This was originally posted on September 22, 2020 on my old blog and is ever so slightly updated.
Exxon et al. are on track for a bailout that will make the financial rescue of ‘08 look like handing a lollypop to a child.Oil companies – no matter what you think of them – create an essential product for modern society.
Covid has caused a temporary surplus of crude which in turn has brought down prices significantly.
US producers have been leaning heavily on horizontal / fracking to extract oil. This method of extracting oil is considerably more expensive than traditional drilling. The reason why oil companies are going that more expensive route is because there are fewer and fewer vertical drilling locations available that economically make sense -we are running out of the affordable oil that society is built on.
The result of companies switching to more expensive production is that – for example – the free cash flow from Exxon has dropped from 30-40bn/year in the mid 2000’s to 5-10bn with more and more quarters showing negative cash flow.
XOM is borrowing money to pay dividends. In an indirect way – borrowing money and then giving it to shareholders reduces the net equity in a company – management is choosing to return investors their own capital in a tax inefficient manner to keep up appearances.
If these trends continue – increasing cost of production with flattish revenue the oil industry may very well found itself in a position where costs consistently exceed revenue which would put the oil industry effectively out of business.
Given that they produce a commodity that is essential to society there would be no alternative than a massive and ongoing bailout until society has weaned itself of oil. The difference between the banking system bailout in ’08 and this one is the time frame. Bailing out big oil is not an option if we want to reduce our oil dependence in a not too destructive manner. This is quite different from the ’08 bailout (which was paid back btw) because it doesn’t entail a one-time cleanup but rather it will be ongoing. The politics will be ugly, and nationalization is a likely path forward – should it come to that.