Exxon Reaches Beyond Oil

Exxon Mobil Corp. executives once again found themselves on the defensive shortly after the company reported a strong first quarter.

The company's $10.7 billion profit in the three-month period struck a nerve with lawmakers and consumers who have lambasted Big Oil companies for their role in rising gas prices. When the company released its earnings on April 28, Ken Cohen, Exxon's vice president of public and government affairs, fired back at critics in a blog post on the company's website.

Cohen noted that a number of factors outside Exxon's control can determine fuel prices. The company doesn't deny that high fuel prices are driving results. But a favorable market alone can't account for Exxon's standing as the world's largest publicly held oil company.

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Some investors have questioned whether the $34.9 billion XTO deal was a smart move to make amid low gas prices. But Exxon says it's looking beyond today. "Of all the companies we talk to, Exxon takes the longest view in terms of the lifetime of their investments," says Iain Reid, managing director of oil and gas research for securities and investment banking firm Jefferies International Ltd.

The company's pulse on long-term trends is evident in its annual energy outlook. The most recent report published in January projects natural gas to overtake coal as the world's second-largest energy source behind oil. Even before the XTO deal, Exxon was a major player in the natural gas market. Prior to closing the XTO purchase, natural gas accounted for 39% of the company's overall production volumes, says Raymond James Financial Inc. energy analyst Pavel Molchanov. Today, it's about 50%.

The XTO acquisition made Exxon the largest natural gas producer in the United States and a leader in shale gas exploration. Despite low gas prices and environmental concerns regarding shale gas drilling, the company continues to make investments in natural gas. In June, Exxon completed a merger with Pittsburgh-based Phillips Resources Inc. and TWP Inc., which added a combined 317,000 acres to the company's Marcellus Shale holdings.

The shale gas boom has not only helped lower power-generation costs in United States, but it also has been a boon to domestic chemical producers. The chemical industry uses a natural gas byproduct called ethane that can be converted into ethylene, which is used most notably in plastics. That also provides some advantages for Exxon's growing chemical business.

Chemical Industry Leader

If it were a stand-alone unit, Exxon's chemical business would be one of the five largest chemical companies in the world. The unit's earnings were a record $4.9 billion in 2010. Its return on average capital employed in 2010 was 26% and has averaged 20% over the past 10 years. That's more than double some major chemical competitors' figures over the same 10-year period, the company said in its annual report.

The abundance of domestic natural gas resources has helped strengthen U.S. chemical industry competitiveness, but much of Exxon's gains in the industry have come from rising demand in emerging markets. The company is building off increasing global demand for plastics as a product substitute and for use in high-performance packaging films, says Neil Chapman, a senior vice president in Exxon's chemical business.

Much of the growth in Asia is being driven by China's emerging middle class, Chapman says. "In China, people will buy packaged products more as their wealth per head increases," Chapman says. "The standard of living in China continues to grow at a very fast rate."

China has a middle class of approximately 180 million people, and that figure is expected to grow to more than 400 million in the next 10 years, Chapman says. China will represent more than one-third of global petrochemical demand growth through 2020, said David Rosenthal, Exxon's vice president of investor relations, during an April 28 earnings call with investors.

The type of chemical-based products Exxon is focusing on in Asia includes packaging films used to package food and nonwoven materials for consumer products such as diapers. The newly expanded Singapore facility will produce what Chapman describes as "new differentiated" plastic and elastomer products. For instance, in the polyethylene business the company is utilizing a catalyst called metallocene to produce a plastic that is stronger, clearer and thinner, Chapman says.

The Singapore plant is fully integrated with Exxon's refinery on Jurong Island. The unique arrangement provides Exxon with an advantage over competitors, says Philip Weiss, a senior energy analyst with Argus Research Group. "Because of its integrated structure, Exxon has been able to take advantage of these lower-priced feedstocks," Weiss says. About 90% of Exxon's chemical facilities are integrated with either the company's upstream or downstream operations, Chapman says. "This means that our feedstocks are not just coming from the refinery into the chemical plant," Chapman says. "It means it allows you to optimize all feed streams -- the feedstocks coming into the refineries, the intermediate feed streams and the products that we make."

Further chemical business developments will take place in China. In March, Exxon's chemical unit opened its Shanghai Technology Center. The $90 million facility will support growth in Asia by providing Exxon's customers with product and processing solutions. The facility contains advanced analytical and testing laboratory equipment and commercial-scale product processing equipment, including blown and cast film extrusion, injection molding, compounding, and packaging. The facility is Exxon's third-largest technology center in the world.

Access to Resources

Over the long term, Weiss says he doesn't foresee Exxon's chemical returns to outperform exploration and production or refining, but the chemical unit will continue to have some growth advantages over the refining and upstream businesses. "Chemicals has some advantages because it doesn't face some of the same obstacles that the upstream business has in terms of gaining access to resources," Weiss says. "So the returns may not be as great as they are from upstream, but they're still above Exxon's cost of capital, so they still add value."

Even so, resource access is a major issue the company will have to contend with along with the rest of the oil and gas industry. Many oil-rich regions around the world are difficult to penetrate because the countries have nationalized oil and gas industries, says Raymond James' Molchanov. Even in Africa, where governments tend to be more friendly toward Western oil companies, Exxon and other domestic oil producers will have to compete with not only each other but companies from emerging markets, such as China, India and Russia, Molchanov says.

Regulatory issues also could hamper further development. Exxon has been answering some tough questions regarding the potential impact that hydraulic fracturing, or "fracking," could have on the environment. Fracking is a method used to extract natural gas from shale rock. At an industry event June 14, Exxon XTO subsidiary President Jack Williams said the company needs to do a better job of "explaining where and how hydraulic fracturing fits into the shale gas development process."

The pace of shale gas-development and availability of ethane in the United States will factor into whether Exxon builds new chemical plants domestically that take advantage of unconventional resources, Chapman says. "We're very disciplined in our investment decisions, and we make large investments," Chapman says. "And when you make large investments, quite frankly, you better get the majority of them correct. So I would describe our approach as being thoughtful.

"But we certainly have a high degree of optimism in this development of unconventional resources in the United States, and we will continue to look at it." A more likely scenario involves the company converting or removing production constraints from existing facilities in North America, Chapman says.