by Steve Coll
Uncertainty and skepticism of this kind leached out from geological engineers in the form of unfavorable press reporting, some of which went so far as to ask whether the American shale gas boom was some sort of Ponzi scheme in which early investors bid up faulty assets and lured in big-money suckers like ExxonMobil. Unconventional gas wells behaved unlike other wells, and their decline and production rates could be hard to calculate—much about the drilling patterns in these fields still remained to be discovered. An individual gas well might lose its productivity much more rapidly in the first year of drilling than an oil well would, “but the decline rate on the [total] field is nil, because you continue to drill” in other sections of the field, as Shell’s Simon Henry put it. Yet there was evidence to support the doubters, too. At a minimum, shale gas producers were going to have to communicate with investors more forthrightly than they had done early on about their costs, risks, and profit potential.19
Wall Street swiftly made clear that it did not approve of Rex Tillerson’s decision to buy XTO. It looked to analysts and investors that Tillerson had overpaid for Simpson’s company and that ExxonMobil had made risky assumptions about future natural gas prices. Investors hammered ExxonMobil’s share price, relative to its peer group, in a way the corporation had not experienced for many years. Instead of the premium price that ExxonMobil shares had long enjoyed, ExxonMobil stock soon sold at a discount. As analysts at Reuters Breakingviews pointed out, during the seven months after the merger announcement, adjusting for the average 4 percent decline in the share prices of its peers Royal Dutch Shell and Chevron, ExxonMobil shareholders saw $41 billion disappear from the corporation’s total market price—an amount that eerily matched the price Tillerson had paid for XTO.20
Had ExxonMobil unwisely bought XTO at or near the top of the boom? It was certainly becoming clear that the peak years of 2007 and 2008 had led to reckless overinvestment in American gas leases by large, debt-burdened companies such as Chesapeake Energy. As that excess investment unwound, there would likely be opportunities for bottom-feeders to sweep up unconventional gas leases at lower prices than were reflected in the price ExxonMobil paid for XTO. That didn’t necessarily mean the merger was a mistake. That would depend on how ExxonMobil exploited XTO’s properties and expertise over time. Yet it was another basis for doubt. John Watson, the chief executive of rival Chevron, slipped the knife in: “We saw valuations for unconventionals that were a bit out of line with our view of value,” he told Wall Street analysts. “So our view wasn’t so much that shale gas wasn’t a good place to be. It was just the valuations at the time [of ExxonMobil’s purchase of XTO] were strong, so we waited.”21
Mark Gilman, the oil industry analyst at Benchmark Capital, regarded the XTO purchase as a sign that ExxonMobil’s long-term failure to build upstream reserves—which Gilman laid mainly at Lee Raymond’s door—was at last coming home to roost. Tillerson had little choice but to buy new reserves in a high-price environment because otherwise, he would be presiding over a shrinking corporation, which could reduce ExxonMobil’s share price, which could further limit its ability to buy its way out of its dilemma. The price paid for XTO might mean a reduction in ExxonMobil’s historical rates of return, but that, too, was inevitable and even welcome, in Gilman’s view, if it led to a more successful long-term performance in reserve replacement. On XTO’s purchase price, “I don’t fault Rex,” Gilman said. “It’s what you have to do when you have a weak hand.” He objected, however, to the specific choice of Simpson’s company, which he believed Tillerson had selected too much for “cultural and geographic” reasons, meaning the similarities in Tillerson’s and Simpson’s personal backgrounds, and the Fort Worth location of XTO headquarters. There were other unconventional gas owners—Devon Energy, for example— that might have paid off better.22
Dissent bubbled about the XTO deal within important sections of ExxonMobil’s executive ranks and alumni networks. Like many acquisitions in commodity industries, the deal’s payout would depend substantially on future prices, which nobody could forecast with certainty. According to a valuation prepared by Barclays Capital, without accounting for ExxonMobil’s potential to extract extra value from XTO’s reserves through engineering prowess, if natural gas prices remained as low as $5 per thousand cubic feet through 2014 and beyond, XTO might be worth only between $21 and $30 per share, a fraction of what ExxonMobil had paid. At least a few current and former senior executives worried about whether ExxonMobil could produce XTO’s gas profitably, even if gas prices did break out of their doldrums.23
Privately, according to some accounts, Tim Cejka argued that if he had been allowed to pay for exploration leases at the high per-unit prices that ExxonMobil had accepted in the price it paid for XTO, he would have more “organic” or ExxonMobil-discovered gas to show for his efforts. Cejka denied in a brief telephone interview that any serious dispute developed over this rate-of-return issue. In any event, ExxonMobil’s record during his time as head of exploration, at least toward the end of his tenure, was poor, whether it was his fault or not. By late 2009, it became apparent that Tim Cejka’s big forays into exploration and land leasing in Europe, at least, would not produce any early bonanzas. ExxonMobil’s early drilling yielded many dry holes. As Tillerson admitted, “Quite frankly, no one has enough information at this point to know” whether European unconventional gas would ever pan out.24 Overall, the corporation’s struggle in exploration and development showed no signs of turning around—its well-drilling failure rates rose by more than a third during 2007 and 2008. Cejka retired, leaving the company soon after the XTO deal closed.
