Who’s Right About Exxon Mobil Corporation (XOM), Jim Chanos or Warren Buffett?

Warren Buffett’s Berkshire Hathaway Inc. (NYSE:BRK.B) recently added 40.1 million shares of Exxon Mobil Corporation (NYSE:XOM) valued at $3.4 billion to its portfolio. As Fool contributor Alex Dumortier noted, Buffett’s decision was probably shaped by the company’s attractive valuation, its market value north of $400 billion, and its longevity and staying power as one of the most capable operators in the integrated oil space.

But not everyone is as optimistic as Buffett about Exxon Mobil Corporation (NYSE:XOM)’s prospects, especially legendary short-seller Jim Chanos. Let’s take a closer look at one major challenge Chanos highlights and what Exxon Mobil Corporation is doing to surmount it.

Exxon Mobil Corporation (NYSE:XOM)Rising costs of finding and replacing reserves
Chanos, who is famous for his prescient calls on Enron and Worldcom, argues that Exxon Mobil Corporation (NYSE:XOM) and the other large integrated oil companies are seeing a deterioration in their businesses for one major reason: the costs of finding and replacing reserves have gone up significantly in recent years. He adds that Exxon Mobil Corporation’s revenues have declined year-over-year, even as the company continues to spend heavily.

Chanos certainly makes a valid point. In an era when the majority of conventional oil reserves — so-called ‘easy oil’ — have already been depleted or are fervently guarded by foreign governments and their national oil companies, Exxon Mobil Corporation (NYSE:XOM) and the rest of the Western integrated oil majors are being forced to venture into harsh environments in search of oil, where costs and risks tend to be much higher.

As the share of global oil supply from these so-called unconventional sources has risen sharply in recent years, so have big oil’s marginal production costs. From 2001 to 2010, marginal costs of production for the world’s 50 largest public oil companies surged by 229%, according to Bernstein Research, while the industry’s annual capital spending more than tripled over the same period.

It’s not so bad…
Exxon Mobil Corporation (NYSE:XOM) is no exception. But while it’s true that the company’s costs have increased markedly over the past decade, the rise looks less worrisome when compared to those of its peers and to commodity prices, which have risen sharply over the same time period. In fact, as research firm Morningstar recently pointed out, Exxon Mobil Corporation’s F&D costs as a percentage of average oil prices have actually fallen over the past ten years.

Furthermore, the measure doesn’t accurately reflect the company’s shift toward natural gas, cemented by its 2010 acquisition of XTO Energy. If one measures finding and development costs in terms of revenue per barrel of oil equivalent production, Exxon Mobil Corporation (NYSE:XOM) appears well positioned relative to its peers, Morningstar notes.

It’s also leading the pack in terms of reserve replacement. Last year, Exxon Mobil Corporation  had a reserve replacement ratio of 115%, as compared to Chevron Corporation (NYSE:CVX)‘s 112%, Total SA (ADR) (NYSE:TOT)‘s 93%, and Royal Dutch Shell plc (ADR) (NYSE:RDS.A)’s worrisome 85%. Moreover, the company’s reserve life for both liquids and natural gas has actually grown meaningfully over the past ten years.

Boost from LNG
Lastly, Exxon Mobil Corporation (NYSE:XOM)’s extensive investments in LNG projects and Canada’s oil sands should help mitigate the rising costs of finding and replacing reserves. The company maintains a leading global LNG position, with liquefaction capacity of approximately 65 million tons per year, and a strong position in Alberta’s oil sands, where its Kearl oil sands project is currently producing between 50,000-60,000 barrels per day.

Crucially, these projects produce at flat levels for extremely long periods of time, while throwing off large amounts of free cash flow and requiring little additional reinvestment once they’re operational. As the share of Exxon Mobil Corporation’s production from these projects rises over the next several years, it should help offset production declines from the company’s maturing fields.

The bottom line
While Exxon Mobil Corporation (NYSE:XOM) certainly isn’t immune to the industrywide challenge of increasing finding and replacement costs, I believe it is better equipped to surmount this challenge than most of its peers. It has consistently demonstrated an ability to deliver significantly higher returns on invested capital than its weighted average cost of capital.

It also continues to lead its peers in terms of upstream returns on average capital employed, save Chevron Corporation (NYSE:CVX), and has a dominant position in global LNG, an area primed for significant growth over the next decade. If I had to invest in a big oil company for the long run, Exxon Mobil Corporation would be near the top of my list.

The article Chanos or Buffett: Who’s Right About Exxon? originally appeared on Fool.com and is written by Arjun Sreekumar.

Fool contributor Arjun Sreekumar has no position in any stocks mentioned. The Motley Fool recommends Berkshire Hathaway, Chevron, and Total SA. (ADR). The Motley Fool owns shares of Berkshire Hathaway.

Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.


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