Private Empire: ExxonMobil and American Power (79 page)

Tillerson said he decided to buy XTO in part because ExxonMobil’s corporate planning department forecasted rising natural gas demand. Climate change legislation in Congress was collapsing, and it was not easy to see when it might be revived, but in the medium run, higher carbon prices imposed by regulators—as already had been laid down in Europe and announced in Australia—still seemed very likely. If enacted, they would hurt coal and help natural gas. Mandates in the United States for more renewable energy such as wind and solar power also complemented natural gas investments because gas-fired electric plants could address, with relatively low emissions, the “intermittency” problem posed by renewables. (Intermittency referred to the fact that the wind did not always blow and the sun did not always shine, and so electricity generated from those sources could be erratic. Complementary gas-fired electricity could keep currents flowing on calm, rainy days.) Also, the megawatt-per-hour cost of gas-generated electricity looked favorable when compared with nuclear and unsubsidized renewable sources.

Tillerson insisted that ExxonMobil’s shift toward natural gas through the XTO purchase was not a “deliberate strategy” to favor natural gas over oil. In fact, however, ExxonMobil was nearing the point where it would own, on its books, more natural gas than oil. During the decade leading to 2010, ExxonMobil had replaced, on average, only 95 percent of the oil it pumped out and sold each year, but it had replaced, on average, 158 percent of the gas it extracted and sold. After incorporating XTO’s reserves, 45 percent of ExxonMobil’s reported reserves would be gas.
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Tillerson claimed that ExxonMobil’s disciplined systems could extract high profits from either oil or gas, but in the industry, gas was often less profitable to produce than oil, for a host of reasons—not least, the low prices plaguing American gas producers after 2008. Conoco forecasted that American gas prices would remain mired at relatively low levels and would not return to the boom prices of 2007 and 2008 anytime soon. Shell’s forecasters were a little more optimistic, but cautious.

A PowerPoint produced by analysts at the Society of Petroleum Evaluation Engineers in Houston noted that ExxonMobil’s purchase of XTO was “based on the assumption that much higher natural gas prices” were coming in the future, and yet, there was “considerable risk in shale plays” because of uncertain geological and commercial factors. “Reserves are overstated,” the presentation continued. “Costs are understated. . . . The gold rush mentality destroys capital and ensures the rule of expediency over science and risk management.”

