Exxon's huge spending plan looks right on the money

It's budgeting $150 billion for exploration over the next five years. That's a really smart move.

By InvestorPlace Mar 12, 2012 10:08AM

By Aaron Levitt

 

As more traditional sources of petroleum have become harder to find, energy companies have been forced to look off the beaten path. Unconventional resources such as shale formations, Canadian bitumen sand and even Arctic exploration have become commonplace.

 

Despite their different locations and extraction methods, all unconventional fields have one thing in common: They're expensive. Given the world's ever-increasing energy demands, it's no wonder capital expenditure programs at a variety of exploration and production (E&P) companies have skyrocketed over the past few years.

 

Energy giant Exxon Mobil's (XOM) recent five-year capital expenditure budget highlights this fact. With the company predicting that global energy demand will rise by more than 30% by 2040, it plans to spend an unprecedented amount on finding new sources of supply over the next five years.

 

Exxon has set the cap-ex bar pretty high. For investors, that could be the key to long-term success.

 

Monster budget

 

Speaking to investors at the New York Stock Exchange last week, Exxon CEO Rex Tillerson unveiled the energy company's aggressive plans to increase production. Overall, finding new sources of supply will be a costly enterprise, and Exxon is preparing itself with a monster budget. The company's capital spending through 2016 will total a massive $185 billion. That's up 29% from the prior five-year period. While some of that includes expenditures for the company's refining and chemical businesses, the bulk ($150 billion) will be spent on new exploration efforts.

 

As global energy demand continues to rise, Exxon is preparing to spend more than $37 billion a year on E&P activities. A total of 21 major projects will begin production by 2014. Over the next two years, the company expects nine major projects to begin their start-up phases and anticipates adding over 1 million barrels of oil equivalent (BOE) per day by 2016.

 

The company's huge budget is certainly justified. Cost inflation in the sector has continued to skyrocket as new unconventional sources get tapped. Deepwater driller Ensco (ESV) is predicting that offshore labor costs will rise about 9% this year, and energy infrastructure engineering group KBR (KBR) has warned of worker shortages in Australia's liquefied natural gas sector. 

 

These higher costs are a necessary evil. That is, if energy companies want to stay in business.

 

Production at a variety of major energy producers has slipped over the last few years as legacy wells have begun to dry up. Generally, when E&P companies can't find oil quickly enough, they're stuck with aging fields where overall output is declining. That's a bad thing, considering the current high price oil environment. A virtual Who's Who of oil and gas companies like Eni (E), Chevron (CVX) and BP (BP), all reported producing less oil last year than the prior one.

 

Putting a tiger in your tank

 

Last September, InvestorPlace Editor Jeff Reeves highlighted Exxon's focus on the long term. Before any oil major really moved into the natural gas business, Exxon's 2010 purchase of XTO instantly made it a leader in the sector. Its recent deal with Rosneft (RNFTF) and the Russian government puts it in a prime position to tap ignored Arctic reserves.

 

As Jeff pointed out, this long-term focus has suited shareholders well. Exxon has continuously paid a dividend since 1882 and has raised that payout every year for the last 29 years.

 

The company's high spending budget is no different. Exxon's aggressive stance toward new exploration efforts is certainly an affirmation of its future-forward process. Overall, Exxon has seen the light and realizes that unconventional resources and natural gas liquids (NGLs) are keys to long-term survival. Accessing these types of reserves is costly. But they're paramount to running a viable energy company. In terms of the other majors, only Chevron and Royal Dutch Shell (RDS.A, RDS.B) come close, with 2012 budgets of $32.7 billion and $33 billion, respectively.

 

While $150 billion is a staggering sum, it's exactly the kind of investment energy investors should want to see. It shows Exxon is serious about its future and that it understands today's changing energy environment. I'd rather own shares of this energy giant, than let's say BP, which is undergoing asset sales to pay for its legal troubles.

 

It will take time for these E&P efforts to bear fruit, but when they do, shareholders will see the benefits via increased cash flows and higher dividends. Exxon is once again proving why it's one of the most valuable companies on the planet.

 

As of this writing, Aaron Levitt did not hold a position in any of the aforementioned securities.

 

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