“The mainstream belief that shale plays have ensured North America an abundant supply of inexpensive natural gas is not supported by facts or results to date,” wrote an analyst at The Oil Drum, an independent online energy journal. “The supply is real but it will come at higher cost and greater risk than is commonly assumed. The arrival of ExxonMobil and other major oil companies on the shale gas scene is positive because they will not follow the manufacturing approach, and will do the necessary science that should make shale plays more commercial. This does not, however, ensure success. ExxonMobil has come late to the domestic shale party. . . . It is also possible that XTO has already drilled the best areas in more mature shale plays, while the potential of newer plays has not yet been established.”25
An unsigned memo carrying similar doubts circulated among retired ExxonMobil executives. “It is a really tough job to figure out if ExxonMobil management is doing a good job of enhancing shareholder value, given the inherent limitations of its already huge size and inevitable momentum,” the memo noted. “Sure, you can make comparisons with competitors (which ExxonMobil has tended to lag in recent years) but given that ExxonMobil is fully a third larger than its nearest competitor, one is dealing with apples and oranges to some extent.”
The memo continued, “One has to respect and acknowledge the positive things that ExxonMobil does on a daily basis, such as:
After the lessons of the Valdez . . . the enormous efforts and expense the company puts into avoiding even the smallest oil spills.
The terrific and expensive commitment to employee and contractor safety. . . .
The vigor with which the company polices employee expense reports to insure that employees are not stealing from the company.
The integrity of its bidding processes in avoiding fraud in its purchasing function.
The commitment to reduce costs in its general business operations. . . .
The engineering quality in its refineries and its production facilities.
The exhaustive capital investment process.
Its industry-leading return on assets.”
On the other hand, “one has to ask, do the shareholders pay Rex Tillerson $29 million a year to be a caretaker? . . . Lee Raymond, former ExxonMobil C.E.O., notwithstanding his dour personality and penchant for trying to control every detail of a huge company’s operations . . . at least kn
ew that when oil prices were at nine dollars a barrel, it was time to buy a company with good upstream assets, which he did when he bought Mobil corporation. Rex Tillerson, on the other hand, with less exquisite timing, agreed to pay . . . an expensive 25 percent over market premium [for XTO]. Had the deal been struck earlier, at the end of March 2009, the purchase price, with the same market premium percentage, would have been a very palatable $38.23 a share.”
The memo concluded: “The stock’s performance in recent years accurately reflects their less than mediocre business capabilities. To call them incompetent may be to go too far, but it is close . . . mighty close. . . . Given the peaceful slumber this Board of Directors has enjoyed for the last twenty years, one has to ask a closing question: Why would anyone want to be an ExxonMobil shareholder?”26
Was this criticism of Rex Tillerson’s leadership fair? During 2010, Tillerson completed his fifth year as chief executive. That was long enough to begin to judge his record. The numbers showed a mixed but far from disastrous performance. Many of the critical questions about his decision making post-Raymond would require a decade or more to measure. The fairest grade was probably “incomplete.” Whether the price Tillerson paid for XTO was too high or not, his essential theory of the purchase was the same as Lee Raymond’s theory about the enormously successful Mobil merger: Exxon would exceed Wall Street expectations over time by extracting value from the acquired assets that no other company knew how to extract. Raymond had paid a 15 percent premium for Mobil’s shares at a time when oil prices were so low that oil doomsayers ruled, just as doomsayers about shale gas were prominent in late 2010. Perhaps the XTO properties would yet perform under Exxon’s management as the Mobil properties had.
