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Commentary

Exxon Girds for Lower-for-Longer Oil Prices

Exxon's move to cut capital expenditures is a departure for the firm and shows the company expects prices to remain low for an extended period, writes Morningstar's Allen Good.

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Lower oil prices took a toll on  Exxon's (XOM) fourth-quarter earnings, more than offsetting the positive impacts of higher oil production volumes and continued strong downstream results. For the quarter and the full year, operating cash flow plus asset sale proceeds failed to cover capital expenditures and shareholder returns, resulting in an increase in debt. Faced with an environment of worsening commodity prices and another year of cash flow shortfall, Exxon took two steps to preserve its balance sheet (although net debt/capital remains a reasonable 17%). First, it suspended its $500 million quarterly repurchase program. Second, it slashed its anticipated 2016 capital budget to $23.2 billion, down from its previous guidance of nearly $34 billion (given at last year’s analyst day). Exxon is withholding any further detail until its analyst day early next month, so it’s unclear what relative roles were played by reduced activity, project deferment, and cost deflation. The company did, however, disclose that cuts were concentrated in the upstream segment.

The sharp reduction marks a departure in strategy for Exxon, which prides itself on being able and willing to invest throughout the cycle. However, while the company is bullish on prices and demand in the long term, it has openly stated its view that prices are likely to remain low for an extended period, which is reflected in the decision to reduce capital expenditures. We look forward to the analyst day, where Exxon should provide greater detail on its strategy, given the collapse in oil prices, including longer-term spending plans and efforts to reduce costs. We plan to update our model with the latest guidance, but do not expect a material change in our fair value estimate or moat rating.

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Allen Good does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.