Why Exxon Won't Produce More

Even with prices at the pump near all-time highs, ExxonMobil isn't projecting increased oil production. Here's why

by Christopher Palmeri

Oil fell nearly $5, to $104 per barrel, Mar. 19, on news of a government report showing slackening demand. Not long ago, a $5 drop would have been an astonishing plunge that shook the trading establishment. These days? Nah, that's just the ho-hum daily volatility in the oil market. But how is it that crude can still trade above $100 a barrel, three times what it sold for at the start of the decade, despite a very wobbly economy?

If you want to understand that, it helps to listen in to ExxonMobil's (XOM) presentation to analysts in New York City in early March. Halfway through the three-hour meeting, Exxon management flashed a chart that showed the company's worldwide oil production staying flat through 2012.

The Calculus of "Acceptable Investment Return"

Ponder that for a minute. Texas-based Exxon is the largest publicly traded company in the energy business. In fact, it's the most profitable company in the history of capitalism, earning a record $40.6 billion on sales of $404 billion last year. Yet even with prices at the pump near all-time highs, Exxon isn't planning on producing any more oil four years from now than it did last year. That means the company's oil output won't even keep pace with its own projections of worldwide oil demand growth of 1.2% a year.

Imagine a chief executive of another growth company making a similar announcement to Wall Street as Exxon Chairman Rex Tillerson. What if Steve Jobs said Apple (AAPL) wasn't going to sell any more iPhones than it did in 2007? What if Howard Schultz said Starbucks' (SBUX) latte production would stagnate, at least until the next U.S. president embarked on his or her reelection campaign? Shares of both companies would plummet.

After the management presentations, Tillerson took questions from the audience. The first hand that shot up was that of Deutsche Bank (DB) oil analyst Paul Sankey, who wanted to know why the company wasn't showing any volume growth. "We don't start with a volume target and then work backwards," Tillerson explained. Instead, he said, his team examines the available investment opportunities, figures out what prices they'll likely get for that output down the road, and places their bets accordingly. "It really goes back to what is an acceptable investment return for us," Tillerson said. In other words, producing incremental barrels just to ease prices for consumers is not part of the company's calculations. Last year, ExxonMobil led the industry with a return on capital of 32%.