Uncertainty and skepticism of this kind leached out from geological engineers in the form of unfavorable press reporting, some of which went so far as to ask whether the American shale gas boom was some sort of Ponzi scheme in which early investors bid up faulty assets and lured in big-money suckers like ExxonMobil. Unconventional gas wells behaved unlike other wells, and their decline and production rates could be hard to calculate—much about the drilling patterns in these fields still remained to be discovered. An individual gas well might lose its productivity much more rapidly in the first year of drilling than an oil well would, “but the decline rate on the [total] field is nil, because you continue to drill” in other sections of the field, as Shell’s Simon Henry put it. Yet there was evidence to support the doubters, too. At a minimum, shale gas producers were going to have to communicate with investors more forthrightly than they had done early on about their costs, risks, and profit potential.
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Wall Street swiftly made clear that it did not approve of Rex Tillerson’s decision to buy XTO. It looked to analysts and investors that Tillerson had overpaid for Simpson’s company and that ExxonMobil had made risky assumptions about future natural gas prices. Investors hammered ExxonMobil’s share price, relative to its peer group, in a way the corporation had not experienced for many years. Instead of the premium price that ExxonMobil shares had long enjoyed, ExxonMobil stock soon sold at a discount. As analysts at Reuters
Breakingviews
pointed out, during the seven months after the merger announcement, adjusting for the average 4 percent decline in the share prices of its peers Royal Dutch Shell and Chevron, ExxonMobil shareholders saw $41 billion disappear from the corporation’s total market price—an amount that eerily matched the price Tillerson had paid for XTO.
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Had ExxonMobil unwisely bought XTO at or near the top of the boom? It was certainly becoming clear that the peak years of 2007 and 2008 had led to reckless overinvestment in American gas leases by large, debt-burdened companies such as Chesapeake Energy. As that excess investment unwound, there would likely be opportunities for bottom-feeders to sweep up unconventional gas leases at lower prices than were reflected in the price ExxonMobil paid for XTO. That didn’t necessarily mean the merger was a mistake. That would depend on how ExxonMobil exploited XTO’s properties and expertise over time. Yet it was another basis for doubt. John Watson, the chief executive of rival Chevron, slipped the knife in: “We saw valuations for unconventionals that were a bit out of line with our view of value,” he told Wall Street analysts. “So our view wasn’t so much that shale gas wasn’t a good place to be. It was just the valuations at the time [of ExxonMobil’s purchase of XTO] were strong, so we waited.”
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Mark Gilman, the oil industry analyst at Benchmark Capital, regarded the XTO purchase as a sign that ExxonMobil’s long-term failure to build upstream reserves—which Gilman laid mainly at Lee Raymond’s door—was at last coming home to roost. Tillerson had little choice but to buy new reserves in a high-price environment because otherwise, he would be presiding over a shrinking corporation, which could reduce ExxonMobil’s share price, which could further limit its ability to buy its way out of its dilemma. The price paid for XTO might mean a reduction in ExxonMobil’s historical rates of return, but that, too, was inevitable and even welcome, in Gilman’s view, if it led to a more successful long-term performance in reserve replacement. On XTO’s purchase price, “I don’t fault Rex,” Gilman said. “It’s what you have to do when you have a weak hand.” He objected, however, to the specific choice of Simpson’s company, which he believed Tillerson had selected too much for “cultural and geographic” reasons, meaning the similarities in Tillerson’s and Simpson’s personal backgrounds, and the Fort Worth location of XTO headquarters. There were other unconventional gas owners—Devon Energy, for example— that might have paid off better.
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Dissent bubbled about the XTO deal within important sections of ExxonMobil’s executive ranks and alumni networks. Like many acquisitions in commodity industries, the deal’s payout would depend substantially on future prices, which nobody could forecast with certainty. According to a valuation prepared by Barclays Capital, without accounting for ExxonMobil’s potential to extract extra value from XTO’s reserves through engineering prowess, if natural gas prices remained as low as $5 per thousand cubic feet through 2014 and beyond, XTO might be worth only between $21 and $30 per share, a fraction of what ExxonMobil had paid. At least a few current and former senior executives worried about whether ExxonMobil could produce XTO’s gas profitably, even if gas prices did break out of their doldrums.
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Privately, according to some accounts, Tim Cejka argued that if he had been allowed to pay for exploration leases at the high per-unit prices that ExxonMobil had accepted in the price it paid for XTO, he would have more “organic” or ExxonMobil-discovered gas to show for his efforts. Cejka denied in a brief telephone interview that any serious dispute developed over this rate-of-return issue. In any event, ExxonMobil’s record during his time as head of exploration, at least toward the end of his tenure, was poor, whether it was his fault or not. By late 2009, it became apparent that Tim Cejka’s big forays into exploration and land leasing in Europe, at least, would not produce any early bonanzas. ExxonMobil’s early drilling yielded many dry holes. As Tillerson admitted, “Quite frankly, no one has enough information at this point to know” whether European unconventional gas would ever pan out.
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Overall, the corporation’s struggle in exploration and development showed no signs of turning around—its well-drilling failure rates rose by more than a third during 2007 and 2008. Cejka retired, leaving the company soon after the XTO deal closed.

“The mainstream belief that shale plays have ensured North America an abundant supply of inexpensive natural gas is not supported by facts or results to date,” wrote an analyst at
The Oil Drum
, an independent online energy journal. “The supply is real but it will come at higher cost and greater risk than is commonly assumed. The arrival of ExxonMobil and other major oil companies on the shale gas scene is positive because they will not follow the manufacturing approach, and will do the necessary science that should make shale plays more commercial. This does not, however, ensure success. ExxonMobil has come late to the domestic shale party. . . . It is also possible that XTO has already drilled the best areas in more mature shale plays, while the potential of newer plays has not yet been established.”
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An unsigned memo carrying similar doubts circulated among retired ExxonMobil executives. “It is a really tough job to figure out if ExxonMobil management is doing a good job of enhancing shareholder value, given the inherent limitations of its already huge size and inevitable momentum,” the memo noted. “Sure, you can make comparisons with competitors (which ExxonMobil has tended to lag in recent years) but given that ExxonMobil is fully a third larger than its nearest competitor, one is dealing with apples and oranges to some extent.”

