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Exxon must act to keep an enviable reputation

 

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Financial Times: Exxon must act to keep an enviable reputation

By Ed Crooks and Sheila McNulty

Published: May 3 2008 03:00 | Last updated: May 3 2008 03:00

Ask anyone in the oil business which company they admire the most, and 99 times out of 100 you will get the same answer: ExxonMobil. The technical excellence of its staff and the rigour of its corporate culture are res-pec-ted, envied and sometimes feared by competitors.

That discipline – a word often used in connection with Exxon, including by the company itself – has paid off handsomely for investors. Whether viewed over the past five years or past 20, Exxon’s total shareholder returns have comfortably exceeded the average of its peers: Royal Dutch Shell, BP and Chevron.

But nobody is perfect, and this week’s first-quarter results from Exxon, in spite of being the second-biggest quarterly profit in US history, proved the point. After rivals Shell and BP had reported earnings well ahead of expectations, and been rewarded with jumps in their share prices, Exxon disappointed on Thursday with lower production and weaker profits in its refining business than expected. Its shares fell almost 4 per cent on the day.

In a week when descendents of John D. Rockefeller, the founder of Exxon’s ancestor Standard Oil, attacked the management for failing to secure the company’s future, it was an embarrassing slip-up.

The question is whether those results were just a one-off, or a warning that Exxon’s growth prospects may not be as bright as the markets had hoped.

As analysts at Credit Suisse put it: “Are we in danger of over-reacting? Probably. One quarter doesn’t make a trend, and ExxonMobil remains a formidable operator. Still, part of the superior operating rationale for [its] valuation premium to other Big Oils took a knock today.”

Exxon’s shares trade at about 10.5 times this year’s expected earnings, compared with 8.8 times for Shell and 9.4 times for BP. The most worrying feature of Exxon’s statement was its decline in oil and gas production: a drop of 5.6 per cent compared with the first quarter of 2007.

Exxon’s withdrawal from Venezuela, where it chose to pull out of a heavy oil project rather than accept the new contract terms imposed by the government of Hugo Chavez, played its part in depressing output. The falling output also reflected the effect of production-sharing contracts that oil companies use in many countries, which give a greater proportion of output to the national government as oil prices rise. But even taking those factors into account, output volumes fell by 3 per cent.

Exxon argues that energy is a long-term business, and it would be ridiculous to judge it on a single quarter. Presenting its strategy in March, Exxon showed a projection that oil output would be roughly flat until 2012, but gas output would grow.

Mark Albers, the vice-president of exploration and production, warned analysts then that output “might well take a less smooth path” than the graph suggested. However, investors will still be troubled by the fear that, as Robin West of PFC Energy said, “Exxon does a lot of things superbly well. But does it have the potential that will permit it to grow?”

One potential problem is Exxon’s famed unwillingness to compromise under pressure from resource-rich countries, as seen in its tough line with Venezuela.

Russia is another example, where Exxon has been holding out for the rights in its contract to sell the gas from its Sakhalin 1 project wherever it chooses. Gazprom, the state-controlled gas company, wants the gas for itself.

European oil companies such as Total of France and Eni of Italy have stressed the need to recognise that the world has changed. They say international oil companies (IOCs) are no longer in the driving seat, and need to approach resource-rich countries differently if they are to gain access to their reserves.

Paolo Scaroni, Eni’s chief executive, spoke last month about the need for a “cultural shift” by the IOCs. That has been reflected in Eni’s willingness to invest more in Venezuela, in spite of the tactics of Mr Chavez.

Christophe de Margerie, Total’s chief executive, says companies need to focus on their “acceptability” in the countries where they operate.

For Rex Tillerson, Exxon’s chairman and chief executive, the best way for the companies to make themselves acceptable is to maximise the value of the country’s resources, which means delivering projects on time and on budget. In that, Exxon has a spectacular record. Since 2003, during a period of rampant cost inflation in the sector, it has on average completed its investment projects only fractionally over budget and with minimal delays. Its costs per barrel of oil produced have risen more slowly than for any of its main competitors.

Exxon’s investment plans, however, suggest either a reluctance or an inability to back that judgment with cash. It used only about 26 per cent of its cash flow on capital and exploration spending last year: less than half the rate for Shell, BP and Chevron. Instead, the money has gone into massive share buy-backs. At the present rate, Exxon would have bought back all its equity in 15 years. If the company is to maintain its outstanding reputation, it will need to prove it can do more than shrink elegantly in the decade to come.

 

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