Should Exxon remain a petroleum and petrochemical company, or become an energy company?

There is nothing like high retail gasoline prices to get Americans talking about energy issues. Even some of the American aristocracy – members of the Rockefeller family -are taking advantage of the current interest to try to gain more support for a shareholder initiative suggesting a change in ExxonMobil’s corporate structure.

Since about 2003, certain members of the Rockefeller family have been working to gain support for several shareholder initiatives designed to modify the company’s direction. According to a front page article by Leslie Eaton and Russell Gold published in the Wall Street Journal issue dated May 24, 2008 titled Rockefeller Rebellion Turns Up Heat on Exxon the family has some concerns about the future value of their company holdings. They want the company to diversify a bit away from oil and gas by investing in alternative energy and they want the company’s management structure to be altered by separating the Chief Executive Officer (CEO) role into two independent offices, a Chairman of the Board and a CEO. The idea is that the current structure is too insular; the CEOs are normally people who have worked their way up in the company ranks and are fully invested in the corporate philosophies. Here is how the current CEO and Chairman of the Board feels about the proposal:

Exxon roundly rejects the need both for an independent chairman and for investing more in alternative energy. Chairman and Chief Executive Rex Tillerson says his job is to protect shareholders’ investments by helping the company’s thousands of engineers and scientists focus on its core business: oil and natural gas. The company says oil and gas will continue to provide the bulk of energy needs and they are working to provide that needed energy.

“We are a petroleum and petrochemical company,” he said in an interview. “In fact, we think we’re the best one in the world and our performance would tend to support that.”

Exxon really is a fine, well focused company that is full of engineers and scientists who are some of the world’s best at what they do. However, I think that the Rockefellers have a point worth considering. The company management is a bit smug about financial results that hide a performance weakness that should worry shareholders – despite enormous investment and hard work, ExxonMobil’s oil production in 2007 was about 10% less than it was in 2006. Its total petroleum product sales fell, its chemical sales fell and its natural gas production increased a very tiny amount. I am sure that there are many corporate managers who would love to be in a market where they can report impressive profit increases even with a drop in production.

It seems to me that the company’s behavior is also indicating that the managers are enjoying current market conditions rather that focusing on ways to improve the company’s ability to produce products for its customers. Like four other major oil companies with US presence ExxonMobil provided an executive – Stephen Simon Senior Vice President – to participate in the routine flaying of oil companies by both the House of Representatives and the Senate this week. He stated that Exxon needed its high current profits to allow the company to invest in the future so that we would all have enough oil and gas. Here is one of his statements as reported by the Voice of America:

Others, including Stephen Simon, senior vice president of Exxon Mobil, said their firms’ profits are invested back into the company.

“Our profitability in absolute terms is large, but it must be viewed in the context of the massive scale of our industry and our dependence on high earnings in the current up-cycle to sustain the huge investments required over the longer term,” he said.

What he did not mention was that Exxon managers had determined that the best possible use for about $8 Billion out of the $10 billion in profit that they made during the first quarter of 2008 was to buy Exxon shares in the open market. That capital did not go into new production capability, it went into the market to try to help prop up the value of shares so that the executives could stand proudly in front of shareholders with a share price graph pointing in the right direction.

The Wall Street Journal’s editorial board thinks that the company leaders are performing their fiduciary responsibilities well, according to The Exxon Fight, Round 2. In that May 22, 2008 opinion piece, the board believes that the Rockefellers are wrong to ask the management to spend a bit more money in areas outside of oil and gas:

“ExxonMobil is an example of how hard work, efficient management and innovative entrepreneurism breed success,” Mr. Canterbury wrote, noting this was why many union pension funds have invested in the oil company. “The Rockefeller resolutions threaten to degrade the value of ExxonMobil.”

And more: The family would impose “rigid, ideologically-based conditions on the company’s future,” would nullify “the judgment of a highly successful management team,” and would “undercut every project and business operation.” This would “hamstring ExxonMobil’s profitability and growth, thus directly harming the police officers, firefighters, teachers and public employees whose retirement savings are invested in the company.”

Mr. Canterbury seems to understand how capitalism works better than do the ostensibly capitalist Rockefellers. His letter is a reminder that Exxon’s legal obligation is to maximize returns to shareholders, and that over the years it has done that by taking calculated risks in drilling for fossil fuels. Many investors put their money into Exxon precisely because the company does that so well.

Similar corporate governance reforms haven’t helped the returns of other oil giants. Royal Dutch Shell and BP have both split the roles of chairman and chief executive, without any discernible benefit to shareholders. Since 2006, when Mr. Tillerson assumed the top roles at Exxon, the company’s stock has climbed 57%, compared with 12% for Royal Dutch Shell and 4% for BP. Over the past 10 years, Exxon has consistently outpaced those rivals and the industry average in annual average returns on investment.

It is pretty clear that the future world extraction rate for oil and gas is not going to be as high as the rate of demand for the power potentially provided by that oil and gas. There is still oil and gas left to be extracted and companies like Exxon can continue to make a huge profit by focusing on that effort. However, the vast majority of the shareholders in ExxonMobil are probably people with a much broader view of the world than the managers at the company.

They realize that a situation of increased profits from the declining sale of oil and gas means a world of far less opportunity for everyone else’s growth and development. They might also recognize that a company whose stock climbs 57% in two years is a decent investment, but that is not the kind of return on investment that can overcome job losses or major market disruptions in energy dependent industries like autos, airlines, trucking, steel, and agriculture.

My advice should come as no surprise. I believe that ExxonMobil should put some of its massive capital assets to work in the nuclear power business. It is a place where they can create massive new sources of power that will allow them to increase production and deliver the energy that will enable the entire economy to grow and prosper. Exxon’s quarterly profitability might drop a bit because a shift in the supply-demand balance would cause lower prices and margins in their upstream crude oil and natural gas businesses, but there is a very good chance that the market would reward a company that looked like it was going to grow through technological improvements that increased production in
stead of growing by increasing the cost of everyone else doing business.

Exxon managers might want to start comparing their company’s share price multiples against some real competition – like Apple, Google, Toshiba, or Areva – instead of just against others in the same business. They might figure out that they are not such good stewards of their shareholder’s money after all.