The memo continued, “One has to respect and acknowledge the positive things that ExxonMobil does on a daily basis, such as:

• After the lessons of the
  Valdez 
  . . . the enormous efforts and expense the company puts into avoiding even the smallest oil spills.
  
• The terrific and expensive commitment to employee and contractor safety. . . .
  
• The vigor with which the company polices employee expense reports to insure that employees are not stealing from the company.
  
• The integrity of its bidding processes in avoiding fraud in its purchasing function.
  
• The commitment to reduce costs in its general business operations. . . .
  
• The engineering quality in its refineries and its production facilities.
  
• The exhaustive capital investment process.
  
• Its industry-leading return on assets.”
  

On the other hand, “one has to ask, do the shareholders pay Rex Tillerson $29 million a year to be a caretaker? . . . Lee Raymond, former ExxonMobil C.E.O., notwithstanding his dour personality and penchant for trying to control every detail of a huge company’s operations . . . at least knew that when oil prices were at nine dollars a barrel, it was time to buy a company with good upstream assets, which he did when he bought Mobil corporation. Rex Tillerson, on the other hand, with less exquisite timing, agreed to pay . . . an expensive 25 percent over market premium [for XTO]. Had the deal been struck earlier, at the end of March 2009, the purchase price, with the same market premium percentage, would have been a very palatable $38.23 a share.”

The memo concluded: “The stock’s performance in recent years accurately reflects their less than mediocre business capabilities. To call them incompetent may be to go too far, but it is close . . . mighty close. . . . Given the peaceful slumber this Board of Directors has enjoyed for the last twenty years, one has to ask a closing question: Why would anyone want to be an ExxonMobil shareholder?”
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W
as this criticism of Rex Tillerson’s leadership fair? During 2010, Tillerson completed his fifth year as chief executive. That was long enough to begin to judge his record. The numbers showed a mixed but far from disastrous performance. Many of the critical questions about his decision making post-Raymond would require a decade or more to measure. The fairest grade was probably “incomplete.” Whether the price Tillerson paid for XTO was too high or not, his essential theory of the purchase was the same as Lee Raymond’s theory about the enormously successful Mobil merger: Exxon would exceed Wall Street expectations over time by extracting value from the acquired assets that no other company knew how to extract. Raymond had paid a 15 percent premium for Mobil’s shares at a time when oil prices were so low that oil doomsayers ruled, just as doomsayers about shale gas were prominent in late 2010. Perhaps the XTO properties would yet perform under Exxon’s management as the Mobil properties had.

ExxonMobil earned $30.5 billion in profits during 2010, short of the Tillerson-overseen record of 2008, but stunning nonetheless. The corporation had earned more profit than any publicly traded corporation in America in each year of Tillerson’s reign so far. In a sign of the times, ExxonMobil jockeyed occasionally with PetroChina, the state-owned oil company, for the status of the world’s largest corporation by stock market value, but ExxonMobil was valued highest more often than not. Much of the corporation’s top-line profit reflected soaring commodity prices over which it had little control. Yet ExxonMobil also remained at the top of its industry class, judging by return on capital employed, or R.O.C.E., the metric by which the corporation preferred to compare itself with its closest American peers, Chevron and Conoco, and the most closely comparable overseas competitors, Royal Dutch Shell and BP. The corporation’s R.O.C.E. was 22 percent during 2010, about where it was after the Mobil merger, and higher than the next-best performer, Chevron, by 5 percent. In all, the numbers showed Tillerson had not allowed financial, investment, or operating discipline to slip during his five years in charge.