Thanks for another excellent column. I clearly remembered that many Wall Street analysts put out sell rating on XOM in 2020, One of their main arguments was that XOM spent too much on CapEx, which was also a point raised Engine #1 in the spring of 2021. The idea that investing counter-cyclically seemed to be lost to those analysts. One deep impression your articles have given to me is to look at the ROCE of an energy company. According to this chart published on Seek Alpha, the ROCE of XOM on twelve-trailing-month basis was already 36.7% as of the end of 3Q2022 (https://static.seekingalpha.com/uploads/2022/11/8/48844541-16679307177203414_origin.png). XOM's counter-cyclical investment is one of the important factor for such a high ROCE. But given your experience, how high do you think XOM's ROCE can go?
Tonyforever, Regarding CAPEX in general and counter cyclical investing, the actual projects (or acquisitions) of course matter. When XOM was arguing they were investing counter cyclically over 2015-2020, the problem was that it was coming after a long stretch of not so great investments (starting with XTO). The 2015-2020 CAPEX may well work out, but I get the Street's skepticism since XOM's fabled ROCE advantage had completely evaporated.
I don't have a specific forecast for XOM. For the sector, traditionally 25%-30% ROCE, which is about the current level, has been about as good as it gets. That may well still be true. However, the range of "normalized" ROCE (measured over 20-30 years) can be as low as 8%-10% for many companies and 15%-25% for "top quartile". XOM could well return to top quartile status and superior structural ROCE.
Apologies for delayed reply...didn't want to give a quick answer.
I did not become an investor in oil and gas companies until December 2019 when I came across a column that mentioned the marketcap of AAPL had become greater than the marketcap of the entire energy sector in S&P 500. So, my knowledge of the sector, especially before 2020, is very poor. Rex Tillerson was the CEO of XOM from 2006 to 2017. Is it fair to say most of the sins in XOM's capital allocation in the past decade were committed while Tillerson was in charge ? The story of moving100-foot oak tree, which was more than 100 year old, from a forest to a courtyard within the XOM's new headquarter, really fit Rex well (the tree eventually died).
Tonyforever, There is little question that something changed and not for the better post Lee Raymond's retirement. In many respects, subsequent management started with a continuation of the Lee Raymond playbook at a time the world was changing (i.e., the 2002-2014 Super-Spike era began). When they did shift, it was too late an into "wrong" assets/projects. There are many reasons for the downfall, but I think it might all boil down to the insular nature of XOM's culture did not welcome a broad enough range of views.
Are you saying that in this scenario demand is flat because MORE CANNOT BE SUPPLIED. In this scenario, PRICE WILL BE USED TO RATION SUPPLY? Thank you for sharing your thoughts.
*****
What do you need to believe that terminal value for the top two ROCE quartiles should not be zero?
(1) Oil and natural gas demand will be higher in 2030 versus 2019, with a reasonable downside case of flat demand driven by a lack of supply growth
Tom, Yes, that is correct. My 107 mn b/d forecast for 2030 assumes that we have 7 mn b/d of oil supply growth. I think that is an entirely reasonable supply forecast but it does assume more of a CAPEX cycle gets going than what we have seen so far. Obviously lots of wildcards geopolitically in areas like Russia and the Middle East. I would suspect that if oil demand is less than 107 mn b/d in 2030, it will be because oil prices spike to ration demand.
I am not expecting the (oil price) bearish path to 100 mn b/d which would occur through a sharp, sustained improvement in efficiency gains unrelated to price. That latter scenario is possible on a multi-decade basis, but I see no evidence you would sustain efficiency gains in a weaker price environment over the shorter term.
Excellent piece. I’m very bullish on energy and commodities for the next 5 or 10 years. I hope more people begin to realize if you aren’t in support of all energy and especially fossil fuels you are basically against human flourishing.
