When you stay within your paradigm, you can be blinded by things that happen outside of it. And so it was with Exxon Mobil (NYSE: XOM) annual meeting for shareholders. The transcript gave no surprises. There was no change in CEO Darren Woods' entrenched view of the world that needs more energy and that oil and gas will be the largest suppliers of energy expansion. He continues to marginalize the contribution of renewable energy, especially solar power plants and wind, as he remains complacent about XOM's role as primarily focused on oil and gas, while its European counterparts (Shell (NYSE: RDS.A) (NYSE: RDS). B) , BP (NYSE: BP) and Total (NYSE: TOT)) all acknowledge that the game is changing and that emissions must be reduced dramatically. Exxon changed its second-quarter revenue tactics by not having Woods appear, and instead the conversation was hosted by Stephen Littleton, VP Investor Relations, and Senior VP Neil Chapman, who oversees upstream operations. Without any respect for the presenters, would such a disastrous Q2 report surely require the CEO to show up? BP's revenues for the second quarter, which not only addressed the second quarter, but had a larger screen, in addition to SVP Investor Relations, were present by the Chairman of the Board, the CEO, CFO and EVP Strategy and Sustainability. The line taken in the XOM Q2 report was that it is facing an economic downturn that has been turbocharged by the COVID-1
Here I present a new perspective on why seeing increased energy needs necessarily linked to increased fossil fuel consumption is wrong. There is a lot of discussion about COVID-19 and the oil price war; while the larger outlook is ignored, it is nevertheless this larger view that will determine whether XOM can maintain dividends and find markets for expanding oil and gas production. The value portfolio has recently highlighted shareholder-unfriendly management problems. Taken together, these considerations suggest extreme caution with regard to investing in XOM. You have control over your investments. Despite the fact that there are many recent Searching Alpha articles that suggest investing in Exxon Mobile, do you need to get confused in XOM's issues?
Dividends are the central focus of the XOM business
A business that clearly states that dividends are the most important business attribute of being preserved the risk of being accused of forgetting what the core business is. Exxon had planned $ 33 billion in capex in 2020, but the goal is now to reduce it by ~ 30% to $ 23 billion by 2020 (with a quarterly running rate expected to be $ 19 billion), and cut operating expenses by cash by 15 %. These are huge cuts, although it is understandable in the time of COVID where both demand and price have fallen longer and faster than ever before. What is less understandable is that the management is clear that they will continue to cut capex by as much as necessary if the dividend is threatened. The goal is to protect the long-term value of investments, but this type of cut must be dangerous unless you do not expect to return to business on the scale you planned before the pandemic. There is a recognition that things can get worse, even though there is no acceptance that the declines are anything other than economic situations.
As for 2021, decisions on 2021 will be made at a board meeting in November, but already under $ 19 billion are being considered. This is a huge decline in capex planned for the coming years. Just to be clear, already the expectation of rigs in Perm is to fall from 30 at the beginning of this year to 10-15 at the end of this year. This is explained as a short-term asset management, and yet in 2021 the run for capex will decrease further. Maybe I'm missing something here? The question of whether the company can continue to expand production to these capex rates was ducked. It almost certainly seems that it can not. In fact, it extends the credibility of believing comments about maintaining production in Perm while it cuts further.
In the absence of free cash flow, the second lever that Exxon has to maintain dividend debt. Management increased its debt level significantly in the second quarter by $ 15 billion.
An interesting debt increase
In the income edition for the second quarter, much is said about how XOM is satisfied with the debt level and that there is no plan to increase the debt level.
Inspection of a recent QQ filing, Q2, shows that XOM's long-term debt was $ 26.3 billion as of December 31, 2019, while it was $ 46.6 billion on June 30, 2020. In other words: thermal Debt increased by $ 20.2 billion in the first six months of 2020.
One can expect a good cash cushion as a result of taking on larger new debt, but the details show a different picture. The cash position as of June 30, 2020 is $ 12.6 billion. This means that there is not enough cash to cover a 12-month dividend ($ 14.9 billion, based on a double payment by June 30, 2020).
Given the low demand for its products and low prices, and the debt situation described above, one can understand why there are plans to reduce capex below $ 19 billion in 2021.