ExxonMobil earned $30.5 billion in profits during 2010, short of the Tillerson-overseen record of 2008, but stunning nonetheless. The corporation had earned more profit than any publicly traded corporation in America in each year of Tillerson’s reign so far. In a sign of the times, ExxonMobil jockeyed occasionally with PetroChina, the state-owned oil company, for the status of the world’s largest corporation by stock market value, but ExxonMobil was valued highest more often than not. Much of the corporation’s top-line profit reflected soaring commodity prices over which it had little control. Yet ExxonMobil also remained at the top of its industry class, judging by return on capital employed, or R.O.C.E., the metric by which the corporation preferred to compare itself with its closest American peers, Chevron and Conoco, and the most closely comparable overseas competitors, Royal Dutch Shell and BP. The corporation’s R.O.C.E. was 22 percent during 2010, about where it was after the Mobil merger, and higher than the next-best performer, Chevron, by 5 percent. In all, the numbers showed Tillerson had not allowed financial, investment, or operating discipline to slip during his five years in charge.
ExxonMobil’s lead over one competitor, Chevron, had narrowed, however, to the point where, by market and financial performance measurements, the two companies were about tied. By 2010, ExxonMobil’s R.O.C.E. topped Chevron’s largely because Exxon’s huge chemical and downstream operations performed twice as well as Chevron’s did. Certainly Tillerson and his team deserved credit for maintaining the high margins Raymond had delivered in these notoriously difficult businesses. Yet the downstream business looked increasingly uneconomic in the long run because governments in emerging economies were installing new refineries and petrochemical complexes, backed by state subsidies, for reasons other than profit making—to ensure energy security, for example, or in the case of Saudi Arabia, to create better jobs and promote scientific education. This glut of subsidized capacity would challenge ExxonMobil in the long run. Yet in the oil and gas upstream, where the great majority of profits earned by fully integrated oil companies resided, and where the greatest future profit opportunities lay, Chevron had now about caught up with ExxonMobil; Chevron’s upstream R.O.C.E. in 2010 was a robust 23 percent. The average barrel of oil or equivalent amount of gas produced by Chevron was more profitable than a barrel produced by Exxon, according to Chevron’s calculations. Moreover, using other metrics often highlighted by Wall Street analysts—total stockholder return and cash flow per share, for example—Chevron now substantially outperformed ExxonMobil. Chevron’s shareholders did better than ExxonMobil’s during 2010. (The rest of the peer group lagged.) Tillerson and his colleagues might rationalize their slippage by blaming a short-term herd mentality on Wall Street that turned hostile to ExxonMobil’s shares because of the XTO deal, and indeed the corporation’s shares did bounce back after the initial XTO hangover, but the numbers spoke clearly enough of a tightening competition.
Tillerson deserved credit for accomplishments not visible on ExxonMobil’s balance sheet. His Hamlet-like performance on carbon taxation and climate change did him little credit, but he had led a determined drive to reduce the greenhouse gases emitted by the corporation’s own operations and had delivered real improvements. On his watch, ExxonMobil had reduced gas flaring—the wasteful burning of natural gas produced during oil extraction, which contributed to global warming—by more than half. In Nigeria and other countries with weak governments, the corporation had missed announced targets for the elimination of flaring; it blamed the failure of its partner regimes. Still, between the progress it did make and greater energy efficiency, ExxonMobil had reduced its total direct greenhouse gas emissions by eleven million metric tons, a significant achievement.
