipeline options to supply its refineries. News emerged at the time of writing that ExxonMobil had acquired 250,000 acres in New Mexico’s Delaware Basin in the Permian from the Bass Family of Fort Worth, Texas.

One of the secrets of exploiting oil profitably is reducing the immense cost associated with drilling a well and getting it ready for production, known as completion costs. In Wolfcamp in the Midland Basin alone, ExxonMobil has lightened its drilling and completion costs between 30 and 40 percent from 2014 to 2015. We are talking here of production that can break-even at an oil price of $40/bbl.

A second step to profitability is extracting as many barrels as you can. ExxonMobil has been managing the oil downturn by looking for additional barrels of low-cost oil, whether it be from Wolfcamp, or the Bakken shale formation further up north in the state of North Dakota. In 2015, it operated 11 unconventional Permian rigs, including in nearby Spraberry and Bone Springs formations, growing its net basin production by 24%. It announced soon after that it will start ten upstream projects primarily onshore in the United States over a two-year period to add 450,000 barrels per day of low-cost operations to its portfolio by the end of 2017.

INVESTMENTS PAY OFF

All this investment is paying off. For the first nine months of 2016, ExxonMobil kept its production essentially stable at 4m barrels per day versus the previous year. In fact, liquids production increased 59,000 barrels per day to 2.4m barrels per day. Project start-ups helped offset the natural decline in oil fields, the setback from Canadian wildfires, and downtime in Nigeria.

So ExxonMobil has stable to higher output, and some of it at lower cost than before. Now imagine OPEC and other oil producing nations adhere to their commitment to reduce output in 2017. Imagine oil prices duly rise above the sweet and elusive spot of $60/bbl. The lower production cost and higher selling price could potentially turn around ExxonMobil’s declining earnings in 2017, provided oil output is stable or higher in the United States and elsewhere. It stands a chance to improve returns from the capital it employs in the upstream segment, which is roughly 85% more than capital employed in either its downstream or chemical divisions.

The company is far ahead of its peers in squeezing more earnings out of every dollar of capital it employs. In other words, its return on average capital employed (ROACE) for upstream, downstream and chemical segments combined has been higher than that of Chevron, Shell, Total or BP during 2011-2015. The ROACE is a relative tracker of profitability, and efficiency. ExxonMobil had an industry-leading ROACE of 7.9% in 2015.

But in 2015, ExxonMobil was churning out only about four dollars for every hundred dollars of capital employed in its upstream division. This compares with seventeen dollars just the previous year. A sudden change in ROACE could signal a loss of competitive advantage even after taking the oil price crash into consideration. Its upstream ROACE could be something to closely watch out for as the company publishes its 2016 figures in a few days. An increase in upstream earnings could help propel its ROACE higher in 2017, given its cost-effective investments.

DOWNSTREAM BRIGHT SPOT

The downstream refining division was a bright spot for the company in 2015. The segment delivered a whopping 28.2% ROACE for the year with low cash operating costs, up from 14.1% in 2013. One of ExxonMobil’s key refining projects is expanding the hydrocracking unit at its Rotterdam refinery to up Group II base oils production. Regardless, the company thinks challenging times lie ahead because of the addition of new global refining capacity, which will outpace demand growth.

At ExxonMobil, there seems to be a subtle shift in marketing itself as a natural gas – arguably the cleaner fuel – company although its origins lie in oil. This is partly because of the onslaught of fuel efficiency measures. There is a certain wistfulness in the company’s statement in its recently published market outlook: “Without efficiency improvements, global energy demand would increase significantly.”

Access to lower-cost natural gas liquids (NGL) feedstocks is important as it has triggered an expansion at its US chemical division. The ROACE for ExxonMobil’s chemicals division was consistent from 2013 through to 2015 at approximately 19%, and it would be eager to capture more of these returns. ExxonMobil estimates chemical demand for energy – both as fuel and feedstocks – will grow by 45% in 2015-2040.

CHEMICALS EXPANSION PLAN

Spurred on by this outlook, ExxonMobil has introduced a major expansion in Texas including a world-scale ethane steam cracker and associated polyethylene facilities. The move will help it capitalise on low shale gas prices by building high-value chemical products. Amid a gathering storm of protest by locals, ExxonMobil and joint-venture partner SABIC are proposing to build the world’s largest steam cracker capable of producing 1.8m tonnes of ethylene per year near Corpus Christi. The site will also include a monoethylene glycol (MEG) unit and two polyethylene (PE) units.

Some estimate the energy giant is preparing to take advantage of the next wave in the commodity supercycle with its chemical expansions. Another ethane-fed cracker with a capacity of 1.5m tonnes per year is due for start up this year at its Baytown petrochemical complex near Houston. Nearby at Mont Belvieu, it plans to add 1.3m tonnes per year of PE capacity. Also, it is building another PE unit of 650,000 tonnes per year at Beaumont. Exxon is not alone at planning crackers in Texas – Chevron Phillips and Dow Chemical are among those who have similar projects in the pipeline. The Mont Belvieu and Beaumont projects combined will increase ExxonMobil’s US PE production by 40%, making Texas the focal point of PE supply for the company.

Ignoring the shifts within individual business segments, if the overall ROACE stays higher than industry peers in the long term, a larger piece of the profits pie can be reinvested back to create even better returns. Including into its chemical division where earnings increased $288m for the first nine months of 2016 compared with the previous year. This is where the Wolfcamp shale in the Permian Basin can come in handy for ExxonMobil as it aims to increase low-cost volumes to profit from the anticipated upturn in oil prices.

Cuckoo James is a journalist based in London and is responsible for covering oil futures and refined products in the integrated ICIS news team. She has a keen interest in new projects and finance at multinational and state-owned oil companies.