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Tsvetana Paraskova

Tsvetana Paraskova

Tsvetana is a writer for the U.S.-based Divergente LLC consulting firm with over a decade of experience writing for news outlets such as iNVEZZ and…

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Reserves vs Valuations: Exxon’s Permian Predicament

The world’s largest listed oil firm, ExxonMobil, has been lagging behind other supermajors in reserve replacement ratio—a key metric in the industry that shows the amount of proved reserves a company adds to its reserve base during the year relative to the amount of oil and gas it produced.

For Exxon, one of the quickest ways to add reserves is to buy a Permian-focused driller, which would be immediately accretive to reserves. However, in order for such a deal to be soundly justified financially, Exxon might need to find enough cost cuts to justify paying a premium for a potential target, says Reuters Breakingviews’ columnist Lauren Silva Laughlin.

In January this year, Exxon bought companies owned by the Bass family in a deal that more than doubled the oil giant’s Permian Basin resources to 6 billion barrels of oil equivalent, after adding an estimated resource of 3.4 billion barrels of oil equivalent in New Mexico’s Delaware Basin. The acquired companies added 18,000 net oil equivalent barrels per day to the output of Exxon, which at the time produced around 140,000 net oil-equivalent barrels per day across its Permian Basin leasehold.

A month later, Exxon reported a net reduction of 3.3 billion oil-equivalent barrels in its reserves for 2016 compared to 2015. Its reserve replacement ratio was at 65 percent last year, a low figure and well below other supermajors’ RRRs. Last year’s reserves reduction was the biggest annual reserve cut in Exxon’s modern history, with RRR down from 67 percent in 2015, and compared with a minimum reserve replacement rate of 100 percent for 22 years running, beginning in 1993.

Related: Oil Price Volatility Is Set To Return

To compare, another U.S. supermajor, Chevron, reported a 95 percent oil and gas reserves replacement for 2016.

According to Citigroup, Exxon has lowered its reserves by an annual average of 11 percent for the past three years, Reuters’ Laughlin reports.

Production at Exxon is also down, with oil-equivalent production in the first half of 2017 at 4 million oil-equivalent barrels per day, down 3 percent compared to H1 2016.

The supermajor, however, is betting big on the Permian, pledging US$5.5 billion of its 2017 spending budget on shale, including in the Permian and the Bakken.

So, buying a Permian-focused driller or a large chunk of assets from such a company would immediately boost Exxon’s reserves and production. But the enterprise value/earnings before interest, tax, depreciation and amortization (EBITDA) multiples at which potential targets currently trade are roughly the same as Exxon’s EV/EBITDA multiple. To justify spending on another acquisition in the Permian, Exxon’s chief executive Darren Woods might have to try harder to find cost cuts, to pay a premium for the shares of a possible target, according to Laughlin.

Related: Supermajors Prepare For A Permian Bidding War

For example, Parsley Energy or Diamondback Energy would add around 70,000 bpd to Exxon’s production right away, but the EV/EBITDA multiple for both companies is around nine times, basically the same as Exxon’s, Laughlin notes.

So, for further expansion in the Permian, Exxon must look at the market multiples and financial performance of possible targets relative to their potential contribution to Exxon’s proved oil resources and production.   

By Tsvetana Paraskova for Oilprice.com

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