I just spent the past hour and 9 minutes listening to the ExxonMobil earnings call for the fourth quarter of 2010. The company reported some impressive numbers. Exxon recorded $9.3 billion in net earnings for the fourth quarter and $30.5 billion in net earnings for the year. The company generated $51.7 billion in cash flow and returned $19.7 billion to shareholders, about $8 billion in dividends and more than $11 billion as part of a share buy back program that has been underway for at least 5 years.
There were a couple of parts of the call that made me do a little critical thinking. Besides the fact that several slides and discussions showed that ExxonMobil is keenly aware of the importance of maintaining a profitable balance between supply and demand (no surprise there), I also learned that the company is very happy with the results from its recent $41 billion purchase of XTO, a large natural gas drilling specialist focused on the North American market.
During the question and answer session, one analyst probed for some details regarding the contributions that purchase had made to the corporate earnings results. The briefing presenter, David Rosenthal, Vice President Investor Relations & Secretary, had earlier described how pleased ExxonMobil had been with the results of the merger and the smooth integration of the new company with the existing company.
The published profit numbers were not terribly impressive – $120 million in earnings for the quarter from XTO. The XTO takeover cost ExxonMobil about $41 billion, so a very rough computation of the annual rate of return on that investment would be about $120M per quarter x 4 quarters/year / $41,000M (purchase price) = 1.1% per year.
My impression of the results from that purchase worsened once the analyst discovered that $84 million out of the $120 million was a result of gains from a hedging program. As David Rosenthal clearly explained, the hedging program contributed a positive number to earnings as gas prices fell. When the market price of gas is lower than the hedge price, selling at the hedge price provides a positive number to the earnings report.
Therefore, the net profit from actual production coming from XTO was just $36 million for the fourth quarter of 2011. If you turn that number into an annual profit number and then divide by the purchase price, the net return on investment was just 0.35%. I would expect a company that prides itself on a disciplined approach to capital purchases and sales to have expressed disappointment with that kind of result.
The questioning analyst also seemed to be a bit surprised by the equanimity that David showed in providing that number. Here is an excerpt from the exchange:
Analyst: “So if I look at it without hedging, the earnings are 36 million only?”
David Rosenthal: “Yes, that would be the answer for the fourth quarter.”
Lengthy period of silence
Analyst: (very quietly) “Okay. Um alright.”
After all, XTO is the company that ExxonMobil purchased for its ability to extract and sell natural gas into the North American market. It is a major component of what ExxonMobil described on its earnings call slides as an “unmatched North American unconventional portfolio.”
Very near the end of the call, I gained a better understanding of the reason that ExxonMobil is pleased with the XTO purchase and the North American natural gas assets that it provides. The revelation came when Ian Reid from Jeffries asked David Rosenthal if he would entertain a question about ExxonMobil’s Energy Outlook.
Ian Reid What’s obvious from that is your more bullish view of natural gas demand versus coal compared to other commentators. I’m just wondering if you could characterize Exxon’s view of natural gas versus coal, how it differs to other people. What’s kind of driving the numbers that you are coming up with here.
David Rosenthal: Sure. Well, of course, the primary growth in the usage of natural gas is going to be in power generation (emphasis added). And I think if you’ve seen our Energy Outlook, you’ve seen the growth in that. One of the fundamental reasons for that, for the numbers that we’ve tabled, of course, is an assumption on cost of carbon. However form that might come it will certainly drive some conversion of coal to gas.
I think one of the other things that we have out there, as you see the economy ramp up and as you see the demand for power generation to ramp up, certainly the source of electricity generation that can be brought on the quickest, particularly here in the US, is fueled by natural gas.
So if you are looking short term, increased industrial demand, increased need for power generation, electricity and then longer term as we go out and look at the dynamics, the assumption that there will be some cost of carbon included. And as you know natural gas has 60% less GHG emissions than a typical coal fired plant you will have inherent competitive advantages.
Although a search of the downloadable 7 MB PDF of Exxon’s Energy Outlook reveals that the word “nuclear” appears 37 times on the full report, the word does not appear at all on the summary page introducing their report. Here is a quote from that page with my favorite energy source glaringly omitted from a lengthy list of options.
We will need to continue to expand all available energy sources to meet this substantial increase in demand. (emphasis in original)
These sources must include oil, natural gas and coal, which by 2030 will continue to meet about 80 percent of the world’s energy demand.
Modern renewable fuels – wind, solar and biofuels – will expand significantly. Coal will decline sharply in OECD countries, but continue to be the predominant fuel for power generation in Non OECD countries.
Technology will continue to evolve and play a key role in increasing efficiency, expanding supplies and mitigating emissions. These three elements must be pursued with vigor and constancy of purpose in order to meet our global energy and environmental challenges.
In the full report, there are several passages that indicate that Exxon believes that nuclear energy will capture some market share from coal, but it expects that natural gas will capture some of of coal’s market share as well. There is no indication that Exxon believes that nuclear has any chance of capturing electrical generation market share from gas.
I suppose if you ask Aaron Rogers he would say that there is no chance of the Steelers capturing a win from the Packers this coming weekend. However, the long running competition for energy market share is in full swing and the winners are still unknown. In a world that prices carbon, that values reliable, low cost power, and that allows nuclear plants to be built on a reasonable schedule driven by technical demands instead of regulatory barricades, nuclear energy beats natural gas. Of course, Exxon is big enough and disciplined enough about its economic analysis effort to be working behind the scenes to tip the scales a bit in its own favor.