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We live in very unusual times. While there have been various conflicts around the world since World War 2, there has nevertheless been a sense of stability and wealth creation. Many long-term investors on Seeking Alpha have tales of very long-term lucrative cash flows from their Exxon Mobil (NYSE:XOM) share dividends. There are a lot of buy and hold investors in the XOM space. Energy investment has had its ups and downs, but the rivers of cash have flowed. Fossil fuel investing has become more fraught, with extreme challenges during the COVID pandemic when transport almost stopped. The result for companies like Exxon Mobil was traumatic but they held the line. Coming out of COVID (although the SARS-CoV-2 virus is not done with us yet) there has been a sense of relief and insistence by Exxon management that the recent challenges are all part of the usual cyclic nature of the fossil fuel industry, which they argue arises due to mismatch of supply (projects take a long time to develop) and demand.
Some, but not all (e.g. BP (BP), Shell (SHEL), TotalEnergies (TTE)), in the fossil fuel industry are adamant in refusing to acknowledge that things are changing (e.g. XOM) and that we’ve entered the beginning of the end of fossil fuel exploitation. This is occurring due to convergence of a need to decarbonize (due to a climate emergency) combined with dramatic advances and cost reductions in renewable power generation. Together these issues mean that there are major and irreversible changes afoot. While I think XOM senior management doesn’t want to acknowledge this, it is crucial that new investors consider the changing energy landscape and also for existing investors to re-evaluate whether their XOM investment is the best place for their investment dollars. I’ve written quite a lot about different aspects of investment in XOM. Here I consider XOM’s Q2 2022 earnings transcript and I explore further issues that continue to make me cautious about investment in Exxon Mobil at this time.
Buy when there is despair not exuberance
In early June the XOM share price exceeded $100 for the first time in 8 years, but by mid-July the share price was back close to $80, before it increased again to the high $90s at the end of July. Now it is tracking down again to close at $87.19. Since the start of the Russian crisis Brent Crude oil price has oscillated between just below $100 and $120 and there is a hint that it might go lower. The current situation reflects a very bullish time in both the oil price and XOM’s share price. This doesn’t look like a time to be buying XOM and it may be a time for long-term XOM shareholders to consider selling because there is little to suggest that the share price will keep going up. There is too much caution from inflation and also the threat of recession.
The point is that while XOM is close to its all-time high share price, I think there is a general sense of caution and even malaise even within the company. If the times really were so buoyant, this would be a time for a positive outlook. Instead management is building up its cash (to $20 or $30 billion and even stating that the good times may not last) and it has a $30 billion share buyback program in 2022 and 2023. Not surprisingly, the company seems to be going slowly with this program; why buy back shares at record prices?
Holding the line: when it’s a good plan and when it’s not
XOM CEO Darren Woods stood out as the contrarian in the oil & gas industry when he held the line with XOM’s oil & gas expansion plans during the COVID pandemic; as demand disappeared the share price fell apart. This is seen as a visionary call from which XOM is benefitting now.
Today it’s different. XOM is looking like the company that relentlessly refuses to acknowledge profound change at a time when it is obvious to all. I argue below that XOM’s actions acknowledge the change, even as the company insists that it is all just business as usual.
Climate change is biting and governments are acting
It is almost impossible for anyone to hold the line that the climate changes we are seeing are part of normal cycles. Fires in Australia, Europe, the US; floods in Australia, Europe, India & Pakistan, China, US; record temperatures in India, Europe and the US. These are just the recent events in areas that attract news coverage. Many record unprecedented highs are coming on top of already 1 in 100 year highs. Elevated temperatures (e.g. approaching 50 C) are a particularly worrying development.
A book just out from Bill McGuire, a volcanologist from the UK Natural Hazard Working Group, “Hothouse Earth: An Inhabitant’s Guide”, doesn’t pull any punches. He makes clear that it is too late to avoid serious climate catastrophes because they are already here. The release of the book accompanied massive heatwave conditions in the UK and US, while disastrous floods were also occurring in Kentucky in the US. McGuire makes the point in his book that it is essentially impossible to catalogue current records as they are being broken on a daily basis all around the world. McGuire makes the point that for too long climate scientists have not been honest about the actual climate situation. He is clear that this dishonesty has to be overcome. The future is now and that means intense summer heat, extreme drought, devastating floods, reduced crop yields, rapidly melting ice sheets and surging sea levels.
