Exxon-Mobil Mobil (XOM) is a long established major energy conglomerate. Exxon-Mobil produces, transports, and sells crude oil and natural gas throughout the world. They distribute their petroleum products and petrochemicals globally via their infrastructure; the diversity of Exxon-Mobil is demonstrated by their involvement in the generation of electrical power. Exxon-Mobil continues to search for yet untapped fields of natural resources, and engage in the development and marketing of petrochemicals and the resulting byproducts.
Exxon-Mobil is the worlds’ largest integrated oil company. Exxon-Mobil currently has 45 refineries in 25 different countries. Exxon-Mobil provides fuel to almost everything in the world. In 2005 year end, the company’s equity was just over $111 billion. Every oil company mainly uses the capital asset pricing model, also known as the CAPM to find out the cost of equity. Exxon-Mobil’s stock markets and bond markets can be at risk depending on how low they are in debt. Most investments in money will be low for large international companies but high for small companies. Exxon-Mobil’s Balance sheet ending in December 2005 fiscal year, ended with $208,335 million total shareholders’ equity and liabilities.
Exxon-Mobil’s income for fiscal year 2003-2005 increased each year. During 1987 – 2005 Exxon-Mobil’s Nominal Oil Prices and real Oil Prices, gradually increased from 1987 to 1990, then decreased from 1991 to 1998. In 1999 Nominal Oil Prices and Real Oil Prices started to increase more, and going up each fiscal year from 2003-2005. Exxon-Mobil’s net change in cash increased constantly in 2003 – 2005. Exxon-Mobil takes on some of the world’s toughest energy challenges. Exxon-Mobil sells more than $600 million gallons of fuel each day. Exxon-Mobil conducts business in many foreign currencies.
Our analysis for this project is to evaluate the investment based on the long-run optimal capital structure of the business. Argentina is an emerging market, because of this fact the evaluation of this project must take into account additional variables such as oil price fluctuations, political unrest, infrastructure concerns. The initial investment $130M must be weighed against the annual cash flow discounted with the cost of capital in order to make a prudent decision whether the investment should be accepted or rejected. In an emerging market such as Argentina the cost fluctuations in oil must be taken into account.
As the cost of oil fluctuates it will affect the NPV or cash flow (positive or negative). As long as the discounted cash flow remains positive regardless of the price oil the project will remain viable. Over the next few pages, we want you to consider whether investing in a drilling opportunity in Argentina is a prudent investment. We will explore with you the risks and benefits involved in this capital management decision. As you consider making a decision regarding the investment opportunity that Argentina presents, we have calculated the discount rates for the potential investments.
These rates represent the risk that you are taking with making this investment. Unlike using a risk-free rate for calculating potential future profits, we understand that there are inherent risks involved in making these decisions. In order to provide you with a complete picture of the risks involved, we have provided you with several different rating methodologies. These methods are specifically used to calculate the risks involved with making investment decisions in foreign countries. Please understand that the lower the number the easier it is to generate a profit. Conversely, the higher the number, the more difficult it will be to be profitable.
Argentina's Projects Discount Rates| Discount Rates| | Lessard Method| 8.2%| Godfrey-Espinosa| 17.7%| Goldman Sachs| 18.4%| Salomon Smith Barney I| 7.9%| Salomon Smith Barney II| 12.9%| Salomon Smith Barney III| 9.6%|
Please consider the Salomon Smith Barney rates enclosed by the red box. We believe that these rates will be your best indicator of future profitability for this project. After reviewing each methodology, we recommend that Exxon-Mobil consider the SSB method as part of your analysis. We make this recommendation based on the fact this developing the discount rates using this method allows you to take into account the following factors that could have an impact on your company.
These factors include: access to Global Capital Markets, the Political Risk, and the importance of Exxon-Mobil making an investment in Argentina. In a report published on July 26, 2002 by Salomon Smith Barney/Citigroup, an illustration is provided which highlights the usage of Political Risk Premium which is a key factor in development of this discount rate.
Most importantly, by using this calculation, adjustments can made be to account for the varying factors related to the market for this project. Since this is an international project, we want to insure that you have the flexibility to revise your decision and your strategies based on the changing environment.
Please note that the discounts rates provided for SSB are based on different risk factors.
| Access to Capital| Political Risk | Importance to Exxon-Mobil| Salomon Smith Barney I| 0| 0| 0| Salomon Smith Barney II| 10| 10| 10| Salomon Smith Barney III| 0| 10| 0|
Again, this methodology allows us to adjust these calculations as market conditions change. Even though we would recommend using SSB as the discount methodology for this project, we did compare the anticipated NPVs for this project utilizing all of the calculated methodologies. This resulted in the following NPV calculations:
NPV Calculations| | NPV| Lessard Method| $168,405,453.15 | $38,405,453.15 | Godfrey-Espinosa| $129,179,278.94 | ($820,721.06)| Goldman Sachs| $126,883,509.99 | ($3,116,490.01)| Salomon Smith Barney I| $169,943,756.84 | $39,943,756.84 | Salomon Smith Barney II| $146,919,108.05 | $16,919,108.05 | Salomon Smith Barney III| $161,508,913.11 | $31,508,913.11 |
As a reminder, NPV’s allows us to discount the future project’s cash flows back to the present before assessing the value of the project. A positive NPV indicates that there will be a positive return on the initial investment. Conversely, the negatives indicated by Godfrey-Espinosa and Goldman Sachs would suggest that these projects would be losers. Please keep in mind, that while both of these methods attempt to account for the risk of investing in a foreign market, neither weighs the individual components of making such an investment, as does the Salomon Smith Barney method. For your consideration, we have also included the calculated Internal Rate of Return on for this project.
