(WoodMac, 16.Oct.2023) — On the day last week that ExxonMobil announced it had reached a deal to pay US$64.5bn for Pioneer Natural Resources, there was a curiously apposite coincidence: the Energy Information Administration reported that US oil production had hit a new record high. US crude production in the first week of October was 13.2 million barrels a day, beating the previous record set in early 2020, just before the pandemic hit.
The coincidence was significant not only because ExxonMobil is making a big bet on hydrocarbons, or because it will become the largest US oil producer by some distance, although both are true. It is also that the deal is a pointer towards potentially stronger growth in US oil output in the future. As ExxonMobil consolidates the traditionally fragmented US tight oil industry, it will have the ability to increase production faster than smaller companies could have managed.
The ExxonMobil / Pioneer deal, the largest in the upstream industry anywhere in the world since Shell agreed to buy BG Group for US$82bn in 2015, has already inspired a large volume of commentary. Our own initial analysis at Wood Mackenzie includes ten key points about significant consequences resulting from the deal. But one issue that has not yet been widely explored, says Wood Mackenzie’s Ryan Duman, our director of Americas Upstream research, is what the acquisition could mean for total US oil output.
In the past few years, investor demands on US exploration and production companies for debt reduction and return of capital have been acting as a brake on the pace of growth in the tight oil sector. In the boom times of the 2010s, there were four years when crude production from the Lower 48 states rose by more than 1 million barrels per day, and in 2018, it grew by more than 1.5m b/d.
Last year, Lower 48 production grew by less than half of that: 629,000 b/d. And although Wood Mackenzie is expecting an acceleration to growth of 812,000 b/d this year, we think it will slow again to just 157,000 b/d in 2024.
The merger and acquisition activity seen in the US tight oil industry in recent years has reflected those constraints. In recent deals, the combined company will typically aim to produce less than the sum of the two parts’ plans. Takeovers have been used as opportunities to step down drilling and completions activity, meeting investors’ demands for capital discipline and extending the projected runway of high-quality acreage. Not so with the ExxonMobil / Pioneer deal.
“Most E&P deals recently have been accompanied by very bearish rhetoric on production growth. This is the complete opposite,” says Wood Mackenzie’s Duman.
“ExxonMobil is talking about producing 2 million barrels of oil equivalent in the Permian Basin by 2027. That is 150,00 boe/d higher than if the deal hadn’t happened. We haven’t seen something like this from a tight oil deal for ages.”
ExxonMobil is not cutting back on activity, and expects to produce more through increased recovery.
The difference between ExxonMobil and the smaller companies, even very large independent E&Ps such as Pioneer, is that it has more flexibility in its capital allocation. Tight oil operates on short cycles, which means that output can be ramped up and down quickly in response to changing market conditions. But since the pandemic, the US E&Ps have been less responsive to oil prices than they were in the 2010s. When prices rose, their first priorities were to pay down debt and return capital to shareholders through dividends and buybacks, rather than to add rigs and step up production growth.
ExxonMobil is committed to its dividend payments, but is not constrained in the same way as those smaller companies. The Pioneer deal will raise the share of short-cycle barrels in ExxonMobil’s total production from 28% to over 40%. And where it sees opportunities to maximise value by accelerating the pace of growth, it can take them.
Darren Woods, ExxonMobil’s chief executive, underlined the point on a call with analysts to explain the deal. “We’re bringing on low cost-of-supply barrels into a market that desperately needs them,” he said.
“When we bring these two [companies] together, it’s not about cutting back, it’s about building up… We’re not looking at cutting either rig operations or people or headcount, we’re looking at how do we take the best of both operations and grow advantaged volume, profitable volumes that generate good returns.”
Kathryn Mikells, ExxonMobil’s chief financial officer, said on the same call that the company would not be changing its approach to capital allocation, and mentioned investment first in her list of priorities. “First and foremost, we’re going to invest in advantaged projects,” she said.
“We consider this to be a very advantaged acquisition, right, maintaining a strong balance sheet, and then making sure that we’re sharing rewards with our shareholders, first and foremost, through a dividend that is sustainable, competitive and growing, and secondarily, through share repurchases.”
As the energy transition creates new uncertainties, particularly over sales of electric vehicles and the implications for gasoline demand, flexibility to respond to market conditions becomes increasingly valuable.
It was noteworthy that the ExxonMobil directors nominated by Engine No.1, the activist investor, joined the rest of the board in voting for the Pioneer deal, according to the Wall Street Journal. Engine No.1 had previously criticised the company for having “no credible strategy to create value in a decarbonizing world.” Adding more flexible short-cycle production, with a competitive greenhouse gas emissions intensity and low breakeven prices, helps strengthen that strategy.
For policymakers and investors as well as industry leaders, meeting the urgent need for oil while recognising that demand is likely to hit a plateau in about a decade — on Wood Mackenzie’s base case forecast — is a complex challenge. With the Pioneer deal, ExxonMobil has positioned itself to tackle that challenge successfully. By increasing the flexibility and responsiveness of the US industry, allowing more production growth when prices are high, it may help consumers and policymakers face that challenge too.
As ExxonMobil’s Woods put it to reporters last week: “It’s a win-win for the country, a better, stronger US economy and better energy security.”
____________________
By Ed Crooks