In the US, after a lot of to-and-froing, finally a bill is being enacted that will have a major impact on the exit from fossil fuels. Don’t be misled by the name of the bill : “The Inflation Reduction Act of 2022”. The point is that the bill allocates $369 billion (over 10 years) to Energy Security and Climate Change. Solar stocks have already risen in response to this breakthrough. While the situation is more complex in Europe and much is being made of temporary actions to avoid energy shortfall this winter, the point is that REPowerEU is a big deal that plans to dramatically increase the scale and pace of the renewables transition.
Q2 2022 Earnings Transcript
Followers of my analysis will be aware that I’m a fan of seeing what a CEO says in commenting on quarterly earnings because often one gets an insight into what the CEO is thinking that is not often seen by investors.
The Q2 2022 Earnings report transcript did not disappoint. Here are a few gems that I found in the transcript:
Renewables are still inadequate
Darren Woods continues to use his assumption that renewables (solar PV and wind) and electric vehicles are not adequate to address the energy transition, but that carbon capture, storage, biofuels and hydrogen are a solution. He provides no basis for writing off renewables.
The dismissal of renewables as being able to contribute to energy demand is used by Darren Woods to justify expansion of fossil fuel production throughout the XOM business, with 25% production growth for the second year in the Permian. In Guyana it is a story of production above design capacity and new production leading to an increase of 180,000 barrels/day in H1 2022 versus H1 2021. A new project in Qatar means that XOM will help Qatar’s LNG production to grow to 30 million tons by 2026. There are 2 new discoveries in Guyana, progressing LNG production in Mozambique and expanded refining capacity on the US Gulf Coast. It is all about expansion of fossil fuel exploitation on a grand scale. Woods is adamant that expanded fossil fuel production is what the world needs.
And he is keen on biofuels, which assume that the ICE is here to stay.
The situation in Europe
It is interesting how Darren Woods conflates issues arising from sudden exit from huge dependence on Russian coal, oil and especially natural gas, with the longer term exit from fossil fuel dependence.
The crisis in Europe results from immediate disappearance of a huge slice of Europe’s fossil fuel supply. I find it amazing that it begins to look as if Europe will cope with the upcoming winter with a large percentage of its expected natural gas source absent. Of course, there has been a frantic search for replacement supplies of the missing fossil fuels.
The above has nothing to do with the renewable energy contribution, because the problem results from absence of expected fossil fuel supply. This isn’t the fault of renewables! The interesting thing is that it seems that Europe is determined to use this crisis to dramatically increase the transition to renewable energy (see above re REPowerEU). Darren Woods sees the solution in potential for a return to fossil exploitation via fracking and unconventional gas in Germany. This seems at odds with the way Europeans are approaching this issue. He genuinely sees the problem in terms of safety of fracking rather than it being an emissions problem. And of course he thinks XOM can help get fracking going in Germany as well as expanding LNG supply. Darren Woods also thinks that there is opportunity with blue hydrogen (made from gas). Shell CEO Ben van Beurden sees blue hydrogen becoming uncompetitive with green hydrogen (made by electrolysis). Studies on life cycle emissions from blue hydrogen emissions suggest that it is cleaner just to burn the gas in the first place and not make the hydrogen.
Transport
While Darren Woods referred to recovery in aviation demand, there was not a word about electrification of wheeled transport (and coming decreased gasoline consumption as a result). How can anyone not acknowledge that the rise of electric vehicles will impact oil consumption much more than a change in air transport? The assumption continues to be that Asia will use vehicles powered by ICE (Internal Combustion Engines) rather than electricity (BEVs : Battery Electric Vehicles). A look at BEV developments in China (and India?) might temper that view.
Carbon capture
While Darren Woods continues to talk up carbon capture and storage (CCS) as cover for expanded fossil fuel production, the vague announcements about CCS belie the reality that XOM is a massive contributor to global emissions through expanded production of oil and gas.
There was an interesting comment in the Q2 transcript in the Q&A where Darren Woods acknowledges for the first time that CCS is not competitive. It was couched in vague terms but basically he said that CCS is too expensive if the CO2 source is not concentrated and if the storage is a long way from the capture. Many investors may not be aware that the capture reservoirs can be 100’s of kilometers away from the site of capture. He is vague about some projects being economic but didn’t mention in detail which ones were, although there was some reference to the Houston Hub. As far as I can gather Houston is still a theoretical concept seeking $100 billion of (Government?) funds to get going. Putting a $100 billion additional cost on fossil fuel exploitation seems a strange way to compete with renewables.
