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Douglas Grandt answerthecall@mac.com

The upstream of the boat sinking, and how is downstream surviving?
July 10, 2015 at 7:59 AM
Rex Tillerson Rex.W.Tillerson@ExxonMobil.com
David Rosenthal David.S.Rosenthal@exxonmobil.com, Kenneth P Cohen kenneth.p.cohen@exxonmobil.com

Rex,
If you believe your diversification strategy will save ExxonMobil, answer me this: What happens to refinery feedstocks as
upstream production declines due to a continued low price for crude?
Whether the international or domestic price of crude is held down by over supply in the U.S., Saudi Arabia, Iran, or OPEC in
general, you know what will happenindeed, what already is happeningas downstream feedstocks decline, and in some
likelihood, dwindle to a trickle. Your downstream end of the boat will sink right along with the upstream end of the boat.
Not-such-a-great strategyshort sighted. Will XTO be your life raft? Surviving with gas? Will you get out of refining, also?
Is that your plan? But what about the consumers you will leave wanting with insufficient supply? How will you fuel your car?
ExxonMobil CEO Leads Industry to Massive Fleet Acquisition of Electric Vehicles as LNG Exports Drive Profits
If that is the media headline you are least expecting what an ironic outcome isn't that where your plan is heading?
Sincerely yours,
Doug Grandt
...

Why You Should Short Public Oil Companies

BloombergView | Carl Pope | July 8, 2015

http://bit.ly/Bloom8July15

U.S. coal companies have lost about 75 percent of their market value during the
bull market that began in 2009. Oil and gas companies, which account for 60
percent of U.S. carbon emissions, and about 84 percent of fossil fuel market cap,
have fared much better. But risks abound.
Publicly traded oil and gas companies have access to only 10 percent of the
worlds oil reserves. As it happens, their reserves are often located in deep water
far from shore or in the complex geology of tar sands, making them among the

far from shore or in the complex geology of tar sands, making them among the
most dicult -- and expensive -- to extract. Readily accessible, inexpensive crude
reserves in places like Russia and the Persian Gulf are set aside by governments
for their own national oil companies.
That didn't seem to matter when prices were high. From 2004 to 2013the real price
of oil almost tripled. Demand jumped by 13 percent. Customers kept driving and
flying even as costs soared. Pumping $25/barrel crude and selling it for $40/barrel
is a good business. Selling it for $120/barrel is a spectacular business. Saudi
Arabia, Russia, Kuwait, Norway, Nigeria and Venezuela reaped bonanzas. So did
the oil majors -- BP, Chevron, Exxon Mobil, Eni, Phillips, Shell and Total profited
from legacy oil costing them only $30 to $60 per barrel.
In 2012 Bernstein analysts produced a
sobering look at the industry fundamentals.

Oil Prices

With oil above $100/barrel, Bernstein found

that the 50 largest, publicly traded, non-OPEC oil and gas companies were under
financial stress. Average net income margins had dropped to 22 percent, 30
percent lower than when oil was priced below $40/barrel. The replacement cost of
oil -- the long-term marginal cost of production -- had increased by 44 percent in a
single year. Easy oil had already been found. When replacement costs were
factored in, the average marginal cost for non-OPEC producers was
$104.50/barrel. Net income margins in the sector are now at the lowest in a
decade. This is not sustainable," the Bernstein report stated. "Either prices must
rise or costs must fall."
In eect, publicly traded oil and gas companies had become dependent on ever
higher oil prices to match their ever higher costs of discovery. Even the biggest
and richest of them, Exxon Mobil, increasingly taps expensive unconventional
sources to maintain production. From 2006 to 2013 the percentage of Exxon
Mobils proven reserves made up of tar sands and heavy oil increased from 15
percent to 32 percent. Relying on a larger share of more expensive oil reduced
Exxon Mobil's margins and returns. Its stock value trailed the S&P 500 by 40
percent during those seven years -- even as the company used the vast majority of

