The Fuse

Exxon Removed From Dow Jones

by Nick Cunningham | August 31, 2020

For the first time in nearly a century, ExxonMobil will no longer be listed on the Dow Jones Industrial Average, edged out by software company Salesforce.com.

The toppling of the supermajor is illustrative of many things at once: the financial pressure and poor performances across the energy sector, the clean energy transition, but also ExxonMobil’s own particular set of problems. The trends have been unfolding for years, but have been magnified by the global pandemic.

Exxon’s eroding position
ExxonMobil was worth $525 billion in 2007 and more than $450 billion as recently as 2014. At the end of August, the oil major was worth less than $170 billion and its stock is down more than 40 percent since the start of 2020.

Exxon posted $4.4 billion in negative free cash flow in the second quarter

The latest blow to Exxon comes after two consecutive quarters of financial losses. Exxon posted $4.4 billion in negative free cash flow in the second quarter, and refused to touch its dividend, hoping to maintain its reputation as an attractive investment case. The flip side is that Exxon has had to pile on debt in order to afford those shareholder distributions. During the second quarter, the company added $16 billion in long-term debt as it paid out $8.1 billion to shareholders, according to a recent report from the Institute for Energy Economics and Financial Analysis (IEEFA).

To be sure, this problem is not new. “For more than a decade, the five largest publicly traded oil and gas companies—ExxonMobil, Shell, Chevron, Total and BP—have paid more to their shareholders than they’ve generated from their operations,” IEEFA analysts wrote. Still, the pandemic has substantially widened this gap.

For several years, Exxon continued to spend aggressively even as some of its rivals trimmed spending and began to slowly pivot to other energy segments. Returns have been deteriorating for years, and Exxon maintained spending in excess of $30 billion annually, hoping to ramp up production in the Permian and offshore Guyana in particular.

Only a few months ago, in the face of the global oil market meltdown, Exxon put on a brave face and largely stuck with heavy spending plans. But in April, Exxon conceded to the reality, slashing capex by 30 percent.

Still, Exxon’s “breakevens” are substantial. It needs upwards of $60 per barrel in order to cover its spending and its dividend. With that possibility still quite a ways off, the company will likely have to take on more and more debt going forward.

The oil and gas industry is in crisis, with peak demand looming.

Big Oil in transition
Exxon’s troubles are also part of a broader story. The oil and gas industry is in crisis, with peak demand looming. Energy now only makes up less than 2.5 percent of the S&P 500, a substantial erosion from over 12 percent in 2011. With oversupply and weak demand growth, the future has never looked less certain.

Some of Exxon’s competitors are charting a new course. Shell and BP have announced plans to transform, reducing the pace of drilling, adding renewable energy and pivoting into electricity assets. They are targeting net-zero emissions by mid-century. They have also written down billions of dollars’ worth of assets and cut their dividends, which reduces the cash flow pressure.

Exxon is stubbornly pressing forward, keeping its dividend intact, but also keeping its oil and gas focus unchanged. It’s not clear how they will navigate the array of challenges in front of them.

“It’s very difficult for Exxon to really grow when you have low economic growth, muted commodity prices and we’re going to be transitioning away from that main line of business into something else,” Matt Hanna, portfolio manager at Summit Global Investments, told the Wall Street Journal.

It is too soon to say how this will play out, or whether Exxon’s competitors are making more prudent decisions to transition with the times. But what is clear is that the threats are real—and the oil companies themselves recognize the danger.

A recent report from Morgan Stanley found that climate change is dominating the concerns among oil executives. “Despite a historically weak quarter, climate change and oil companies’ energy transition strategies remained a key topic in the 2Q20 conference calls,” Morgan Stanley analysts wrote in a note.

Meanwhile, divestment risk is growing.

Meanwhile, divestment risk is growing. Globally, the amount of funds with an explicit divestment policy has tripled over the past two years, according to Raymond James. The investment bank cautioned that the impact to date is relatively “mild,” with divestment carrying a much bigger penalty for coal than for oil and gas.

But the broader ESG trend (environment, social and governance principles) is becoming impossible to ignore, and ESG is a “structural headwind” for oil and gas. “This issue needs to be front-and-center for oil and gas investors — as well as the companies themselves — even if divestment is mostly a side show for the time being,” Raymond James concluded.

Exxon’s share price is now down to about $40; it started the year at $70. While some analysts see oil prices rebounded a bit later this year and into 2021, some of the larger headwinds facing the oil industry are not going away. Exxon’s removal from the Dow Jones is a sign of the times.