Is Exxon Mobil's future running dry?

That discipline has worked for Exxon Mobil. This is an amazingly profitable company, even by oil industry standards. Exxon Mobil's return on capital is a whopping 23.5%, when the average for major oil and gas companies is 17.7%, and the average for the companies in the Standard & Poor's 500 Index ($INX) is just 10.7%.

If you look just at returns on capital in the upstream business -- the oil exploration and production business -- Exxon Mobil's returns are twice that of Chevron, the second-best company in its industry, according to Deutsche Bank.

Buying back its stock

Oh, there are large-scale, capital-intensive projects that promise the kinds of returns that Exxon Mobil targets. But such big projects are few, often because rising oil-field costs have reduced the projected return below Exxon Mobil's target. For example, in February, Exxon Mobil and Qatar Petroleum dropped plans to build a plant that would have turned natural gas into liquid fuel after costs climbed to $18 billion from $7 billion, the estimated price tag when the deal was signed in 2004.

Instead of investing in projects that don't meet its target for return on investment Exxon Mobil continues to buy back stock -- $32.6 billion worth in 2006, $31.8 billion in 2007 and $8 billion in the first quarter of 2008 alone. Those purchases reduced the share count to 5.38 billion, or 6%, in 2007 and to 5.28 billion by the end of this year's first quarter. As recently as the end of 2003, the company had 6.67 billion shares outstanding. That's about 1.4 billion more than today.

Where does Exxon Mobil go from here? I see three possible scenarios:

• The company uses all the shares it's been buying up as treasury stock to do a really big acquisition like the $80 billion all-share deal in 1998 to acquire Mobil. An all-stock deal would be a way for Exxon Mobil to work around the big run-up in oil company share prices because Exxon Mobil would be paying in its appreciated shares for the appreciated shares of a target such as Occidental Petroleum (OXY, news, msgs). (By the way, at the time the Exxon-Mobil merger was announced in 1998, oil was selling for $11.28 a barrel.)

• Exxon Mobil gets the kind of collapse in oil prices the company seems to be planning for and can pick up the exploration and production assets it needs on the cheap. It's hard to tell what price for oil Exxon Mobil is using in its long-term calculations for return on investment. But many oil analysts speculate the company is using a planning price of somewhere between $30 and $50 a barrel as its long-term price of oil.

• Exxon Mobil doesn't get the collapse in oil prices it seems to be planning for and can't find a merger candidate willing to sell at a price that meets the company's targets for return on investment. In this case, Exxon Mobil continues along its present course, buying back stock and paying out dividends to shareholders until, sometime around 2015 to 2018, it goes private or, having turned itself into a trust years earlier, liquidates and disappears.

I don't think the last of these alternatives would be a disaster for the economy or for shareholders. Companies should return money to shareholders -- for those shareholders to put to work in other investments as they see fit -- if they can't find a way to earn the appropriate return in their business.

The history of oil company diversification, some of it at Exxon Mobil as early as the 1970s, suggests oil companies are not particularly good vehicles for developing new energy technologies. We all might be better served if Exxon Mobil gave its shareholders the cash and let them invest in the most promising solar or battery or hydrogen technology companies.

Cushioned from correction

None of these alternatives should deter investors from holding Exxon Mobil stock. In fact, they demonstrate the unique role the company's shares have to play in an energy portfolio. Exxon Mobil's conservative approach to reinvestment means these shares are the least risky shares you can own in the sector, if the sector does suffer a major correction. (I think the odds of that are small, but the chance is greater than zero.)

Because the company is, in fact, hoping it can pick up assets cheaply in a correction and because the company has been hoarding cash and shares rather than investing in new production, it hasn't bought into the kind of high-cost production that would suffer most in a correction.

In the long run, the world needs oil from Canada's oil sands and from deep-water drilling in the South Atlantic, but the companies that have invested in those areas have taken the biggest risks.

Exxon Mobil hasn't. That makes it a haven in any energy storm. And a likely big winner from any correction.

And if that correction doesn't materialize? Well, there are worse things than collecting the returns from owning shares of the oil industry's most efficient cash-generating machine as it gradually disappears.

Continued: Developments on past columns

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