percent during those seven years -- even as the company used the vast majority of
its profits to buy back shares to sustain their value. Two years ago the situation
was suciently dire that the Economist proclaimed that the day of the huge,
integrated international oil company is drawing to a close.
From 2004 to 2014 oil companies kept investing more than a half trillion dollars a
year in finding and developing new fields for which the break-even point would be
$75-to-$125 per barrel. Development completed, companies started pumping the
new crude. Demand didnt rise as fast as expected; supply outran it. In the
summer of 2014 the oil market was suddenly glutted. A 5 percent shift in the
supply-demand ratio cut prices by more than 50 percent, from $110/barrel to
below $50, then back into the $50-to-$60 range.
Chevron cancelled its stock buy-back program, but even so is in a negative cash
flow position. Goldman Sachs calculated that more than half of the new oil
projects awaiting investment go-ahead would be uneconomic at todays prices,
leaving in limbo $750 billion in investment and 105 million barrels a day of potential
production.
As prices fell, the first Canadian tar sands oil companies began to file for
bankruptcy. About 1.4 million barrels a day of tar sands projects were put on hold
or cancelled . Oil and gas revenues in Alberta are down almost 50 percent.
Independent U.S. oil producers scrambled for cash to service their debts. Bankers
worried that oil and gas debt could be the next sub-prime crisis.
Many new projects are losing money. Due to sunk development costs, however,
their owners keep pumping to generate cash flow -- keeping the market soft. North
American exploration dropped by 35 percent;the U.S. rig count is down more than
50 percent. Oil majors slashed their exploration budgets by up to one third.
Productivity and output kept rising. (Meanwhile, BP just agreed to an 18.7 billion
settlement of claims stemming from the Macondo oil spill in 2010.)
The market initially didnt seem particularly worried by all this. Exxon Mobil stock,

The market initially didnt seem particularly worried by all this. Exxon Mobil stock,
for example, is down only 10 percent from its peak. But if public oil companies
couldnt make robust profits when oil was priced at more than $100 per barrel,
how will they fare long-term if a barrel of oil is priced in the $50-to-$80 range?
Capital and operating eciencies may be leading to greater productivity, creating
the potential for the break-even point to drift down the price range. But how low
can they aord to go?
Worse, the world is not especially eager to remain hooked on oil. California has
committed to cutting oil consumption by 50 percent. Electric vehicles have tiny
market share, but sales have more than doubled every year for three years. Natural
gas as a U.S. trucking fuel is growing 15 percent a year. Along with radical
increases in vehicle eciency, these trends will all combine to undermine growth in
demand for oil for years to come.
A looser oil market wouldnt end global use of oil. But demand growth could easily
slow enough that legacy production, along with new OPEC and Russian fields and
the most ecient U.S. shale deposits, could satisfy the market. Prices would fall
even if demand held steady. In that situation, any public oil company that
continued to invest heavily in expensive new projects would be burning up
shareholder value.
It could get grimmer still. The Saudis just suggested -- before retracting the
statement -- that the era of fossil fuels might end in the middle of this century.
Suppose they actually believe it -- and even hedge against it? Suppose the
Kingdom tries to sell o its oil before the price collapses. What would that do to
the market for Shells costly Arctic drilling? For the complex, dirty extraction of
Canadian tar sands? Ultra-deep Brazilian pre-salt wells in the South Atlantic? Even
some of the more expensive U.S. shale wells?
It wouldn't take much to send such a market spiraling down. By contrast, the
reverse path back up to profitable $100+ prices seems very steep.

For some time to come, oil as a commodity will still enjoy powerful incumbency
advantages. But as market pressures intensify, publicly traded oil companies will
be increasingly squeezed by OPEC, Russia, electric vehicles and other competing
energy sources. Barring another revolution in shale technology, the majors would
have access only to the highest-cost segments of a potentially oversupplied
market. That market is inherently volatile, and the industry is vulnerable.
Divestment from oil may be a moral cause for some investors. Others -- those
seeking profit over the long term especially -- might want to follow suit simply to
save their shirts.