The Making of a Leader

Exxon Mobil (XOM - Free Exxon Mobil Stock Report) was originally formed in Ohio as the Standard Oil Company by John D. Rockefeller and his associates in 1870. At its inception, the company had the largest refining capacity of any single firm in the world. Rockefeller chose refining over oil exploration and production because the profits were steadier. Wildcatters made big money when they struck oil, but had nothing but expenses if they didn’t hit pay dirt. The Standard name was chosen to signify high, uniform quality for kerosene, its main product, which was marketed regionally.  A visionary, Rockefeller used research and development to transform what was considered waste in the refining process into byproducts such as lubricants and grease.

Growth was in the company’s veins. In 1879, Standard Oil purchased a 75% interest in lubricants pioneer Vacuum Oil (later to become part of Mobil) for $200,000 and by 1882 the company was so successful that it formed the Standard Oil Trust. Along the way, Standard Oil lubricated Thomas Edison’s first central generating system and the Wright Brothers, Orville and Wilbur, used fuel from a Standard Oil company for their first historic flight at Kitty Hawk, North Carolina in 1903.

But overwhelming success sometimes has a price. In the free-wheeling days of late-19th Century America, companies could, and did, grow extremely large, by eliminating the competition, usually through buyouts, but sometimes by way of hard-nosed business practices. Rockefeller himself, ever the efficient manager, looked upon competition as a ``ruinous’’ threat. The large concentration of power that Standard Oil held in the oil industry led the government to break up the company in 1911 following a landmark United States Supreme Court decision, after years of legal wrangling.

The Age of the Automobile

Exxon, Mobil, Chevron, and several other descendants of Standard Oil were on their own beginning in 1911, marking the start of a long period of parallel evolution. But fate smiled on the company. The Twentieth Century brought a huge expansion in the amount of oil consumed, and great prosperity for the oil business, with Exxon and Mobil becoming two of the industry’s leading companies. The year 1911 also marked the first one in which sales of gasoline outstripped those of kerosene, as Americans started driving cars in large numbers. Thus, it didn’t matter that the electric light bulb had replaced kerosene lamps as the main source of light in homes.

The new challenge was to secure oil for the company’s refineries. When Standard Oil of New Jersey came into being in 1911, it had almost no oil of its own. In 1920, Jersey Standard (so called until the name was officially changed to Exxon in 1972), bought a 50% stake in Humble Oil & Refining of Texas, diversifying into oil exploration. Over the years, the company became one of the world’s leading drillers and made great strides in chemicals manufacturing.

Exxon and Mobil were separate until late in 1999, when they merged following an industry slump to form what is now the corporation with one of the largest stock market capitalizations. The company is best known for its three familiar brand names: Exxon, Esso, and Mobil. The Esso brand name, used internationally, is derived from the initials `S’ and `O’ in Standard Oil.

The Model of the Integrated Oil Company

The company epitomizes the integrated approach to the oil business, dividing its operations into three main segments. The upstream division, usually Exxon Mobil’s most profitable line, is comprised of oil and natural gas exploration, development, and production. Downstream refers to the refining and marketing of petroleum products, such as motor fuels and lubricants. A world-class petrochemicals unit fills out the bill.

Exxon Mobil’s daily oil production of around 2.4 million barrels of oil a day is less than 3% of what’s pumped globally, meaning the company has almost no control over pricing. Nevertheless, the amount pumped is sizable when considering that it is similar to what several medium-sized OPEC members produce. One sign of Exxon’s notable efficiency is that its per-barrel profits exceed those of its competitors.

The annual challenge in the upstream division is to find more oil and gas to replace what’s been taken out of the ground. Exxon’s good track record of regular additions to its sizable resource base suggests that it is up to the task. Higher spending in recent years also has boosted production. Notably, most of the rise in upstream volume is coming from increased natural gas production, as the technology to extract gas from shale rock has come into its own, while the state-run companies that control most of the world’s known oil reserves limit drilling access.  Boosting volume is no easy task for a company the size of this one. But production from in-house sources should see a modest uptick in the coming years as a host of projects in various stages of development come to fruition.   
Exxon’s reputation as the "engineer’s oil company’’ shines through in its refining and chemicals segments. Even as a number of competitors have dramatically lightened up on their downstream operations, Exxon Mobil has largely stayed the course in these areas, relying on its low-cost operations to meet the challenges posed by industry cycles. Returns from the refining and chemicals lines can be stellar during peak periods, but tend to be subpar during broad business slumps.

The company puts economies of scale to work in the downstream where, with interests in 36 refineries, it remains the world’s largest supplier of petroleum products. Exxon’s refineries are 60% larger than the industry average, and have more capacity to handle the lowest-grade feedstock and greater integration with chemicals operations. Those types of advantages in scale and efficiency are difficult for competitors to replicate.
21st Century Strategies

The plunge into ``unconventional’’ assets is the latest twist in the oil and gas development program, punctuated by the company’s 2010 acquisition of XTO Energy, its first large business combination since the Mobil deal.  XTO brought with it reserves in five major shale gas plays that are proving significant sources of fuel, plus the technology to develop similar fields around the globe. Add to that the proximity of the acquired assets to customer markets, and the logic behind the deal was compelling. Rising demand for natural gas to use in power generation should allow the move to pay off over time.

In refining, Exxon aims to capitalize on ties with its oil production unit, and is investing to improve energy efficiency and bring along new products, such as ultra-low sulfur diesel. Down the road, for example, R&D could make algae biofuels a commercial success.

The oil giant has also been supplementing its base in mature petrochemicals markets with a greater presence in the high-growth Asia-Pacific region. A construction project in Singapore aimed at doubling capacity and a relatively new top-of-the-line facility in southern China highlight the recent investment program. In chemicals manufacturing, as in refining, Exxon takes a long-term, disciplined approach to investing.

Exxon’s efficiency extends to its capital base, evidenced by the large amount of share repurchases every year. The company has retired all of the stock issued from the Mobil acquisition, without taking on additional debt. Exxon is sometimes criticized for using cash to buy its own shares, instead of making acquisitions. However, in one sense, the grand scale of Exxon’s repurchases is the equivalent of buying a large company every year.

A Quintessential Blue Chip

Exxon Mobil clearly has a well-honed game plan that will continue to serve it well over time. The company is head-and-shoulders above its rivals in many respects, making these top-quality shares a core energy holding. But no matter how big or efficient Exxon is, it still needs pricing and margins to go its way to achieve the best returns. Pricing and margins, in turn, rely on consumer demand, which is off its peak owing to the sluggish economy, and may not accelerate sharply until business conditions show more pep. Assuming global growth accelerates by mid-decade, the stock is a good selection for growth and income and, with finances second to none, is especially fitting for conservative investors.

At the time of this article, the author did not have a position in any of the companies mentioned.