Saturday, April 21, 2007

Exxon-Mobil: economic insights from big oil

An article on the firm greenies love-to-hate, Exxon-Mobil, that is in the latest Fortune particularly interested me. In terms of share-market capitalization and profits this is the largest Fortune 500 firm and one of the world’s biggest - profits in 2006 were the largest in US history at $39-5 billion*. Exxon’s business is mainly oil and gas and that is exactly where it sees its future too. Unlike other oil majors it is uninterested in alternative energy supplies arguing that they are either uneconomic (solar, ethanol) or economic though out of its field of expertise (hydroelectric, biogas).

Exxon is an immense business with very high rates of return on capital relative to the other oil majors. In business terms it has managed to get things right. If it did seek to change its bottom line, by changing its areas of specialisation, it would need to be involved in very large new projects. But it just doesn’t envisage these arising in the energy area because it sees oil, gas and coal as the dominant fuels through to the end of the twenty-first century – other fuels and technologies will supply less than 30%.

Exxon admits it doesn’t have a clue what future oil prices will be but fears one particular long-tailed event - a collapse in oil prices. I have posted before on this possibility. Economists like Morris Adelman (of Genie out of the Bottle: World Oil Since 1970 fame) argued that price rises for supply-side reasons happened repeatedly over the 20th century only to be invariably followed by price collapses as demand fell with a lag in response to the increased prices and as new oil supplies were eventually brought on stream**. The current oil price hike is due to massive increased demand from China and India. But eventually these demands will be hit by persistently higher prices and as new and substitute supplies come on stream. These processes occur with long and variable lags – variable now because the global economic structure has changed and reactions to oil price increases will be tempered by feverish economic growth.

If oil prices slumped to say $25US per barrel none of the alternative energy technologies envisaged by the greenies would look remotely economic. If oil prices rocketed to very high levels then, although Exxon would face competition from new fuels, damage would be limited by the increased value of existing oil sales. Hence Exxon regards the prospect of low oil prices as the more severe business risk and emphasizes the role of oil and gas in its future.

By the way, Exxon is now acknowledging that climate change is a reality and that a policy response is required – it has stopped funding some of the denialist groups it did support and now lists, among the climate change groups it supports, our own ABARE. Exxon's own internal policy response to warming is to emphasise fields where it does have expertise – reducing CO2 emissions from oil and gas, designing more fuel efficient cars and so on.

* This is one helluva big firm. Market capitalisation is $426 million or 3X that of BHP-Billiton Australia's mining giant.

** I am a Adelman fan having listened to him speak in the 1980s. He is about as knowledgeable as anyone alive on world oil markets and has a passionate writing style. Currently in his 80s he is an Emeritus Professor at MIT. But he might finally be getting it wrong. As late as 2004 he was denying the existence of a world oil supply problem.

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