By Cyrus Sanati
FORTUNE -- If it wasn't clear before, it certainly is now: Big Oil has got some big problems.
In a year in which oil remained near historic highs at around $100 a barrel, ExxonMobil (XOM), the all-around best-in-class energy company, said on Wednesday at its analyst meeting in New York that its return on capital employed (ROCE) for 2013 was 17%. Let me repeat that -- 17%. This is bad, people.
Admittedly, achieving a 17% ROCE is something many companies would kill for -- even other energy companies. But this is ExxonMobil. No other energy company is as skilled or as adept at maneuvering the political and economic quagmire that comes with drilling for fossil fuels than Grandpappy Exxon. In the 2000s, ExxonMobil's ROCE, which is a measure of profitability and efficiency of how capital is employed, was legendary for its strength and power, with 35% considered the internal benchmark. Achieving a level below 30% was considered failure among Exxon's conservative lot, according to a longtime engineer at the firm.
But the financial crisis put an end to ExxonMobil's profit party. Oil and natural gas prices plummeted, and, as one would expect, so did Exxon's ROCE. It still stayed in the mid-20% range, which, while disappointing, wasn't the end of the world. But investors cut the company some slack. They thought that once the tumult was over Exxon would again reign supreme.
And now we have this -- 17%. Even amid high oil prices, the company couldn't even hit 20%? Even more embarrassing, Chevron (CVX), the other big U.S. energy company, is expected to beat Exxon hands down when it comes to ROCE -- it has done so every year since 2010.
This must be very disturbing for Rex Tillerson, ExxonMobil's chief executive. On Wednesday, Tillerson took action, which he believes will boost Exxon's legendary profitability -- spend less. In a surprise move, Tillerson said that 2014 will see a $4 billion, or about 10%, decrease in ExxonMobil's ridiculously large $40 billion capital expenditures budget. Spending less capital means that the ratio will go up, provided that profits stay level. That's probably a good bet considering that it takes years, even decades, for a project to start paying off.
So is Tillerson making the right move? The markets don't think so -- Exxon's stock price sank 3% after the announcement, dragging the entire Dow Jones Industrial Index (INDU) down with it. Tillerson must be very confused. He is doing exactly what he thought shareholders and analysts wanted -- delivering a higher ROCE.
But while ROCE is an important metric, it isn't the only thing investors care about. People who invest in ExxonMobil tend to be conservative value players, more interested in consistent cash flow with long time-horizons than with hitting some financial target. For example, Warren Buffett, the king of value investing, disclosed last November that he had accumulated a nearly 1% stake in ExxonMobil during the second quarter of 2013, equating to some $3.45 billion.
At the same time he bought Exxon, Buffett slashed his relatively large stake in dimming energy giant ConocoPhillips (COP), which, at the time, was going through a major reorganization. Some investors found his choice strange as ConocoPhillips' stock was up 27% for the year at that point, while Exxon's stock was up only 8%. But it plays to the theme of value investing. Exxon's earnings are stable, with defined long-term earnings potential, while COP's future had been up in the air. Uncertainty isn't ideal for value investors, even if it means giving up some of the upside.
Exxon has made a point to be as consistent as possible with its returns, despite, of course, the volatility in oil prices. When it says it is going to invest $40 billion, investors trust that the company will deliver world-class returns on that money over the next few years.
That's why when Tillerson said on Wednesday that he was cutting the CapEx budget, investors ran for the exits. They had projected that Exxon would continue to plough money into new projects and that those projects would yield strong and consistent 20% to 30% returns over time. Sure, it is nice to have that extra $4 billion returned to shareholders, but that's just this year. Value investors are in it for the long haul and cutting CapEx means that they should expect decreased revenue down the road.
To be sure, no one is saying that Exxon should invest in unprofitable ventures just to keep busy -- too many companies already do that. It was just disappointing for investors to hear that the company doesn't believe it can deliver a strong enough return to justify its carefully planned CapEx budget.
Then there is the big fear -- did Exxon think a 17% ROCE was a strong enough return to justify last year's massive capital expenditure outlay? If so, what exactly does Exxon think its future projects will yield if it can so easily slash so much off of it -- 15%? Maybe 10%? You can see how this might have caused a bit of a panic.
Press release or legal defense? Or a fat finger?
By Roger Parloff, senior editor
FORTUNE -- In Chevron's civil RICO suit against Steven Donziger and other Amazon Defense Front leaders who won a $19 billion environmental judgment against the company in 2011, each side's legal filings have sometimes seemed intended more as press releases than as serious attempts to persuade federal judges of a point of law or fact.
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In its RICO suit against environmental lawyer Steve Donziger, the oil giant may drop all its damages claims in hopes of avoiding a jury and winning a faster verdict.
By Roger Parloff, senior editor
FORTUNE -- In a motion filed Monday in federal district court in Manhattan, Chevron (CVX) states that it may drop damages claims possibly worth tens of millions of dollars against Steven Donziger, the lead U.S. lawyer behind a $19 MORESep 10, 2013 11:53 AM ET
Despite all the legal, political, and business risks, Chevron has unapologetically doubled down on Argentina with a partnership with the state-controlled energy company YPF.
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FORTUNE -- Chevron is taking quite a gamble snuggling up with Argentina. The U.S. oil giant confirmed this week it is officially partnering up with Argentina's (now) state-controlled energy company, YPF, in a bid to help the firm develop the South American nation's potentially vast MOREJul 19, 2013 5:00 AM ET
Hugo Chavez obliterated Venezuela's credibility among the world's largest oil producers, and it will take some time for the troubled nation to earn back that trust.
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FORTUNE -- The death of Venezuelan President Hugo Chavez is no panacea for the nation's dysfunctional energy industry. Political and economic uncertainty will likely continue to deter foreign investors from fully committing the necessary cash, resources, and expertise that are desperately needed MOREMar 6, 2013 10:38 AM ET
If the fines levied against Chevron and Transocean are any indication, grandstanding may dash Brazil's dreams of becoming an oil exporting powerhouse. After all, Petrobras can't go it alone.
By Cyrus Sanati, contributor
FORTUNE -- Corruption, grandstanding and total incompetence may sink Brazil's dreams of becoming an oil exporting powerhouse. Prosecutors in the country last week slapped Chevron and drilling partner Transocean with an $11 billion fine for accidentally releasing around 3,000 MOREDec 19, 2011 10:51 AM ET
Demand for oil will continue to rise as developing economies in Asia and elsewhere fuel their rapid growth. Here's how to play a bullish outlook on oil.
by Lou Gagliardi and Kevin Kaiser, Hedgeye
As we move into 2011, we remain bullish on crude oil fundamentals for the long term. Increases in merger and acquisition activity and in capital spending by the oil and gas industry reinforce our view. And countries MOREDec 29, 2010 5:00 AM ET
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