EXXON'S MISTAKEThe Daily Reckoning PRESENTS: Why ExxonMobile - the
world's largest oil company - could be flat broke in
twenty years time...
EXXON'S MISTAKE
by Justice Litle
"In 1930, we found 10 billion new barrels of oil in the
world, and we used 1.5 billion. We reached a peak in
1964, when we found 48 billion barrels and used
approximately 12 billion. In 1988, we found 23 billion
barrels and used 23 billion barrels. That was the
crossover when we started finding less than we were
using. In 2005, we found about 5-6 billion, and we used
30 billion. These numbers are just overwhelming."
- Charley Maxwell
Less than 20 years from now - not a long time in the big
scheme of things - ExxonMobil Corp. could be flat broke.
Imagine that. One of the biggest, most outrageously
profitable corporations in the history of markets...an
awe-inspiring behemoth that rakes in tens of billions
per quarter in pure profit...broke. Busted. Kaput.
Tapped out. Like a poker player down to the felt.
This isn't some whacked-out, nearly impossible
prediction. It's based on the analysis of Charley
Maxwell, a veteran analyst with Weeden & Co. in
Connecticut in the US.
In addition to being one of the most respected energy
analysts on the Street, Maxwell has had nearly 50 years
of experience in the oil and gas industry. He got his
start with Mobil Corp. - since merged with Exxon -
way back in 1957. (To give some perspective, my father
was nine years old at the time.)
After 11 years in the field, Maxwell headed for the
canyons of Wall Street in 1968. He quickly established a
reputation as the top oil analyst in the business,
dominating the rankings for decades. Now he works with
institutional traders, meets with top industry execs and
OPEC officials twice a year and routinely advises the
top dogs in the energy and hedge fund world.
In other words, the guy's opinion is probably worth
listening to.
In a recent interview with Barron's, Maxwell marvelled
at the utter folly of Exxon's decisions. To understand
his line of thinking - and to see why Exxon is in major
trouble - we first need to consider the energy industry
from a big-picture perspective.
By conservative estimate, 75% of the world's oil supply
is produced by national oil companies, or NOCs. This is
not good news, as Maxwell explains:
"Most of [the NOCs] were nationalized in the '70s and
early '80s, and they have real structural problems
today. They bring in a lot of money, but most of it goes
to support the national treasuries and the various
political constituencies that are in favour in the
various countries, whether it's the army or a host of
other bureaucratic ministries. In the end, in the
political battle for budgetary support, the national oil
companies tend to be a constituency with little or no
political influence. All in all, the national oil
companies have been shortchanged and held on a poverty
diet for a long time."
Imagine the US Postal Service in charge of America's
energy supply. The efficient, well-run oil majors are
like FedEx and UPS - they do a good job, but handle a
very small portion of the job overall. Now expand this
analogy to a global energy scale.
The situation with NOCs is ugly for multiple reasons. On
one side of the coin, you have leaders like Hugo Chavez,
who turn their countries' oil and gas operations into
political fronts and largesse-distribution programs.
On the other side of the coin, you have leaders like
Vladimir Putin, who see the strategic value of energy as
a weapon.
Those NOCs that are asleep at the wheel are making the
energy supply problem worse as their operations fall
into decay. Those NOCs that are wide awake see the
increasing value of their reserves and are increasingly
loath to share them. Witness Russia's recent
belligerence regarding its Sakhalin and Shtokman fields.
Russia rejected all Western partnership offers for
development of its massive Shtokman gas field, on
grounds that the spoils are simply too valuable to
share.
Cynics have their own interpretation of the golden rule:
He who holds the gold makes the rules. This is doubly
true for energy reserves.
As Russia demonstrates, oil majors in future will have
two choices: They will have to pay through the nose for
access to new reserves, or be left out in the cold. The
first option could eventually disappear altogether. And
the inevitable corruption of paper currencies makes
energy hoarding all the more likely. When the world
clamours for a refuge from paper, even as the developing
world bursts at the seams, NOCs will be all the more
aggressive about keeping the goods to themselves.