On the figures above, the current situation for pricing oil and gas, plus huge global reserves and no solution in view of the COVID pandemic, it is starting to look like a very big call to keep dividends at current levels.
The critical issue of Exxon Mobil's business strategy
It is agreed that there will be a need for increased energy as the Asian region continues to develop. Darren Woods' core premise is that energy needs will be met by expanding fossil fuels, as has been the case for a century. Traditional bodies such as the IEA have indicated that Asia and India are the regions where fossil fuel-based energy will expand, and XOM and other oil and gas majors have used the IEA to base their expansion plans on. In 2017, the IEA indicated that Southeast Asia would have a huge increase in energy, and while renewable energy became a major energy supplier, there will still be huge increases in fossil fuel consumption. Fast forward to 2020 and the situation is about to transform.
While China started the development that was strongly focused on the use of fossil fuels, this is no longer the case for several reasons. I expand on this below regarding various plans from China and the United States.
India appears to be the first major economy to avoid developing fossil fuels. There are several reasons for this, the first being the catastrophic pollution caused by large-scale distribution of fossil fuels. COVID-19's economic shutdown has given a clear focus on how polluting existing fossil fuels are. Clear skies and being able to see distant mountains are strong reminders of what today's ICE-based transport and electricity production from coal means. Secondly, India has essentially no oil, so oil imports are a major drain on the economy. Prime Minister Modi has implemented dramatic plans for the Indian economy to be driven by massive expansion of renewable energy, with a target of 450 GW implemented by 2030. India has major nationwide plans to electrify transport. All of these initiatives suggest that XOM's assumptions about energy expansion are inconsistent with what India plans to do.
The main countries that the IEA had estimated to expand the use of fossil fuels are considering all their strategies in the light of the need to reduce emissions and the dramatic cost reductions for renewable energy.
The IEA's view of the role of COVID-19 in the transition to clean energy
The results report from Exxon Q2 indicates that the COVID-19 pandemic has changed the situation for fossil fuels massively. companies. COVID-19 and overproduction of oil and gas have led to record low oil and gas prices and large surpluses of oil and gas, so that reserves are unlikely to be cleaned up before the end of 2021 even if things return to "normal" in early 2021 (as they will not).
Less attention has been paid to the effect of COVID-19 on recovery from the pandemic. There is increasing talk that the COVID-19 pandemic represents a historic opportunity to reset the disc on fossil fuel consumption, and also as a way to provide new employment at a time when entire segments of the economy are gone and probably will not return to there the world economy set before COVID.
The IEA has traditionally been a supporter of the fossil fuel industry, and its predictions have been inaccurate (underestimated) about the rate of change to renewable energy. In its 2017 report, for example, the IEA still predicted a major expansion of coal. Anyone who follows the coal industry's travels understands that the question now is "how much longer will the coal industry survive?" The IEA now expects the global coal industry to decline 8% by 2020. Even this seems optimistic when considering that the IEA's figures indicate that Southeast Asian coal demand will decline significantly in 2020, although less than 25% decline in the US and 25% decline in Europe.
The car industry is in turmoil, but Tesla is booming, and it is now by far the most valuable global car company (in fact, it is much more than a car company). This tells me that the transition to electrification is largely long-awaited. Nevertheless, the oil and gas masters still assume that the increased number of cars in the Asian region will mostly be traditional cars with internal combustion engines. Transport accounts for ~ 40% of oil consumption, so a major change in electrification spells disaster for oil and gas makers. This is why both Shell and BP now explicitly accept that they need to abandon fossil fuels.
Discussion of US truck miles returning to pre-COVID levels generally assumes that this recovery will be permanent, even as a number of truck manufacturers prepare to release large electric trucks in the near future. Once again, this suggests that Exxon's management does not yet understand that there is a permanent shift to electrification of everything to meet an urgent need to decarbonise, and that COVID will almost certainly accelerate that transition.
Given the above, the IEA has recently published a 4-point summary of where the IEA believes energy should / should be managed when the COVID-19 crisis begins to recede. Fatih Birol, CEO of the IEA, articulated these 4 points (which have evolved from the IEA mindset since March 2020) in an interview with Fortune magazine on July 25. This represents a massive change in the view of the IEA and removes a major defense of Exxon, which has used the IEA estimates of fossil fuel use (especially in SE Asia) to validate its claim that oil and gas will expand until 2040.
