The performance and strategy of Exxon Mobil Corp. is a good place to start in grasping the twilight years of the investor-owned oil sector that has dominated the extraction of petroleum resources since the industry began in the 1850s.

Putting aside the Valdez debacle of 1989, Exxon has been the best-managed of the oil majors.

Exxon has avoided the faked-reserve scandals that have plagued rival Royal Dutch/Shell PLC, the Alaskan pipeline ruptures and fatal refinery explosions that forced out the CEO of BP PLC, and thoughtmore than twice before committing to its multibillion-dollar bets on gargantuan offshore oil-production platforms, heavy-oil projects in Athabasca, and signing production contracts with the state-owned oil agencies that control about 90 per cent of the world's petroleum reserves. The same state-owned agencies who have an unsettling habit of ripping up those contracts — as in Russia, Venezuela and Kazakhstan, among other countries — to demand a heftier share of output when oil prices skyrocket, as they have in recent years.

As the industry's most consistently successful player, Exxon's dilemmas offer a disturbing forecast for a business in decline. For a variety of reasons, but mostly shifts in geopolitics, it's increasingly easy to imagine a world not too far off in which Exxon and its investor-owned peers have given way to ascendant state-owned resource giants, at least in the "upstream," or exploration and development part of the industry, traditionally the most lucrative end of the business, compared with "downstream" refining and distribution activities.

Exxon is the world’s largest investor-owned oil firm, and produces more oil than any OPEC nation apart from Saudi Arabia and Iran. On staggering 2007 revenues of $404 billion (U.S.), Exxon posted earnings of $40.6 billion, the biggest annual profit in the history of capitalism. The market capitalization of Exxon, which began life as John D. Rockefeller's Standard Oil of New Jersey, has more than doubled over the past five years, to half a trillion dollars.

Thus ends the good news.

Exxon's production dropped 2.4 per cent last year, a fate shared with its biggest investor-owned peers. (Shell's production slumped 4 per cent.) On the exploration side, Exxon failed to replace 24 per cent of its production with new reserves, its worst "reserve ratio" showing in three years. With reserves increasingly difficult to find, drawing Exxon and its rivals into more costly, remote and politically volatile regions, Exxon has seen its failure rate of exploratory wells searching for commercially viable pools of oil or natural gas rise to 46 per cent, up from 36 per cent in 2006.

Exxon's production cost per barrel soared 18 per cent last year, following a 13 per cent rise the year before. The company in March committed to a 20 per cent increase in spending on exploration and refinery upgrades, to more than $25 billion, or an industry record of $68 million per day. But that hike will do little more than cover the spiralling cost of everything from drilling rigs to engineers.

At a March 5 conference with analysts in New York, Exxon unveiled an impressive number of new exploration and production projects, a dozen of which are set to begin this year alone. Exxon hopes to bring new fields into production in the Middle East, Africa and Russia by 2012; recently brought a large offshore Angola field into production; and is adding to its network of enormous liquefied natural gas (LNG) operations in Qatar.

But Exxon will be fortunate if its new projects make up for declining production at its aging fields in the North Sea and Alaska.

Not that Rex Tillerson, Exxon’s CEO, is the least bit apologetic about that scenario. The average Fortune 500 CEO who promised investors zero volume growth through 2012 would soon be looking for a new job. But this is the conservative oil business, whose executives recall the $10 per barrel crude of the late 1990s as if it was yesterday. And no oil major has been more disciplined in capital spending than Irving, Texas-based Exxon.

As Tillerson explained to analysts early this month, Exxon doesn't set a volume target and strive to achieve it, the way Procter & Gamble, Apple Inc. and Toyota Motor Corp. do. Instead, it calculates the likely payoff from a potential project, factoring in setbacks like skilled-labour shortages and soaring rig-crew costs, and places its chips accordingly. Which means passing on potentially high-volume plays vulnerable to Venezuela-type expropriation.

With good reason, BP announced with considerable fanfare the Russian partnership it struck earlier this decade, since it would account for about one-quarter of BP's total reserves. BP's share of its flagship Russian project has been repeatedly reduced, ceded to its Russian state-owned partner, following Kremlin accusations against BP of everything from fraud to environmental degradation – charges that mysteriously disappear once BP consents to a lower share of output, only to recur, accompanied by police raids on BP's Russian offices, when the Putin/Medvedev regime clamours for still more. Exxon was spared the water torture treatment in Venezuela, where the Chavez regime simply expropriated properties once Exxon's technology had brought them into production.

Given the potential for devastating reversals, Exxon doesn’t see itself on a mission to ensure energy security in North America or elsewhere. The shareholders come first, last and always.

"It really goes back to what is an acceptable investment return for us," Tillerson told the analysts.

Last year, Exxon spent more money buying back its stock – $36 billion – than on reinvesting in the business. Since replacing his similarly unsentimental predecessor, Lee Raymond, in January of last year, Tillerson, 55, has raised capital spending just 18 per cent against a 75 per cent jump in expenditures on share buybacks.

That gambit increases earnings per share, but obviously doesn't add a drop of oil or gas to the firm's reserves in order to sustain the business. Yet Shell and Chevron Corp. also are furiously buying back their stock, at a rate that will see Exxon and Chevron retire all of their stock by about 2024. It comes down to this: buying back the company's stock is a far more certain bet on increasing investor returns than operating a new deep-water drilling program.

In the past, consolidation has been the industry’s response to declining reserves. Companies simply bought oil on the stock market rather than drilling for it, which accounted for the late-1990s merger wave that brought Amoco and Arco into the BP fold, the merger of Exxon with Mobil Corp., the amalgamation of French giants Total and Elf, and the creation of ConocoPhillips Co., among other combinations. The Canadian oil patch would be especially vulnerable to a future takeover trend: the total 2007 revenues of Calgary's eight-largest Canadian-owned firms was $97 billion, about 19 per cent of Exxon's market cap.

But mergers don't add to global oil supply. The merger rationale was that firms with a more substantial "critical mass" could better afford to undertake ever costlier megaprojects. That notion went out the window when the likes of Exxon Mobil learned that even the world's largest corporation can be stripped of its assets by the likes of Hugo Chavez. Indeed, all of the "super majors" created in the last merger wave have been forced to surrender production under contracts with producing nations by which those nations gain a larger share of output as crude prices increase.

Example: Chevron Corp. was producing almost 2.7 million barrels of oil a day in 2002 when it acquired oil giant Texaco. Last year, Chevron's daily production was 2.6 million barrels a day, making a hash of Chevron's 2002 expectation of increasing the combined firms' volume by 3 per cent by 2006. Like its rivals, Chevron lost output under production-sharing contracts with oil-producing nations, and was hit with an unfavourable contract revision dictated by Venezuela.

Which suggests that the petroleum industry of the future will belong to the state-owned enterprises. After working in some cases for decades with the investor-owned giants, state oil firms have accumulated enough of the required technology to forsake joint ventures and go it alone. They have every incentive to do so in those many oil-producing nations in which oil and gas are the sole, or largest, source of export revenue, no longer to be shared with investors in companies based in London and Houston.

It's beginning to look like the investor-owned sector's long-term plan is to phase itself out of business, becoming a glorified annuity that returns outsized dividends to a dwindling number of investors from a dwindling reserve base. As early as 2001, oil analyst Charles Maxwell of Weeden & Co. of Greenwich, Conn., told Bloomberg News, the investor-owned oil majors will no longer be able to increase their production.

"They'll be in liquidation," he said.

An apt expression for an industry running out of juice.





David Olive is a business columnist with the Star. He can be reached at dolive@thestar.ca.



