Cosan and Shell hook up

From the department of long overdue business news... Cosan and Shell have decided to merge their fuel retail businesses in Brazil in a deal worth $12 billion, and the market liked it:

Shares of Cosan jumped more than 6 percent in Sao Paulo, while Shell rose nearly 1 percent in London.

Cosan, a leading Brazilian sugar conglomerate, also bought Exxon's fuel retail business in Brazil a few years back, surprising industry watchers who expected an oil and gas player to come out atop the bidding. Brazil's energy story is more nuanced than the simple triumph of biofuels, but nevertheless the ascent of a sugar company to prominent status in the country's fuel retail industry is striking and has no analogy worldwide, as far as I know.

First reactions to Exxon’s big play

Exxon’s $41bn deal to buy XTO energy is the big news of the day. I’m sure there will be much analysis forthcoming from every corner on this one, but here are my quick-hit thoughts from afar:

1. Great timing by Exxon. Everyone is worried about a gas glut from shale and LNG this summer, and while the price isn’t exactly distressed, this is probably about the best moment to pick up a premium large asset like XTO. I continue to admire Exxon’s countercyclical investment strategy, which they execute perhaps better than any other company on earth.


2. Great synergy between XTO’s capabilities in unconventional gas and Exxon’s global reach. Shale gas is still largely a North America story – see for example this WSJ article from tow weeks ago – and clearly has massive geological potential in many other parts of the world.


3. Related to the first two – there may be substantial balance sheet synergies, in that there are attractively priced unconventional gas opportunities out there, but with low gas prices in the near future, XTO lacks the capital and cash flow to take full advantage of them. Exxon, of course, does.


4. I think of Exxon as carrying an enormous cash hoard, so found it fascinating that they chose to do an all-stock deal. Then I looked and saw that they have burned through almost $25bn (net of income!) in the last 12 months, mostly on capex and stock buybacks. Once again… I am hard-pressed to find another company that plays the cycle better.

Update on #4: Cyrus Sanati makes the good point that Exxon did this deal with the treasury shares it bought back - much like it did for its transformative $80bn acquisition of Mobil a decade ago.

Update 2: An eagle-eyed analyst picks out an interesting condition:

Buried deeply in the 76 pages of legalese that is the Exxon Mobil-XTO $31 billion merger is a clause that basically says: If Congress regulates hydraulic fracturing, aka fracking, Exxon gets to back out of the deal.

Exxon is ever conservative, and maybe more of the value is in the U.S. than I thought in #2.

The same analyst doesn't believe this is a concern in the short term, although more for feasibility than because the underlying science is settled:

“It is our understanding that the EPA is already investigating some reports of contamination. We believe congressional leaders will wait to act until more information is available from the EPA and it is unclear when EPA would be able to complete a study,” he says.

I wonder if/how the deal gets unwound if this regulation passes a few years down the road?

Turning Oil Into Salt (6): Batteries are the crux

Anyone plugging PHEVs has to address the issue of vehicle cost, and the authors own up to the fact that the battery is currently the critical bottleneck. They cite Ford that a lithium ion battery for a PHEV costs $8,000-15,000 (~$1,000 kWh), a number which needs to come down to ~$300/kWh for PHEVs to be cost-competitive.

One very interesting fact I did not know before was that the most costly element of a lithium ion battery is not the lithium or rare earth metals that get so much press, but rather “hair thin sheets of plastic called separators.” It turns out Exxon has the world’s best separator technology, and the authors hope a prize can inspire others to match it. I wish they had broken out in one place the cost of a battery by its different components, since without that it’s tough to infer more.

All the same, the question of raw material availability looms. The authors cite the well-known predominance of Bolivia’s lithium reserves and China’s rare earth metals reserves and point out known reserves elsewhere in the world. They also cite recycling and extending battery life as mitigating strategies for the West. But while they squarely name this challenge and address it head-on, I come away unconvinced that an electric car revolution wouldn’t be trading strategic energy dependency on one commodity (oil) for dependency on a host of others.

Ultimately, the authors also have the right, open attitude toward technology and avoid the “picking winners” trap:

As the backdrop of all of the above activities, it is important to remain open-minded about other battery chemistries and realize that advanced battery technology is only at the beginning of its upward trajectory. While significant progress is made toward mass production of advanced LiIon batteries, it would be imprudent for the government to crown one battery chemistry “the winner,” particularly in light of its questionable track record of picking R&D winners. With all their potential, the race is not over.