(By the way, did you hear China will start filling its
second oil reserve soon? By the end of this year, we're
told.)
Exxon puts on a confident face, but seems to have no
plan...other than assuming things will just work out
somehow. If Exxon's management is confident that cheap
oil will be readily available anytime soon, they are
deluded. The NOCs are going in the other direction. They
are moving toward hoarding, not sharing.
If not cheap oil, then what about expensive oil?
For the most part, energy optimists don't dispute that
the cheap oil is gone. They just assume that technology
will save the day, by giving us access to the more
expensive, harder-to-reach stuff.
Chevron's deep-water drilling is just such an example of
technological triumph. So is Exxon confidently betting
on technology, then? Will the great behemoth save itself
with skillful application of technology?
Apparently not. Maxwell reports:
"As we understand it, Exxon is not taking on any leases
for deep-water drilling after 2008. They haven't leased
anything. If you think deep-water leases are going to be
very important, and the recent big discovery in the
Gulf of Mexico suggests they will be, you would have
contracted for the future use of rigs.
"But if you think the deep-water leases aren't going to
be important because the oil found will be more
expensive than the common garden-variety Texas oil from
6,000 feet down, and that you will have lots of oil
coming from sources like that, then you don't need these
high-cost leases down the road. On the other hand, many
major oil companies have taken these rigs to 2010 and
2012 and 2014 and are pre-empting Exxon's ability to get
these rigs. Exxon is putting itself at a huge
disadvantage if there should be a need for this type of
deep oil. I find that remarkable."
Maxwell goes on to clarify his belief that Exxon is
taking a huge gamble, on the assumption that oil will go
back to $30 and none of this high-tech foofaraw will be
necessary. He thinks Exxon is "dead wrong"...and I
completely agree.
Optimism is good when logic and reason support it.
Optimism sans logic is foolhardy and dangerous. I agree
with the energy optimists that technology will
eventually pull us through...the key word being
"eventually." This idea that oil markets will have a
Goldilocks soft landing, though, and that the gusher
days of yesteryear will roll back around is just plain
silly.
This leads to a conundrum: Exxon is an excellent
company, with a history of excellent management. How
could it make such a boneheaded mistake?
Not to put too fine a point on it, how could it be
so...so...dumb?
It makes sense if one considers that Exxon is steeped in
a rigid, old-school culture that doesn't respond well to
change. It fits in terms of seeing Exxon as a gigantic,
tradition-steeped company with a history of dogmatic
authority at the top of the pyramid.
It also makes sense that Exxon would have adopted this
"nothing is wrong" view early on, as a defense of its
larger-than-life profits, and then got stuck in a rut of
consistency bias.
For Exxon management to adopt the Peak Oil view, even as
it rakes in tens of billions per quarter, would be a
public relations disaster. If the world's most
profitable corporation were to sound the energy alarm,
political heat would increase to unbearable levels.
Nationalization would be on the table.
Furthermore, the required investment response to Peak
Oil - ramping up capital expenditure like crazy,
plunging into high-cost, high-risk deep-water projects
with both feet - would be anathema to Exxon's
hard-bitten conservative management. So they reject the
facts out of hand, and stubbornly dig their own hole.
In sum, Exxon has become entombed by its own success and
its own culture. This in itself is not surprising. It
has happened plenty of times before, to companies and
empires alike.
Regards,
Justice Litle
for The Daily Reckoning
Editor's Note: Justice Litle is an editor of Outstanding
Investments, ranked number one by Hulbert's Financial
Digest for total return performance over the past five
years. He has worked with soybean farmers, cattle
ranchers, energy consultants, currency hedgers, scrap
metal dealers and everything in between, including
multiple hedge funds. Mr Litle also acted as head trader
for a private equity partnership, and made contributions
to Trend Following: How Great Traders Make Millions in
Up or Down Markets, a popular trading book by Mike Covel
(FT/Prentice Hall).