The point is that one of the only significant CCS projects currently, the Gorgon gas project in Western Australia, has failed to achieve its contracted carbon capture goals (80% of CO2 in the extracted gas). This is one of the ”easy” CCS projects that involve high concentrations of CO2 (14%) in the gas that is harvested. This isn’t about capturing CO2 released by burning a fossil fuel (coal or gas), but instead it involves capturing the CO2 that is mixed with the gas as extracted. Normal processing of this involves just venting the separated CO2 into the atmosphere. Chevron (CVX) has not revealed how badly it has failed to meet the 80% capture target, but it has purchased 5.23 million tons of carbon credits to make up the failure in its first reporting period. In fact over the period that Gorgon has been operating the carbon capture, (it was supposed to start in 2016 but capture only commenced in August 2019 through June 2021), it has captured 5.5 million tons of CO2, indicating that approximately half of the contracted capture has been achieved.
While Chevron is the Gorgon project operator, XOM must know about this project intimately as a 25% owner of the project.
Another CCS project that has been scrutinized recently involves a plan to retrofit CCS to the San Juan Generating Station in New Mexico. The claim is that 95% of CO2 will be captured, but a recent study by IEEFA indicates the high rate of capture is achieved by overlooking a substantial amount of carbon released in a full cycle analysis. When the overall proposed CCS is considered, the amount captured will fall to 72% (or less). Indeed lifecycle capture is likely to be closer to 50%, Note that there is no investor enthusiasm to fund this program and $1 billion of Government funding is being sought to make it happen.
Electrification of transport
Above I’ve indicated challenges to the business model of XOM based on expansion of natural gas production. What about the future for oil? Transport consumes ~45% of oil production, so there is an opportunity to reduce emissions dramatically by electrifying transport. In BP’s (BP) 2017 annual energy outlook it was predicted that penetration of electric vehicles by 2035 would be 6%. Fast forward to 2021 and massive electrification of personal transport is being observed. In Norway 86% of new car sales were electric in 2021. Comparable figures for Iceland (72%), Sweden (43%) and Netherlands (30%) are stunning, while in China in 2021 16% of domestic new car sales were electric. The key driver for electric vehicle sales is recognition of the need to reduce CO2 emissions.
The CAGR for electric vehicle sales between 2016 and 2021 was 61% in Europe, 58% in China and 32% in the US. There are 5 times the number of electric car models in 2021 compared with 2015.
It takes time for the electrification of transport to make an impact, but it is coming fast. Of the major manufacturers only Toyota (TM) is seeking to continue long term production of the internal combustion engine. I see no evidence that Exxon Mobil management accepts what is becoming obvious. There will be an impact on oil consumption soon. The big question for me is how and when will disbanding of the legacy ICE (Internal Combustion Engine) fleet be addressed?
Dividend and share buybacks
I’ve been puzzled by Darren Woods’ reticence about raising the dividend which was a significant feature of the Q&A section of the Q2 2022 transcript. He was asked several questions about raising the dividend and in each case he refused to indicate that a significant increase in the dividend is planned. Nor does it look like the planned $30 billion in buybacks is going to plan. Given the rivers of cash currently, this suggests that the plan to increase the cash held by a factor of almost ten to $20-30 billion will be easily achieved. So why sit on so much cash? This makes sense if you consider that the current times are an aberration and that things will return to earth sooner than many expect. It might also mean that senior management knows that expansion of fossil fuel production cannot keep increasing if the world is to address accelerating climate change. The problem for XOM is that there is little indication that the company has a plan to address what to do when reality strikes (other than have a big pile of cash to cushion the changes).
Conclusion
In this article I’ve addressed several questions that deserve investor attention in coming to a decision about investment in XOM at this time. There are a combination of both short- and long-term issues that are relevant today. In the long term I suggest that XOM’s licence to operate is being scrutinised in a way that previously the company has been able to avoid.
The bigger issue concerns energy pricing and the role of renewable energy projects in changing the metrics in favour of energy production that is controlled locally rather through far flung or politically unreliable (e.g.: Russia) sources. Now is a good time to reflect on the changing energy landscape and indeed think about alternative investment possibilities. Clearly solar PV and wind (especially offshore) are coming into view as massive investment possibilities are opening up, and BP, Shell and TTE are aware of this. Why invest in an industry that is destined for closure? Of course there is money to be made in an industry in closure mode, but it is a more complicated investment opportunity than an industry undergoing massive expansion.
I’m not a financial advisor but I do follow closely the huge transitions happening as energy becomes clean and cheap through exit from fossil fuels. I hope my perspective is helpful to you and your financial advisor as you consider possible investment in Exxon Mobil.
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