Tillerson had also taken steps to address ExxonMobil’s fudging about whether the corporation was finding enough oil and gas each year to replace the amount it pumped and sold. Under Raymond and again during Tillerson’s first years, ExxonMobil had declared publicly through press releases and at Wall Street analyst presentations that it had found enough new “proved reserves” of oil and gas to replace each year’s production and sales. But in making this claim, the corporation ignored the accounting methods required by the Securities and Exchange Commission. In some years, ignoring the S.E.C. reporting rules allowed the corporation to sidestep embarrassment. In 2008, using S.E.C. rules, and based on the corporation’s limited public disclosures, ExxonMobil’s reserve replacement would have been below 75 percent, an alarming rate. But instead of accounting forthrightly for this failure, the corporation issued a press release that quoted Tillerson boasting, “ExxonMobil . . . has replaced an average of 110 percent of production over the last ten years.”27 That was a defensible claim only if one preferred ExxonMobil’s self-regulation to federal rules.
On December 31, 2008, the outgoing Republican-led Securities and Exchange Commission revised its reserve reporting rules to allow the counting of oil sands, shale gas, and other previously banned categories of reserves. The commission also changed other reporting rules that Raymond and Tillerson had found objectionable. The changes, achieved by oil industry lobbying, liberated ExxonMobil from spinning. The corporation ceased double counting: From now on, it would report only numbers authorized by the S.E.C. It did not retract its previous claims to Wall Street and the public, however, noting only that its long reserve replacement “streak” was based on some years when the S.E.C. rules were not used.
The cleaner 2010 reserve replacement numbers looked good on the surface, but were concerning underneath. When the XTO gas properties were incorporated into ExxonMobil’s resource base, the corporation reported that it had replaced an extraordinarily strong 209 percent of the oil and gas it produced that year. Yet XTO’s purchased properties accounted for four fifths of the corporation’s new reserves. Without XTO, according to Barclays, ExxonMobil would have replaced only 45 percent of its 2010 oil and gas production—a performance so abysmal that if it continued for a prolonged period, ExxonMobil would be on a path to liquidation. By comparison, Conoco’s “organic” or internally generated reserve replacement rate in 2010 was 138 percent. Shell’s was 133 percent.28 Of course, ExxonMobil had always been better at buying other people’s oil than at finding it. Arguably, from a shareholder’s perspective, it made no diff
erence whether the oil and gas ExxonMobil pumped and sold so profitably each year had been discovered because of geological genius or bought with piles of cash generated by financial and operating acumen. If Tillerson could maintain the financial performance that made the XTO acquisition possible, he might continue to buy what he could not find. But at a minimum, the numbers made clear how important the XTO purchase would be to Tillerson’s legacy on Wall Street and in the oil industry: If the deal underperformed, the corporation would be hard-pressed to maintain its superiority.
Tillerson promised when he took charge to increase ExxonMobil’s annual production of oil and gas to 5 million barrels per day by 2009. The actual number was 3.9 million—more than 20 percent short. Tillerson promised again that ExxonMobil’s production would grow steadily until 2014, but the trailing numbers showed the corporation in a long, flat pattern—its annual production in 2001, after the Mobil merger closed, was 4.3 million barrels per day.29 Tillerson had not cracked the challenge of reserve replacement that had also daunted Raymond.
Before Tillerson, dissent and hard feeling inside ExxonMobil often traced to Lee Raymond’s blunt manner. Under Tillerson, ExxonMobil might be a kinder, gentler place to work, yet some of the old guard feared a loss of the toughness and discipline they had valued in Raymond. Retired executives of the Raymond era took one another out to dinner in Houston, Dallas, and elsewhere and talked about whether Tillerson had enough of the guts and firmness that Raymond had mustered to drive ExxonMobil’s financial performance.
Tillerson’s remarks to Wall Street analysts increasingly made it clear that he was aware of these dissenters. It required the equivalent of Kremlinology to perceive Tillerson’s public replies to these dissenting factions, but his rejoinders were detectable. At analyst meetings, Tillerson started to use 2006, the year he took the top job, as the basis for reporting about—and boasting about—ExxonMobil’s financial performance. He ignored the Raymond years, and he went so far as to explain how his leadership had extracted profitability from one tough project, the Kearl oil sands play in Canada, because he had made flexible analytical judgments about projected rates of return that would not have been taken “five, six, eight years ago,” when Raymond was in charge.