1. Clean energy should be at the heart of the economic recovery
It is clear that governments have no alternative to take an important role in keeping economies alive and charting their future course. This means unique stimulus plans amounting to trillions of dollars. The IEA sees this as a historic opportunity to dramatically increase and accelerate the energy transition from fossil fuels to renewable energy.
2. An important task for the IEA is emission reductions
COVID has caused outstanding energy needs in 2020 (7 times more than the financial crisis in 2008). Oil is hardest hit, but gas and coal are also experiencing huge falls. Although the growth rate has slowed, renewables continue to grow during the COVID crisis. Total global energy investment will decline by 2020 by 20% (~ $ 400 billion), and this means a massive reduction in emissions due to less fossil fuels being consumed. The IEA points out that it is crucial that this reduction in emissions is maintained.
3. Starting strategy from the pandemic is a sustainable recovery plan
The core objectives of the recovery process are: increase economic growth, create jobs and avoid recurrence of emissions. Key policy proposals to achieve the goals are: accelerate energy efficiency, especially in the construction sector; strong push for renewable energy (solar and wind); modernization and digitization of power grids. The IEA sees an economic boost of 1%, 9 million new jobs and emissions set in structural decline. The Exxon management will no doubt dismiss these goals as unrealistic, but my view is that these are too conservative as greater reductions must be made if the goals of the Paris Agreement are to be achieved.
4. Political will to make the change
The IEA indicates very recent discussions with energy ministers from 40 countries covering 80% of the global economy, indicating procurement to accelerate the global energy transition. Fatih Birol indicates that important countries, including the United States, China, India, all European countries, Japan, Brazil, Indonesia and Mexico, are keen to accelerate the transition to clean energy. The most important outcomes include a strong European stimulus package that emphasizes clean energy, and China articulates that clean energy is the core of the 5-year planning. Japanese plans to phase out coal plants.
Fatih Birol indicated that even countries where climate change is not central to their political goals to understand that the points above are a path to improvement. Birol also suggested that there is a political agenda being formulated here that is putting pressure on reluctant countries.
Fatih Birol indicated two challenges: i) Whatever is built in the future must be renewable (ie no new fossil fuels) and ii) existing processes using fossil fuels (eg iron and steel, petrochemicals, cement) must be switched to renewable solutions.
A point specifically addressed was that some oil and gas companies talk well about emission reductions, but their investment decisions remain massive in the new development of fossil fuels. Birol says that these companies are under increasing scrutiny, and that national oil and gas companies must be included in this control.
There was no word on this at any recent presentation of Exxon. In fact, Neil Chapman's view of the IEA's position was in stark contrast to what Fatih Birol suggested in his July 25 interview.
In the revenue report for XOM Q2, there were a couple of preliminary questions about the energy transition, but these were dismissed without answer. I think this is surprising given the IEA's position over and commitment from Exxon's European competitors to zero net emissions by 2050.
China against the US approach to energy
John Mathews has recently published a cut that opposes the Chinese and US approaches to energy and how divergent approaches have been affected by the oil price wars and the COVID-19 crisis. Investors in XOM or indeed any of the oil and gas industries will be well advised to read John Mathews' article, because it can help provide insight into why I believe Darren Woods & # 39; basic view – that things will not change with regard to future growth in demand for oil and gas – is deficient.
The regulatory landscape in the United States is unclear
The Trump administration has been an explicit supporter of the fossil fuel industry, and this is reflected in significant support for his re-election from major players in the fossil fuel industry.
At the federal level, the Trump administration has been determined to reverse a large number of environmental regulations. On the other hand, California, which is the world's 5th largest economy, is going the other way, with new rules to gradually introduce zero-emission cars to reduce transportation emissions, which account for 40% of California's greenhouse gas emissions.
Perhaps November will provide more clarity on whether the United States will join forces in international efforts to meet climate change, or alternatively continue the federal government's increasingly isolated position on climate change and the environment. If a democracy president takes responsibility, things will be different for the regulatory landscape for the oil and gas industry, and it will be beneficial for the development of renewable energy.