The IRR focuses on the rate earned on the initial investment. For this project the IRR 17.45%. When comparing to the discount rates mentioned above, the IRR requires a higher rate of return than all of the methods except for Godfrey-Espinosa and Goldman Sachs. When comparing IRR to our recommended SSB methodology, we would argue that the IRR method for evaluating this capital investment does not account for the fact that this is a foreign project. Because of this, we would continue to recommend the use of the SSB discount rates.
The final analysis that we would like for you to consider is the impacts of the price of oil on the overall profitability of the project. Our calculations were made with oil being $58 a barrel, which is a high value based on the Nominal and Real Oil Prices from Dec. 1987-Dec. 2005. With this in mind, we did a sensitivity test, analyzing the NPV’s using varying oil prices from $25 - $90. The chart below indicates where the project would be profitable based upon NPV calculations:
| 130,000,000| Initial Investment| | | | | | Cost Per Barrel| Free Cash Flow| Lessard Method| Godfrey-Espinosa| Goldman Sachs| Salomon Smith Barney I| Salomon Smith Barney II| Salomon Smith Barney III| 58| $36,650,000| $38,405,453.15 | ($820,721.06)| ($3,116,490.01)| $39,943,756.84 | $16,919,108.05 | $31,508,913.11 | 20| -$1,350,000| ($136,203,202.23)| ($134,758,309.05)| ($134,673,744.57)| ($136,259,865.53)| ($135,411,754.32)| ($135,949,168.70)| 25| $3,650,000| ($113,228,379.15)| ($117,134,942.21)| ($117,363,579.50)| ($113,075,178.38)| ($115,368,219.80)| ($113,915,210.56)| 30| $8,650,000| ($90,253,556.08)| ($99,511,575.37)| ($100,053,414.42)| ($89,890,491.22)| ($95,324,685.28)| ($91,881,252.43)| 35| $13,650,000| ($67,278,733.00)| ($81,888,208.52)| ($82,743,249.35)| ($66,705,804.07)| ($75,281,150.75)| ($69,847,294.30)| 40| $18,650,000| ($44,303,909.92)| ($64,264,841.68)| ($65,433,084.28)| ($43,521,116.92)| ($55,237,616.23)| ($47,813,336.17)| 45| $23,650,000| ($21,329,086.85)| ($46,641,474.84)| ($48,122,919.20)| ($20,336,429.76)| ($35,194,081.71)| ($25,779,378.04)| 50| $28,650,000| $1,645,736.23 | ($29,018,108.00)| ($30,812,754.13)| $2,848,257.39 | ($15,150,547.19)| ($3,745,419.90)| 55| $33,650,000| $24,620,559.30 | ($11,394,741.16)| ($13,502,589.05)| $26,032,944.54 | $4,892,987.33 | $18,288,538.23 | 60| $38,650,000| $47,595,382.38 | $6,228,625.68 | $3,807,576.02 | $49,217,631.70 | $24,936,521.86 | $40,322,496.36 | 65| $43,650,000| $70,570,205.46 | $23,851,992.52 | $21,117,741.09 | $72,402,318.85 | $44,980,056.38 | $62,356,454.49 | 70| $48,650,000| $93,545,028.53 | $41,475,359.36 | $38,427,906.17 | $95,587,006.00 | $65,023,590.90 | $84,390,412.63 | 75| $53,650,000| $116,519,851.61 | $59,098,726.20 | $55,738,071.24 | $118,771,693.16 | $85,067,125.42 | $106,424,370.76 | 80| $58,650,000| $139,494,674.69 | $76,722,093.04 | $73,048,236.31 | $141,956,380.31 | $105,110,659.94 | $128,458,328.89 | 85| $63,650,000| $162,469,497.76 | $94,345,459.88 | $90,358,401.39 | $165,141,067.46 | $125,154,194.47 | $150,492,287.02 | 90| $68,650,000| $185,444,320.84 | $111,968,826.72 | $107,668,566.46 | $188,325,754.62 | $145,197,728.99 | $172,526,245.15 |
As you can see, up until $50 to $55 per barrel, this project would not be profitable. Considering this analysis, we would have to consider our need for the price of oil per barrel to continue to be above the $58 threshold. If the price oil were to go back to historical levels, the opportunity for this being a profitable project would be marginalized. Even with using the SSB methodologies, we would need the price per barrel to maintain a $50 per barrel norm in order for this project to be profitable.
Based upon our findings, although the prospects of exploring oil opportunities in Argentina are intriguing, it is our recommendation, that despite seeing the positive returns using the Salomon Smith Barney discount rate methodology for the basis of our NPV calculations, that the project is far too reliant on the price of oil per barrel. If we believe that the $58 per barrel was sustainable, we would recommend this project without hesitation. Unfortunately, given the historical trends, we simply do not feel that this will be the case. Please consider our recommendation that you should forego this project at this time. We will continue to monitor any changes and will re-visit as needed in the future.