Dr. P.V. Viswanath

pviswanath@pace.edu

Exxon's Stingy Capital Spending May Haunt It
April 16, 2008; Page B2, WSJ

Exxon Mobil Corp. doesn't make many mistakes. In the often-chaotic petroleum business, its careful budgeting and efficient operations are widely admired.

But Exxon's stingy approach to capital spending -- amid skyrocketing oil prices -- could be a target of second-guessing for years to come. With crude oil hitting a record above $113 a barrel Tuesday, the payoff for extracting more petroleum is enormous. Until very recently, Exxon hasn't been sprinting to win that race.

Consider these numbers. In 2007, Exxon spent 5.3% of revenue on exploration and capital outlays, down from 6.5% in 2003. The actual dollar amounts did increase, to $20.9 billion from $15.3 billion. But they didn't keep pace with Exxon's overall revenue growth, let alone soaring oil prices. Crude climbed to about $92 from $34 a barrel during that period.

Meanwhile, the Irving, Texas, oil giant poured cash into stock buybacks. In 2007, Exxon repurchased $31.8 billion of its shares, up five-fold from the amount acquired in 2003. That activity helped earnings per share. It didn't increase oil output.

Wall Street analysts generally have cheered this financial conservatism, on the notion that big oil companies tend to waste money when they start drilling with too much gusto. But some now wonder if Exxon played it too safe. Benchmark Co. analyst Mark Gilman mutters about the company's "moribund" exploration program.

"Exxon has consistently been the most cost-disciplined of the big oil companies," says Morgan Stanley analyst Doug Terreson. "They most likely believe that the historic rise in oil prices isn't sustainable. Otherwise they would be spending a lot more than they have."

Exxon keeps a tight lid on its internal oil-price forecasts, but analysts say it has acted as if it wants to make sure its spending decisions still make sense in a world of $65 or even $40 per barrel oil. In moderation, such "stress testing" is an essential part of good budgeting. Taken to extremes, it can stifle almost any initiative.

Last month, Exxon finally announced a big boost in drilling efforts. Rex Tillerson, the company's chief executive, said exploration and capital spending for 2008-2012 were being raised at least 20% beyond previous forecasts. That amounts to outlays of more than $125 billion over that five-year period.
[Rex Tillerson]

Part of the increase simply reflects higher costs for oil projects, Mr. Tillerson told analysts, as boom times send both labor and equipment rates soaring. But he also hinted at greater optimism within Exxon about what projects are worth pursuing. "Some things are moving ahead that we were not as prepared to put in the outlook last year," Mr. Tillerson said.

Exxon officials say they like their competitive position. Current or planned projects range from Greenland to New Zealand. They include a wide mix of conventional oil and gas, heavy oil, liquefied natural gas and deepwater initiatives. Spokesman Gantt Walton calls the company's resource base of 72 billion oil-equivalent barrels "the largest and highest quality in the industry."

Even with the cautious capital spending of recent years, Exxon has added reserves slightly faster than it has drawn them down. But making new projects pay off will take years.

What's more, countries such as Venezuela and Russia have become more assertive about the terms on which foreign oil companies can operate within their boundaries. That's made it harder for companies such as Exxon to roam the globe as profitably as they used to.

"So many places are off limits," says J. Bennett Johnston, a former Chevron Corp. director and senator from Louisiana who runs Johnston & Associates, a political-consulting firm in Washington. He contends that Exxon and other major oil companies are "going about as fast as they can."

Exxon isn't under any obligation to push every dollar of its sturdy profits -- $40 billion last year -- into dubious exploration efforts. But its recent strategy of focusing heavily on share repurchases can't go on forever, either. By some calculations, if Exxon sticks to its current buyback rate, its last share of publicly traded stock will disappear in 15 years.

Exxon's other big alternative could be to use some of those repurchased shares to finance a major acquisition. But at current oil prices, almost any logical target is far more expensive than it was a few years ago.

The company could just wait until oil prices stumble and acquisitions become cheaper. But the way energy markets are behaving, and the way global demand for energy keeps climbing, that could be a long, lonely vigil.

Questions:

1. What