Musings: The Oil Industry's Era of Austerity - Part Two

Exxon Mobil Corp. (XOM-NYSE) attempted a culture shift when it purchased XTO Energy a few years ago. At the time the deal was announced, observers questioned how ExxonMobil would be able to retain the key XTO managers who were used to a high degree of freedom to experiment, which is often found in smaller, independent oil and gas companies, as opposed to the monolithic and highly structured enterprise of its new parent. ExxonMobil’s approach was to retain XTO’s offices and management and to move ExxonMobil’s shale staff in. So far this shale investment has yet to financially pay off as envisioned by ExxonMobil’s management. Fortunately, the company has avoided the embarrassment of having to write down the value of its shale investment despite continued low natural gas prices and CEO Rex Tillerson’s lament in 2012 that the company was “losing its shirt” in shale gas. The fact ExxonMobil has not taken an asset impairment charge as many of its peers have caused the Securities and Exchange Commission (SEC) to question the company about how it was able to avoid that fate.

According to a Wall Street Journal blog in early February, the company responded to the SEC inquiry stating that placing a value on wells that pump oil and gas for decades requires considering many factors, including future events. For example, the company has had approved a liquefied natural gas (LNG) export terminal that once in operation could lift the value of its domestic natural gas resources above the current price and, importantly, future prices as suggested by quotations in the futures market. Whether that reflects true conviction or significant leverage over the company’s auditors is difficult to know.

Another way in which producers are addressing their reduced profitability is to attack their cost structures. Royal Dutch Shell says it plans to begin using cheaper Chinese oilfield equipment in order to lower operating costs. This would be a significant cultural adjustment as oil company purchasing departments are mandated to find the lowest cost equipment as long as it meets industry and company specifications. If the company has not been using Chinese equipment, the question is why?

This Chinese equipment strategy reminds us of Shell’s “Drilling in the Nineties” program designed to cut E&P costs. The approach was that oilfield service companies needed to bundle all its drilling and completion offerings into a single package and then price the entire package cheaply. The problem was that Shell’s drilling engineers, responsible for the success of wells and fields, wanted to make sure they could get the best equipment and services to ensure their success. If the service company that won the contract only had, for example, the number three ranked drilling fluids needed, the Shell engineer would arrange to purchase the number one product from a different service provider.