Exxon Mobil: Elephant hunter found herd (NYSE: XOM)

zodebala

(Note: This article appeared in the June 4, 2022 newsletter and has been updated as needed.)

A company like Exxon Mobil Corporation (NYSE: XOM) (“ExxonMobil”) needs a very big project to have an impact. Luckily for investors, this company has found such a project off Guyana. As the project is in the early stages of cash flow generation, the incremental results are not yet significant on an annual basis. But the cash flow of the project is increasing, which will change in the near future.

The project is also beginning to show tangible growth potential. This is not just the announcement of a neighboring discovery in Suriname by another partnership. But also, a very public discussion on the rise by John Hess, the CEO of Hess (HES) whose company is a partner in the Guyanese project.

At the recent Bernstein Lecture, Dr. Hess discussed that a recent discovery was in the 18,000 foot depth range. Previous discoveries were in the 15,000 foot range. This opened up a whole new gap for the partnership with Guyana to explore. The partners hope that this interval will likely contain billions of barrels as the most explored shallower area. If so, the project will have considerable benefits both on a geographic basis, meaning that the production area will continue to expand from what is now known, and operators can drill more wells deep that are competitive to produce more wells. The result is that the project’s growth horizon has now stretched beyond the long-term vision of most companies.

Mr. Hess predicted that this project should allow production to increase by 10% per year for the foreseeable future. Initial production increases will be lumpy until a reasonable size (production base) is established. Since Hess is a small company, production growth will be significant for Hess much sooner. But a project of this size will also become important for a company the size of ExxonMobil. This importance could allow a rate of growth rarely seen for a company the size of ExxonMobil.

The Hess Corporation FPSOs that produce and will produce

The Hess Corporation FPSOs that produce and will produce (Presentation by Hess Corporation at the JP Morgan Energy, Power & Renewables Conference on June 23, 2022.)

This partnership already has two floating production, storage and offloading (FPSO) units in production. The second of them accelerated production to the point that the partners considered complementary projects to increase production capacity. This capability increases the profitability of initial production projects. The real question is whether more of these cheap projects are available for production platforms.

This puts this partnership well ahead of others in Guyana in terms of cash generation. The market did not come close to responding to the discovery in Guyana. But the start of cash flow should be a game-changer for a small company like Hess. It will also start to affect the market perception of a company like ExxonMobil.

Note that the partnership shows the ability to support 10 FPSOs. These ships are not cheap. Indeed the cost of a project like this requires a lot of reserves to justify the cost of building and installing an FPSO.

The current price of oil and gas is extremely important when a partnership like this is just beginning to generate cash flow. The reason for this is that the return on investment occurs very quickly. Assets like FPSOs typically have long returns to support long-term production.

But now the return on investment of the project is very fast. At a production rate of BOD 200,000 (very roughly), this current production sells for $20 million at current prices (not including natural gas and other production). This rate is $6 billion per year for the partnership, meaning that the cost of an FPSO is roughly recouped in one year in revenue. This is almost unheard of in a large offshore project like this.

Mr. Hess estimates that Hess’ share of cash flow is about $1 billion per year for each producing FPSO (except the first) at current prices. This is the Hess share of cash flow. ExxonMobil has a bigger stake. Therefore, ExxonMobil has a bigger advantage. This makes this project self-funding (virtually) at current prices. As more FPSOs begin production, the pace of exploration and development is very likely to increase.

Note that the public discussion used $90 for the price of oil next year. Next year is an extremely long time in an industry like this with very low visibility. Therefore, the projection is likely to have a large swing in terms of the actual price when that future arrives.

Now Project Yellowtail, which is estimated to come online in 2025, also has the highest projected cost at $10 billion. However, the current price atmosphere makes it a very profitable project. Mr. Hess talked about the sticker aspect of this FPSO project. This could at some point in the future make another FPSO a non-starter until prices improve. But right now, the low break-even point of any of these production projects is impressive enough to make it a remote possibility.

In the end, there is no need to add money or add less money when production first begins, which greatly increases the overall profitability of this project, because the money received earlier has a much greater influence on calculations such as return on investment than money received later.

Additionally, in the event of an industry downturn, the partnership is able to use debt to continue to ramp up production when early assets are quickly depreciated and likely remain debt-free.

Summary

The partnership has recently increased its activities in response to rising oil prices. This has resulted in an accelerated pace of discovery announcements.

ExxonMobil has just announced two additional discoveries to bring the total discoveries to the highest number ever for the partnership. There will likely be more to add in the future as the year is not over yet.

Hess Presentation on Guyana Discoveries and Expected Production Growth

Hess Presentation on Guyana Discoveries and Expected Production Growth (Hess presentation at the JP Morgan Energy, Power And Renewables conference on June 23, 2022)

The recoverable resource has been on an upward trend for some time. For shareholders, the importance of the start of production is illustrated at the bottom right of the slide. Production increases at a time when demand is unbalanced. The timing of the production expansion couldn’t be better. Specifically, investors can already see over BOD 300,000 of production with another FPSO expected to begin oil production in 2023.

Even for a company the size (KING) of ExxonMobil, more than 500,000 barrels of low breakeven production is significant (as a partner) in 2023. The 6 projected FPSOs shown above are likely to generate a production of at least 1.5 million BOD. At this point, ExxonMobil’s production growth should reach a rate rarely seen for a company the size of ExxonMobil.

Summary of ExxonMobil's operating results for the second quarter of 2022.

Summary of ExxonMobil’s operating results for the second quarter of 2022. (ExxonMobil Earnings Press Release, July 29, 2022)

The entire industry, including this company, is reporting previously unexpected cash levels and earnings. This allows initial investments in Guyana that were made during periods of low prices abroad to be amortized very quickly. Having the initial assets of partnership profitability in a huge project like this is an incredible competitive advantage that is rarely seen. It alone increases project profitability because more dollars sooner are worth more in any time value of money calculations (not to mention ROE calculations). It also means that the partnership can support a higher level of activity sooner. This is reflected first in the record number of discoveries.

The effect of currently high prices on long term projects like FPSO construction is mitigated as these projects as well as infrastructure take years. A partnership doesn’t want to be caught in an industry downturn with big bills from too many expansion projects.

The project promises production growth that will be significant for ExxonMobil for a very long time. This will make the company a vehicle for growth and revenue rarely seen in a cyclical industry. Yields could be low as production continues to grow in the near future. But that will change even if another discovery is never made again (highly unlikely).

The advantage of offshore projects is that growth is often predictable for years. In this case, the project’s production will clearly increase for the rest of the decade based solely on the discoveries made. The extremely low break-even point will help all partners to significantly reduce the break-even point of the business. For those with patience, this stock, even at the current price, is likely to prove a decent long-term buy.

Comments are closed.