XOM's approach to decarbonization
Discussion on the decarbonization of Exxon Mobil continues to be window dressing. For example, when we talk about transportation, CEO Darren Woods ignores electrification and focuses on biofuels that still produce emissions. The investments made by XOM in biofuels are little change compared to the business investments.
The lawsuits come forward for XOM
While XOM continues to largely ignore the need to decolonize the business and instead expand emissions, comes.
Rhode Island is the first state to introduce a climate suit to get oil and gas companies to address climate change driven by their industry. XOM is one of 21 companies named in the suit that was created in 2018 and continues. This suit underscores the impact of storms and sea level rise on Rhode Island. It is a slow process, but it continues to grow.
The State of Minnesota has now filed a lawsuit called XOM, three Koch Industries units, and the American Petroleum Institute for Consumer Fraud by misleading commercial practices and false advertising. This action is the first to involve the American Petroleum Institute, and it seeks to get the defendants to fund a public education campaign that sheds light on the climate risk for the oil and gas industry. Instead of seeking to make companies responsible for climate change themselves, the lawsuit seeks to publicize its knowledge of the negative effects of business. It is claimed that climate change (increased temperature, extreme weather including floods) has negatively affected the Minnesotan economy.
And local authorities (Boulder, Boulder County and San Miguel County) in Colorado have been given the go-ahead for climate action after industry lawyers (including from XOM) tried to prevent action in state courts.
The lawsuits initiated by the US states are part of a broader international approach that seeks to get the oil and gas industry to recognize its climate impact and take action. A recent report in Nature indicates that these actions are becoming increasingly sophisticated and coordinated.
The central investor reason for XOM investments is the dividend
When you look at investors' comments on Seeking Alpha, one sees an almost religious connection to the dividend as something sacred that cannot be lowered. Dividends are meant to be a way to return the good times to shareholders. They are not set in stone, and management's need to consider them as part of their management tools to run the company efficiently.
I have been aware for some time that the oil and gas masters have paid unsustainable dividends. True, the extravagant dividend has been a tool to keep shareholders, but as Shell recently showed when it lowered dividends by 66% to a more sustainable level, and BP cut dividends in two, is the moment to count.  Gold and silver flourish because people are nervous about cash. Bonds are going negative, so it's starting to cost money to stay in cash.
I have recently written a lot about XOM's outdated views on how energy and transport expansion should be managed. Here I have argued that by making sweeping generalizations, XOM has avoided the reality of today's energy and transportation environment. This has made it possible for the company to ignore major developments that have a negative effect on business plans. Investors who dispute my claims can compare the Q2 results from Exxon Mobil with those from Vestas Wind Systems (OTCPK: VWDRY) . The differences are strong and the future of energy is unrecognizably different between the two companies. Exxon Mobil lives far beyond its means and relies on oil price recovery and significantly increased markets for the planned increased production. It is clear that there are strong headwinds on many levels regarding XOM's assumptions. I do not understand how a company that plans to continue exploring and developing fossil fuel assets can state that these core businesses are subject to keeping retail investors (who make up 70% of Exxon's shareholders) happy. Admittedly, retail investors are smart enough to appreciate that if the core business is shut down and no steps are taken to chart another course, then the company is in trouble. It is time for investors to explain what is happening. On the other hand, when one looks at investors' comments to XOM about Seeking Alpha, one sees an almost religious connection to the dividend as something sacred that cannot be lowered.
My comment is not aimed at traders or investors who want to make money. from short-term market events. I do not profess to understand what is happening in the markets at the moment when they are testing new highs with a catastrophic COVID pandemic that is demonstrably happening.
My question to you as a long-term investor is whether you want to buy into XOM's problems by becoming (or becoming) a shareholder. The risk is high, and as Shell and BP recently demonstrated, the very high dividends currently paid by the oil and gas masters are unsustainable. What is the attraction of a dividend with risk, and a company that fails to address the fact that the industry is in decline (not expansion)? There are safer and more attractive places to place your investments.
I am not a financial advisor, but I closely monitor the energy and transport sectors as the world begins to decarbonise both areas. If my comment helps you understand what's going on and how it might affect your investment in XOM, consider following me.
Disclosure: I have been a VWDRY for a long time. I wrote this article myself, and it expresses my own opinions. I do not receive compensation for it (other than from Seeking Alpha). I have no business relationship with any company mentioned in this article.