Big Oil Relocates to a Different Planet

(Bloomberg Opinion) -- When Exxon announced in 1989 it was leaving midtown Manhattan for new headquarters in the Dallas suburbs, Stanley Grayson, New York's then deputy mayor for finance and economic development, offered this bon voyage:

It's part of an industry which I think is generally perceived as a Southwest, Texas-based industry. It's part of an industry that's half the size it was 10 years ago. Its outlook is not necessarily bright and it's not perceived as a tremendous growth industry right now.

What else would you expect a New Yorker to say? Three decades on, Exxon Mobil Corp. is on the move again, shifting its home south to Houston. And while some of what Grayson said was flat-out wrong, Big Oil was indeed under a cloud in the late '80s — and is again today.

Not that it's immediately obvious: On Tuesday, Exxon announced its best financial results in many years. Last year's free cash flow was the highest since 2008, when oil hit its all-time peak and Exxon was the biggest listed company in the world. Having borrowed to fund its dividend in recent years, corroding its reputation for discipline, free cash easily funded payouts in 2021, teeing up an imminent resumption of share buybacks. Elsewhere in Big Oil, rival Chevron Corp. reported similarly huge cash flow numbers on Friday.

That looks like a lot of blue sky and, compared with much of recent history, it is. With both Exxon and Chevron now trading at or close to all-time highs, though, some context is required.

Even with blockbuster numbers, Big Oil is more defensive these days. For all the symbolism, Exxon's shift to an existing campus in Houston, coming alongside combining its downstream oil and chemicals divisions, looks like straightforward physical consolidation after job cuts. Only about 250 people actually work at the Irving campus, even fewer than the 300 Exxon employed in New York before its last move. Cost-cutting and debt reduction featured up top of Tuesday's earnings announcement. And whereas free cash flow for both Exxon and Chevron recalls the heady days of the mid-aughts, the big difference is that, back then, they were also big spenders. Today, their cash flow is freer because they've cut capex to preserve dividends.

That's not a bad thing! High spending trashed return on capital, and investors demanded a reset. True, it took a pandemic and a proxy battle to get Exxon to take that on board, but still. In addition, climate change puts a huge, existential cloud over the future of oil investment. Back in 1989, that sour New York official was right about oil not being a growth business in the short term, but he was wrong in the long term; global demand is now about 50% higher. Today, it's the opposite: He would be wrong in the short term, given the rebound in supply and demand from Covid-19. Exxon in particular is poised to bring on more barrels in Texas and Guyana. But he would be right in the long term as decarbonization takes hold. Slide decks from Exxon and Chevron now feature extended discussions of lower carbon businesses, not the charts of yesteryear forecasting ever-increasing oil demand.

This is a bid to boost relevance with investors in a world where the two oil majors' combined market cap is dwarfed by that of one electric vehicle maker whose own free cash flow is less than 1/10th theirs. (Fun fact: Exxon's new HQ will be only a two-and-a-half-hour drive from Tesla Inc.'s new digs in Austin.) Despite sharp rallies — including a big jump for Exxon on Tuesday morning — the energy sector's weight in the S&P 500 is a fraction of what it was in 2008.

It was telling last Friday when, despite solid numbers overall, Chevron's stock tumbled because it missed earnings expectations on a mixture of one-off factors. Both oil majors have restored some faith in their financial chops and have benefited enormously from strong oil and gas prices. Yet, at about 12 to 13 times forward earnings, both stocks already trade at multiples that are higher than they enjoyed for much of the past two decades. Their discount to the S&P 500 of roughly 40% is also about where it was for much of the same period.

For investors, it's no bad thing that, in an uncertain world, the oil majors are rebalancing toward payouts over growth. It remains to be seen whether they will award an even higher multiple for that.

More from other writers at Bloomberg Opinion:

Exxon's Partial Net-Zero Target Is Actually Useful: Liam Denning
Oil Producers Can Expect More Turbulent Years Ahead: Julian Lee
Shell's Rejigger May Help It Shrink More Than Grow: Chris Hughes

Quoted in "Exxon Will Move Its Headquarters To Texas," by James Barron, The New York Times, Oct.27, 1989.

Exxon's average forward price/earnings multiple from 2000 through 2019 was 10 times, while Chevron's was nine times. Exxon's average discount to the S&P 500 was 37%, while Chevron's was 43%. I exclude 2020 due to the impact of the pandemic crash, rendering earnings multiples meaningless that year.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Liam Denning is a Bloomberg Opinion columnist covering energy, mining and commodities. He previously was editor of the Wall Street Journal's Heard on the Street column and wrote for the Financial Times' Lex column. He was also an investment banker.