ExxonMobil plans to invest big, expect other energy companies to follow suit

ExxonMobil’s announcement Monday that it plans to invest more than $50 billion over the next five years to expand its business in the United States reflects several factors — and not just the impact of the recently passed tax reform package. It won’t be surprising to see similar announcements from many more energy companies.

First, energy capital investment was severely cut following the late 2014 oil price collapse. This was a predictable response to the drop below $30 per barrel, as well as the result of uncertainty over OPEC’s response. When OPEC decided not to follow its traditional role of cutting production to stabilize prices, the drop in prices led to a rout, even though global supply exceeded demand by less than 2 percent. 

The industry had allowed costs to balloon during the boom. When oil was above $100, virtually any investment would provide solid returns, even if costs were high. It seemed that many investments required oil prices above $70 to make a 10 percent return on investment.

{mosads}Oil production follows decline curves that require annual investment just to stay level. And many investments will not see first production for five to seven years or longer — for example, in deepwater offshore, the Arctic and areas lacking infrastructure, etc.

Companies projected prices would rise in a few years as production declined and demand slowly grew, but they weren’t prepared to invest because of market uncertainty. They chose to preserve cash. The income tax rate isn’t a determining factor if you aren’t making money. 

Second, oil prices have risen and stabilized around the $60 per barrel level (with about a $5 premium for oil in the “Brent” market as compared with “West Texas Intermediate”). OPEC’s determination to maintain cuts, even while allowing flexibility for a couple of member countries, strengthened the market and increased confidence. Substantial hedging of oil prices in the mid-$50 range relieved pressure on some companies that are now more confident about investing.  

Third, natural gas is a different story. Prices are likely to stay low because production can be increased rapidly, production costs have dropped and export options are still limited despite new liquefied natural gas export terminals. Also, gas has to compete head-on with wind power in markets like Texas even as coal-fired generation plants close. 

But the U.S. shale play has created an attractive investment environment for the production of liquids. Technology has identified and enabled production in old fields like the Permian in West Texas and necessity forced surviving firms to cut costs to an unexpected degree.

Costs are now rising to lease privately owned land, and service companies are exercising market power to compensate for their losses during the crash. Both producing and service companies have learned hard lessons during those times and are determined not to repeat mistakes.

Fourth, the industry is confident that regulatory relief in a number of areas will continue at least in the medium term. That ranges from regulation of fracking on federal lands to revised standards for offshore operations. The Trump administration has also proposed a substantial increase in offshore leases, although pushback in Florida has already led to adjustments. The industry’s response to the opening in Alaska is also questionable. 

Finally, the ExxonMobil announcement included investment in chemical and refining facilities. This has been underway for a few years now, with investment in the Houston area approaching $100 billion and slated to grow. In some cases this involves reconfiguration to adapt to lighter crudes produced in the Lower 48 states, expanded capacity to refine heavier crudes being brought from Canada in the Keystone pipeline system and demand in a growing U.S. economy for consumer products made from petroleum derivatives. With more than two-thirds of U.S. new vehicle sales in trucks and sport utility vehicles, there is robust demand for oil products even as electric vehicles take a growing share of the market. 

The tax legislation was the capstone that brought these other technical and market forces together. Companies vote with their capital budgets, and energy in all its forms is the basis for the growing national economy. Look for other big names to follow ExxonMobil’s lead.

Bill Arnold is a professor in the practice of energy management at Rice University’s Jones Graduate School of Business. Previously, Arnold was Royal Dutch Shell’s Washington director of international government relations and senior counsel for the Middle East, Latin America, and North Africa.