Yet despite that attitude and the optimism it engenders, in the end they do not illuminate a line of sight to the day that PHEVs will be cost-competitive with normal cars. And without that, their OFS story is basically a biofuels (or other hydrocarbon-to-liquids fuels) story... and is that really that revolutionary?

Turning Oil Into Salt (1): Things I liked

First off, there were a number of things I liked about Turning Oil Into Salt. The overall thesis - the emphasis on fuel choice as the path to energy independence, and the Open Fuel Standard as the primary mechanism – was compelling, and while I will tear into some of their arguments shortly, I think the overall case holds together pretty well.

They also addressed all of the major issues. Every time I thought “Hmm, what about Issue X” (e.g. methanol feedstock, price of electric cars, sourcing lithium, etc.), they addressed it a chapter or two later. Not always to my satisfaction, but each issue was at least addressed in a whole-hearted way, so kudos for that.

Despite a fair amount of political rhetoric, they side-stepped some of the tempting memes like demonizing Big Oil:

This is probably the point where cynics would suggest that Exxon’s interest in critical components of car batteries stems from its desire to perpetuate oil’s monopoly in the transportation sector, that they will sit on the patent, drive up the battery price and keep us addicted to oil forever. The evidence for such conspiratorial thinking is flimsy. Oil companies have shown growing interest in technologies that can displace oil. [followed by several examples]

They also recognize resource interdependencies that are often overlooked in public dialogue:

For example, environmentalists who still lament the killing of the electric car and who promote the so-called “green economy” should realize that the road to electric cars, efficient light bulbs, and both wind and solar energy production passes through the mine and entails easing some of our mining laws and opening new areas for exploration and discovery. To put it plainly: one cannot go green and tout energy independence while reflexively opposing any mining activity and lobbying for the designation of millions of acres where essential minerals can be found as wilderness.

Finally, the analogy with salt is surprisingly good. Not only did I not appreciate beforehand the strategic importance of salt (as the only method of food preservation), which the authors convincingly make a case for, I particularly enjoyed how it was brought full circle at the end with the anecdote of how Napoleon (desirous of more logistical flexibility for his armies) incentivized the invention of modern food canning by offering a 12,000 franc prize in 1800. The authors suggest a similar prize for whoever can devise a thin-film plastic separator for electric batteries as good as Exxon’s, and it sounds like a great idea to me.

Not so fast

Looks like Exxon’s Jubilee bid isn’t a done deal yet, with talk of a counterbid from China’s CNOOC and discontent within the Ghanaian government and national oil company.

China National Offshore Oil Corp. is in advanced talks with the Ghana National Petroleum Corp. to make a rival bid challenging Exxon Mobil Corp.'s $4 billion offer for a stake in a giant oil discovery off of West Africa, said people familiar with the matter.

A GNPC-Cnooc bid, which one person said "will be competitive to what Exxon has offered," reflects both the Chinese government's desire to secure access to more of the world's oil and the Ghanaian government's to be a larger participant in the discovery, known as Jubilee.

News of the Exxon agreement infuriated the Ghanaian government and GNPC, which had been trying to negotiate to increase its 13.8% stake in the field. "I don't see the Exxon-Kosmos deal as done," said GNPC chief executive Thomas Manu said in an interview this weekend. The Ghanaian oil minister also expressed his unhappiness with not being notified that Kosmos had made a deal with Exxon and said he believed the country had the right to block the offer.

Kosmos thinks it can sell to anyone, but even with Ghana attempting to hold itself to a higher level of sophistication and investor friendliness, it would be unwise to count out the host government so soon. (That said, Blackstone and Warburg will probably still make out like bandits.)

This is also getting boringly repetitive, but China is really leaving no stone unturned in its quest to secure resources in Africa, Guinea being the latest target (or beneficiary, depending on how you view it and whose interests you're rooting for).

Exxon forecasts vs. actual

This chart from Econbrowser shows how Exxon has repeatedly (well, at least twice since 2000) forecast 3% production growth and failed to deliver.


An interesting question is whether Exxon’s famed investment discipline holds in the case of their recent $4 billion acquisition in Ghana.

Alan von Altendorf thinks they can't make a good return unless they sell the oil for $100/barrel. Presumably the company is reckoning on more oil in the field than current estimates suggest. But even if von Altendorf's calculations are off by a factor of two, it still seems to signal a change in philosophy for a company that has historically been extremely careful with its investments in order to maintain its position as a very low-cost producer.

