Exxon mobile finally starting to acknowledge capital misallocation

In summer I argued (here) that integrated oil majors look overvalued and require much higher oil prices to justify current valuations. I was especially puzzled by the fact that Exxon had not written down any of its upstream assets, despite a significant drop in the oil price over the preceding 24 months, something that even had attracted the scrutiny of the SEC.

Well, yesterday Exxon missed forecasts by a large margin, due to impairments (USD 2 billion) on some of its gas fields, which makes it the 9th straight quarter of yoy profit declines. Clearly its fortunes correlate heavily with the oil price. This, however, is missed by the wider analyst community, whose average earnings estimate was almost double the actual result.

And it gets worse.

For, if oil prices stay at current levels, Exxon might be forced to de-book almost 20 (!) percent of its reserve assets, as extracting oil from them has become unprofitable. From Bloomberg (here),

About 3.6 billion barrels of reserves in the Canadian oil sands and the equivalent of another 1 billion barrels in other North American fields could fall off the company’s books if low energy prices persisted, Exxon said in October. That would equate to 19 percent of Exxon’s reserves and would be the largest de-booking since the 1999 merger that created the company in its modern form. Woodbury said an undefined portion of those revisions would be offset by new additions.

Yeah, an “undefined portion” will be replaced by new additions. By the way, production volumes were down 3 percent over the year too.

I do not know about you, but to me Exxon looks like a shrinking business.

Management seems to agree. It is management planning to increase capex to USD 22 billion for 2017, an increase of 14 percent compared to the past year, and equal to the entire “cash flow from operations” of 22 billion for 2016, according to page 19 of the most recent SEC filing (here), increasing the probability that shareholder distributions have to be paid out of debt. Jim Chanos’s “liquidating trust” hypothesis certainly doesn’t look far-fetched to me (here).

The market (ETFs) seems to disagree, however, and thinks that Exxon at a TTM PE of over 40 is a bargain. As does the Swiss central bank, for whom EXXON and Chevron are among the Top 15 holdings together worth more than USD 2 billion.

Conclusion

All the investors in oil majors are betting on a significant recovery in the price of oil. With so much illusory wealth  (add the heavily indebted shale plays as well as suppliers) depending on the trajectory of a highly volatile commodity, one can see why markets get nervous when oil goes down.

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