Big Oil In Trouble, Enters "No Man’s Land" of Collapsing Balance Sheets

A great many fracking companies are going out of business with carbon fuel prices this low, because revenue doesn't cover the cost of production. Big producers like Exxon are being affected as well, via their balance sheets (source).

by Gaius Publius

Just a reminder that there are many ways to stop the burning of carbon, in addition to negotiation and smooth, well-planned transitions. Those two are preferred, of course, but we don't seem to have those options any more, and yet we do need to stop burning carbon.

Other options include disrupting consumption and disrupting supply. Of these two, I prefer disrupting supply, since as I've noted before, if they extract it, someone will burn it. Both of these disruptions can be accomplished through legislation and/or executive action.

But one of the unique ways of disrupting supply is to disrupt (degrade, destroy) the financial health of the companies doing the extraction, for example, Exxon. Divestment campaigns — making the holding of Exxon stock morally toxic for institutional buyers like universities — are a form of disrupting supply by disrupting corporate financing. Unfortunately, though divestment campaigns do work — witness the divestment campaign against South African apartheid — they can be slow and spotty, not broad enough to effect an entire industry.

Enter the "magic of the market." If the price of oil is so cheap that it's not profitable to dig it, because it's so plentiful relative to demand, companies will collapse, go bankrupt. We've already seen that with small and mid-size U.S. fracking companies, many of which are so highly leveraged that they can't make a profit on sales and they can't finance their debt.

That method of disruption works for smaller companies, but what about the giants? There are actually two ways to financially "attack" a company like, say, Exxon. One is to attack the profit-and-loss statement by making sales unprofitable, as described above.

The other ... is to attack the balance sheet, the net worth of the company. In either case — bad balance sheet, bad earnings statement — no investor will will touch the stock until the stock price is revalued to reflect the "new realities."

What's the best way to attack the balance sheet of any company in the oil and gas industry? You make their in-the-ground assets worthless, and then make sure that until those "stranded assets" are properly revalued in the annual statement, the stock is, well, toxic.

That would disrupt any company that depends on "proven reserves" or unextracted assets for the bulk of its valuation. (That will also disrupt, as in panic, the companies' CEO classes, since generous stock grants are one of the three ways that CEO pocket the loot from companies they run.)

A pipe dream? Not at all. It's already happening. From EcoWatch and Oil Change International in October (emphasis added):

Big Oil Is in Big Trouble

Something significant happened on Friday [Oct 28] that warrants more than just a few column inches in a newspaper.

With the most divisive presidential election in U.S. history just days away from concluding, it is easy to understand why more is not being made of the news, but just to tell you something seismic happened on Friday last week.

The world's largest listed oil company, Exxon, announced that it was going to have to cut its reported proved reserves by just under a fifth—by 19 percent.

It would be the biggest reserve revision in the history of the oil industry. It is yet another sign that Big Oil is in big trouble.

The explanation why that's bad:

For years people have been warning that Big Oil's business model was fundamentally flawed and was not only putting the climate at risk, but millions of dollars of shareholders' money. ...

From the article, quoting the Chicago Tribune:

"Big oil companies have been solid investments for years, with a deceptively simple business model: Find at least as much new oil as you sell, book those barrels as future sales and reinvest in the hunt for new reserves. That made sense as long as oil prices went up, but it locked companies into a vicious cycle of replenishment, leading them to search for ever more extreme, and expensive, sources of crude oil in the Arctic and beneath the oceans. ...

"Cheap oil has stopped that business cold and the threat of climate action raises fundamental questions about whether it'll ever be viable again."

Back to the article itself:

In May this year, the London-based Chatham House warned in a report, entitled The Death of the Old Business Model, that the world's largest oil companies "Faced with the choice of managing a gentle decline by downsizing or risking a rapid collapse by trying to carry on business as usual."

Importantly, most of Exxon's de-booked reserves, about 3.6bn barrels, will be at the company's dirty Kearl oil sands project in Canada. The reduction would account for over three quarters of the reserves. Not only are tar sands very energy intensive, but they are expensive to produce.

In a low oil price, carbon-constrained world, they are stranded assets.

Notice the word "collapse" above. Collapses, like many stock market crashes, for example, often happen quickly. This one is happening slowly, for now. But still, no oil company will book more reserves than it now has on its balance sheet. Investors already believe that not all booked reserves will be sold. "Stranded assets," unsellable reserves, are a subtraction from balance sheets, and more and more assets are just waiting to be stranded. At what price point will Exxon stock cease to be an attractive investment? I think that's about to be tested.

Death by Market and What It Means for Us

We may be witnessing the "death by market" of the oil and gas industry. If so, cheer. But also, get energy lean as fast as you can, since that market will have to be replaced by something else. Renewables is the obvious choice, but that something else will just as obviously have to be in place in order to be available.

Will the Trump administration make renewable energy abundantly available before it's needed, or only after the carbon market falls terminally ill? I'm betting on the latter. The good news, however, is still the good news. We do have to get off of carbon at the fastest possible rate to keep the planet human-habitable ... and this may do it.

GP