This week, Engine No. 1 took a small stock position in ExxonMobil and with it, proceeded to send it a letter,asked to get on the board and for them to change their approach to the business.  No big deal, and a little humorous, I did that too with CDEV  and it was about as well received.  Activism is a tough road to take, but when the momentum of energy investing is on your side, as it has been over the last 5 weeks, you can certainly create a catalyst, and in a week when energy investors were looking for any reason to go long, they found it, and Exxon outperformed Chevron all week.

What to make of the content of the letter itself? The key issues it addresses are:

1. Poor long term capital allocation.
2. Long standing commitment to counter cyclical investing.
3. Lack of a long term plan to enhance and protect value.
4. Exxon shouldn’t yield ground as an innovator
5. Management compensation isn’t aligned with shareholders (….. don’t even get me started)

To be clear, this letter could have been addressed to anyone in the E&P space.  We are a commodity business that under utilizes hedging.  We have focused on growth when world demand wasn’t growing as fast as the U.S. was (and at the expense of OPEC capacity) and that was done to compensate for the lack of core value in the assets at a level that makes the industry investable.  As a result, we have been a subsidy to consumers by growing production (uneconomically) rather than investing to maximize NPV.  The question is: does a new board of directors fix that?

Their candidates are impressive to be sure: Gregory Goff, former CEO of Andeavor, who bought Western Refining and later merged with Marathon; Kaisa Hietala (diversity!), who was the EVP of Renewable Products and Neste, a private company European company; Alexander Karsner, a renewable energy entrepreneur; and Anders Runevad, former CEO of Vestas Wind systems.  We have long talked about ESG NOT being the problem with the oil and gas industry, but instead, it has been a “G” problem, so I’m all for board turnover.  But I’m not sure THIS slate of folks are the ones I want steering Exxon to address the problem with it’s current business: namely the points they made early in the letter: Exxon has increased debt to fund operations, has a ROCE that has fallen to 6% from 2015-2019 (not that oil prices haven’t been great in that period);a nd shareholder returns vs. the S&P over the last 10 years is -20% vs. 277% (it has sucked to be a public energy investor… much better to have been an investor in OneEnergy).

As I have said in the past, I believe the solution for Exxon is to buy EOG and turn onshore U.S. operations over to the EOG team.  EOG is the best capitalized and best run company in the space, and in concert with Exxon’s expansive land position, access to capital, and fully integrated energy business, the combination would be a powerhouse.  By focusing on generating positive operating cash flow, paying down debt and adjusting the dividend to reflect a $50/bbl world rather than a $100/bbl world, they would substantially improve the balance sheet and sustainability of the business.  By focusing on energy projects were their core skill sets can be utilized to generate the highest rate of return, rather than on virtue signaling renewable projects in a market that is saturated with overvalued companies already, they can be the best at what they are.  And finally, they need to diversify away from the U.S. where inventory is not competitive with the rest of the world, and where regulations will make it harder, not easier, to operate and while there is a substantial role for natural gas in a reduced carbon world, perhaps international opportunities offer the best of both worlds.

Letters are fun to write and it’s great when the stock market cooperates by throwing money at the sector on the heels of massive under positioning and a view of a declining U.S. dollar, increasing inflation, and underinvestment in oil (the commodity) sets up what is assumed to be a super bull market.  And while I don’t share the view that owning E&Ps even at $50/bbl is a great investment, I can’t fight the trade and I can’t deny that with the froth that is the market these days, oil could hit $60 before it hits $35.  Don’t fight the fed, or the money flow.

Be safe, be good, and have a great rest of your day.