Hi Arjun,
Thanks for another excellent column. I clearly remembered that many Wall Street analysts put out sell rating on XOM in 2020, One of their main arguments was that XOM spent too much on CapEx, which was also a point raised Engine #1 in the spring of 2021. The idea that investing counter-cyclically seemed to be lost to those analysts. One deep impression your articles have given to me is to look at the ROCE of an energy company. According to this chart published on Seek Alpha, the ROCE of XOM on twelve-trailing-month basis was already 36.7% as of the end of 3Q2022 (https://static.seekingalpha.com/uploads/2022/11/8/48844541-16679307177203414_origin.png). XOM's counter-cyclical investment is one of the important factor for such a high ROCE. But given your experience, how high do you think XOM's ROCE can go?
Tonyforever, Regarding CAPEX in general and counter cyclical investing, the actual projects (or acquisitions) of course matter. When XOM was arguing they were investing counter cyclically over 2015-2020, the problem was that it was coming after a long stretch of not so great investments (starting with XTO). The 2015-2020 CAPEX may well work out, but I get the Street's skepticism since XOM's fabled ROCE advantage had completely evaporated.
I don't have a specific forecast for XOM. For the sector, traditionally 25%-30% ROCE, which is about the current level, has been about as good as it gets. That may well still be true. However, the range of "normalized" ROCE (measured over 20-30 years) can be as low as 8%-10% for many companies and 15%-25% for "top quartile". XOM could well return to top quartile status and superior structural ROCE.
Apologies for delayed reply...didn't want to give a quick answer.
Hi Arjun,
Thanks for the reply.
I did not become an investor in oil and gas companies until December 2019 when I came across a column that mentioned the marketcap of AAPL had become greater than the marketcap of the entire energy sector in S&P 500. So, my knowledge of the sector, especially before 2020, is very poor. Rex Tillerson was the CEO of XOM from 2006 to 2017. Is it fair to say most of the sins in XOM's capital allocation in the past decade were committed while Tillerson was in charge ? The story of moving100-foot oak tree, which was more than 100 year old, from a forest to a courtyard within the XOM's new headquarter, really fit Rex well (the tree eventually died).
Tonyforever, There is little question that something changed and not for the better post Lee Raymond's retirement. In many respects, subsequent management started with a continuation of the Lee Raymond playbook at a time the world was changing (i.e., the 2002-2014 Super-Spike era began). When they did shift, it was too late an into "wrong" assets/projects. There are many reasons for the downfall, but I think it might all boil down to the insular nature of XOM's culture did not welcome a broad enough range of views.
Thanks Arjun.
Are you saying that in this scenario demand is flat because MORE CANNOT BE SUPPLIED. In this scenario, PRICE WILL BE USED TO RATION SUPPLY? Thank you for sharing your thoughts.
*****
What do you need to believe that terminal value for the top two ROCE quartiles should not be zero?
(1) Oil and natural gas demand will be higher in 2030 versus 2019, with a reasonable downside case of flat demand driven by a lack of supply growth
Tom, Yes, that is correct. My 107 mn b/d forecast for 2030 assumes that we have 7 mn b/d of oil supply growth. I think that is an entirely reasonable supply forecast but it does assume more of a CAPEX cycle gets going than what we have seen so far. Obviously lots of wildcards geopolitically in areas like Russia and the Middle East. I would suspect that if oil demand is less than 107 mn b/d in 2030, it will be because oil prices spike to ration demand.
I am not expecting the (oil price) bearish path to 100 mn b/d which would occur through a sharp, sustained improvement in efficiency gains unrelated to price. That latter scenario is possible on a multi-decade basis, but I see no evidence you would sustain efficiency gains in a weaker price environment over the shorter term.
Excellent piece. I’m very bullish on energy and commodities for the next 5 or 10 years. I hope more people begin to realize if you aren’t in support of all energy and especially fossil fuels you are basically against human flourishing.
Thank you very much. It is shocking to see things like the Glasgow Alliance for Net Zero and how anti-humanity it is.