23 mayo 2007

Pumping Cash, Not Oil

Exxon's risk-averse stock-buyback strategy is the new profit model

With gas prices hitting record highs, Exxon Mobil (XOM ) Corp. ought to be drilling like mad and refining more of that black gold, right? As it turns out, the world's largest oil producer thinks it is smarter to use more of its resources to buy back stock. The indirect result: increased pain at the pump for consumers.

It's Big Oil's new formula for making money. Last year, Exxon pumped out $49 billion in operating cash flow on sales of $365 billion. It's the world's most profitable company, but Exxon is plowing a smaller percentage of its spare cash back into the business. Although capital expenditures have risen from $11 billion at the start of the decade to nearly $20 billion, that spending amounts to roughly 40% of cash flow, down from 50% in 2000. Meanwhile, overall production has barely budged since its megamerger in 1999.

Instead, Exxon is bingeing on buybacks to help boost profits, which also benefit from higher commodity prices. Repurchases have been part of Exxon's strategy for decades, but they've exploded in recent years. Exxon spent 60%, or $29 billion, of its cash flow on repurchases in 2006, more than any other company in the Standard & Poor's 500-stock index and a tenfold increase since 2000. The company has retired 16% of shares in the past five years, adding an estimated 88 cents to earnings of $6.68 per share. With Exxon's stock handily beating the market and peers with a 15% annual return over the past decade, others in the oil patch are catching on to the strategy. "They don't need to grow production in order to generate shareholder returns," says energy consultant Richard Gordon.

Exxon takes pride in its fiscal restraint. At a three-hour-long meeting with Wall Street analysts in March, top brass used the word "discipline" no fewer than 29 times. In Exxon parlance, that refers to a sharp focus on returns. It means not chasing marginally profitable oil wells, not pouring money into costly new refineries, and not staffing up aggressively. Exxon employs 82,000 people, 10,000 fewer than in 2002. "Our business model," Chairman and CEO Rex W. Tillerson told analysts, "begins with discipline."

That mantra traces back to the early 1980s. Like many oil producers, Exxon tried to diversify during the 1970s boom, pouring billions into unsuccessful forays such as an attempt to produce oil from shale deposits in Colorado and the acquisition of Reliance Electric, an electric motor manufacturer. "We had huge cash flow and not many good investments to put it into," then-CEO Clifford C. Garvin Jr. said at the time, according to The Prize, Daniel H. Yergin's Pulitzer-winning book about the industry.

If anything, it's even more challenging for Exxon to find opportunities today. For one, there are issues with access to oil fields. In April, Venezuela President Hugo Chávez nationalized a number of large oil fields in that country, including Exxon's. Exxon also must compete for hot prospects with government-sponsored oil companies that don't have to worry about pleasing Wall Street. Plus, the really juicy fields are located thousands of feet underwater off the coast of Africa or in remote parts of the former Soviet Union, locales that require years of spadework to start producing. "An investment of any consequence takes a minimum of six years," says Kenneth P. Cohen, Exxon's vice-president for public affairs.

But sometimes it's important to take a little risk. Despite the failed ventures during the 1970s, that boom period also produced world-class fields in the North Sea and Alaska's Prudhoe Bay that appeared speculative at the time but are now critical sources of supply. Exxon seems to be shying away from such risks today. Citing higher-than-anticipated costs, it backed out of a project in February that would have converted natural gas in Qatar into diesel fuel for export. Similarly, Alaskan politicians have been begging oil companies to build a new pipeline to carry natural gas to the 48 continental states. Exxon says it would pursue the project only if the tax situation in the state is favorable. CEO Tillerson has also indicated publicly that he won't build a new refinery in the U.S., pointing to internal research that domestic gasoline consumption will plateau in coming years as ethanol and energy-efficiency measures crimp demand. Indeed, there's plenty of legislation in Congress right now aimed at curbing consumers' appetite for gasoline. So Exxon is partnering with two companies, one Chinese and one Saudi Arabian, to build a $3.5 billion refinery in China, where demand seems more assured.

Currently, Exxon pumps out 4.4 million barrels of oil and natural gas a day, roughly the same as its output seven years ago. The company's production of gasoline, jet fuel, and other refined products is 5.7 million barrels a day, modestly higher than 2000. Exxon says it has added 130,000 barrels of capacity but also divested plants to improve profitability.

Exxon isn't the only big company facing essentially flat output. Oil and gas volumes slid 1% last year at Royal Dutch Shell (RDS ) PLC. After adjusting for recent acquisitions, they were flat at BP (BP ), Chevron (CX ), and ConocoPhillips (COP ). "Companies say, 'There are fewer places we can find big oil,' and there's some truth to that," says Amy Myers Jaffe, who heads the Baker Institute Energy Forum at Rice University in Houston. "Wall Street has to ask itself whether it made sense to create these big oil companies when some smaller, nimbler players are doing better [at finding opportunities]."

Although Exxon has said it will increase oil and gas production from 4.4 million barrels to just under 5 million barrels by 2010, it has a poor record, like other oil majors, of generating such growth. It's also unclear whether it really makes sense from a profit standpoint. After all, Exxon has proved that buybacks enhance earnings nicely. And management doesn't seem to be easing up. In the first quarter, Exxon repurchased $7.8 billion worth of stock.

Exxon is not alone. Chevron, which also says it plans to increase production, bought back some $4.5 billion of its stock in 2006, vs. $2.6 billion the prior year. Overall, the industry spent $52.4 billion on buybacks last year, nearly double the amount in 2005. "Exxon has established the path most companies are following," says Arthur L. Smith, chairman of industry researcher John S. Herold Inc. "The profound fear is that prices are going to fall again, and the relief valve is stock buyback."

But as gas soars past $3.10, politicians and others are increasingly scrutinizing the way Big Oil does business. On May 9 a handful of lawmakers held court at an Exxon station near the Capitol to offer their prescription for lower prices. Senator Maria Cantwell (D-Wash.) is promoting an "anti-gouging" bill aimed at oil companies. Senator Bernie Sanders (I-Vt.) wants a windfall tax on outsize profits such as Exxon's and hopes to break up the massive oil companies formed through mergers, which he says have curbed competition.

Still, even Sanders concedes that his proposals are a long shot. "Economists tell us high prices should send the signal for Exxon to invest [in growing production]," says Tyson Slocum, director of the energy program at the consumer group Public Citizen. "But that's not happening. They're transferring that money from the wallets of consumers to shareholders."