If I recall correctly, Exxon’s longtime breakeven hurdle was $22/bbl, so this would indeed signal a sizeable shift unless we are missing something. But then again, given that oil bottomed out around $35/bbl during the scariest recession the world has faced in a generation, so some change in worldview is certainly justified.

Blackstone and Warburg win big with oil

Raw commodities are far from the ideal private equity play - heavy value exposure to volatile commodity prices and seemingly little competitive advantage in either deal flow or operations. But a brave few have tried, and in at least one case succeeded:

Warburg Pincus and Blackstone Capital Partners are set to make a four times return on their investment in West African oil company Kosmos after oil giant ExxonMobil agreed to acquire Kosmos’ stake in Ghana’s Jubilee oil field for $4bn, according to reports.

I checked the Warburg Pincus website and found that:

Warburg Pincus led the company’s initial $300 million equity financing in 2004, and also led a $500 million follow-on equity financing in 2008.

I then checked the news for when in 2008 (makes a big difference!), and it was in June, or basically when oil prices were well above $100/bbl and racing towards $150. So it's not as if Blackstone and Warburg simply bet on and nailed the commodity cycle - it seems their add-on investment came at the peak. It seems the bet was more on the management team and their track record, which is impressive. That said, I doubt we see too many more of these deals - with the recent levels of commodity volatility, most major PE firms are shying away from direct commodity price exposure and looking for more indirect ways to get exposure to the overall volume and price growth.

Exxon CEO on carbon tax

Few people believe that ExxonMobil CEO Rex Tillerson's defense of a carbon tax is not motivated partly by the political difficulty of passing such a tax. In his latest address, he shows that he's cognizant of this criticism:

But when the boss of Exxon attacks climate-change legislation, skepticism is usually in order. “We think it’s fair to view Exxon’s opposition to cap-and-trade – Tillerson’s reasonable critiques notwithstanding – as a tactic meant to delay passage of meaningful legislation,” argue the folks at Green Energy Reporter.

Mr. Tillerson addressed that head on:

Now, some people have suggested that a revenue-neutral carbon tax has no chance of gaining sufficient support in Congress to become law. They say a carbon tax is too politically sensitive and that it is easier and more politically expedient to support a cap-and-trade approach, because the public will never figure out where it is hitting them. They will just know they hurt somewhere in their pocketbook.

I disagree with this assessment. I believe the American people want climate policy to be transparent, honest, and effective. Economists generally agree that achieving a given emissions target costs less under a tax or fee approach than under a cap-and-trade system. I firmly believe it is not too late for Congress to consider a carbon tax as the better policy approach for addressing the risks of climate change. Indeed, there has never been a more opportune time for Congress to pursue this course of action.

Good for him for recognizing, although it doesn't change my opinion of his underlying motivations.

Exxon lends credibility to algae

I was under the impression that most of the big boys had looked at algal biofuels and passed, and that the space was dominated by start-ups like Sapphire, but now the biggest skeptic of them all, Exxon, has announced a substantial partnership and investment:

ExxonMobil Research and Engineering Company has entered into a research and development alliance with SGI, a privately held company focused on developing genomic-driven solutions and founded by genome pioneer, Dr. J. Craig Venter, to develop advanced biofuels from photosynthetic algae that are compatible with today’s gasoline and diesel fuels.

Under the program, if research and development milestones are successfully met [my emphasis added later], ExxonMobil expects to spend more than $600 million, which includes $300 million in internal costs and potentially more than $300 million to SGI.

Maybe things have just been quietly chugging along - both Chevron and Shell announced similar partnerships about 18 months ago, and I have not heard anything about them since. My own limited understanding is that algae is technically attractive because of its super-high photosynthetic rate, but that unless you can figure out how to grow it in the ocean it runs into the same space/scaling issues as other biofuel feedstocks.

Update: Looks like this play still has a long time horizon:

Exxon’s Mr. Jacobs said it would be “five to ten years” before small-scale plants are up and running. And neither company wanted to put a pricetag on the fuel produced from algae, which with today’s technology is still vastly more expensive than gasoline.

Update 2: Earth2Tech has a nice cheat sheet of major investments in algal biofuels. At $650m, Exxon's is the second-largest behind Algenol Biofuels' $850m plant in Mexico, and the two are the only ones above $100m.