Exxon's 10-K: Russia, Reserves and a Lot of Rebuilding

(Bloomberg Gadfly) -- Exxon Mobil Corp.'s annual report, released this week, reads like an epitaph for the tenure of its last CEO, who now spends his time wrestling with a very different kind of multinational.

The bit that caught the most attention was the disclosure that Exxon will abandon several joint ventures with Rosneft PJSC, which have been moribund for several years anyway due to sanctions against Russia. This is a heavy blow. Russia represented a promised land of new mega-projects to carry the company into the 2020s, and clinching the deal with Rosneft was to be the central part of Rex Tillerson's legacy. On the other hand, by the time Exxon filed its 10-K this week, it merely confirmed what everyone was assuming about Russia anyway.

But on the other, other hand, it also confirmed something else: Tillerson's successor, Darren Woods, has his work cut.

Russia's Crimean seizure was bad luck, but the same can't be said for some of Tillerson's other deals. The $41 billion purchase of XTO Energy Inc. in 2010 was struck just before natural gas prices collapsed. Meanwhile, his foray into Iraq saw Exxon secure barrels in a major development, but on terms offering razor-thin margins.

Driving all these efforts was, in part, a desire to secure reserves to replace the 4 million or so barrels of oil equivalent Exxon pumps out every day. This instinct animates all oil and gas producers but carries a risk of overpaying for deals or investing in sub-par projects -- as Exxon's proved reserves disclosure in its filing illustrates.

Similar to rival Chevron Corp., Exxon announced thumping reserves replacement in 2017 after several mediocre years. It's just that Exxon's were more mediocre:

The legacy of Tillerson's deals really showed up in 2015 and 2016. About 8.4 trillion cubic feet of U.S. natural gas proved reserves got taken out via revisions, largely because of falling prices (if prices fall enough, some gas reserves become uneconomic to produce and, therefore, vanish from the books). Exxon even had to take an impairment on its U.S. gas assets in 2016, an unheard-of step for the company.

Meanwhile, reserves at the giant Kearl bitumen project in Canada, having suffered several years of delays and contributing to a marked decline in Exxon's all-important return on capital, were also wiped out due to price effects in 2016, leading to that year's enormously negative replacement ratio.

Looking at the five years as a whole, Exxon's replacement ratio is dismal, due especially to the reckoning in 2016 and the shale-gas effect:

Higher oil and gas prices helped unwind some of that last year. Exxon re-booked more than 400 million barrels in its bitumen operations via revisions, as well as almost 700 billion cubic feet of U.S. natural gas.

Buying reserves was just as important last year, though. Exxon has been especially active in U.S. tight oil, where it is a relative latecomer, spending $5.6 billion on one deal alone, for the Bass family's assets in the Permian basin. You can see the outsize role played by acquisitions last year, looking at both Exxon's data for the past five years and comparing 2017's additions with those of Chevron, which reported a similar all-in replacement ratio of 166 percent last year:

 

Exxon's buying spree is like a multi-billion-dollar form of retail therapy, helping it get over its earlier missteps. The company isn't solely reliant on deals; organic reserve replacement was 127 percent last year, and discoveries like those offshore Guyana will keep adding to the stockpile for years to come.

Yet it's clear that after being denied in Russia and suffering setbacks in Canada and shale gas, Exxon had to open its wallet to stake out new positions in shale oil.

Exxon claims it can make shale work within its Big Oil business model. If misadventure in Russia helped to unravel Tillerson's legacy, his successor's will depend largely on rebuilding credibility far closer to home.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

Liam Denning is a Bloomberg Gadfly columnist covering energy, mining and commodities. He previously was the editor of the Wall Street Journal's "Heard on the Street" column. Before that, he wrote for the Financial Times' Lex column. He has also worked as an investment banker and consultant.

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