Managing the Budget Process Ref.:

Managing the Budget Process

REF.: INSTRUCTIONS FOR PREPARING THE 2006 BUDGET

The 2005 revenue figures have shown a remarkable increase since last year results during the same period. On one hand, these were generated by an increase in the price of crude oil barrel, which has attained levels of over $60 in the last couple of months. On the other hand, the management team has thought out a certain repositioning of the company, which meant that some of the other sectors where the company is operating, such as the chemical industry or the gasoline refining market, although less profitable than the crude oil extracting operations, have begun to show small financial profits.

In 2006, the operating revenues will probably remain subject to the same general coordinates, with most of the company's revenues generated by crude oil extraction. Nevertheless, as the lines below will show, the company has begun to make amendments in its strategy and pay more attention to areas were its presence on the market is still less developed. The budget is thought out so as to increase spending in such areas, especially in terms of research and development or marketing (see below).

In terms of expenses, there are several categories of budgetary activities we need to consider. The three categories I have identified and I will be referring to are research and development expenses, marketing and general and administrative expenses.

The research and development expenses will be evaluated and discussed related to the main areas of activity at EXXON. I will be referring to gasoline refining, chemical production, exploration and drilling and pollution reduction reach activities.

In terms of gasoline refining activities, all analysts were keen to note that these are much less profitable than our crude oil operations. We should consider that this is not a long-term approach to the issue. Indeed, crude oil is most likely to finish in less than a century, which means that researching better ways to refine gasoline, perhaps using fewer resources in this sense and having more profitable returns, is necessary.

We have to diversify our activities and operational hedging is required in this sense. By operational hedging, I am summing up a set of activities that will imply growing the area of expertise and EXXON, gradually building a larger operational base and reducing the company's excessive dependency on its crude oil related activity. Gasoline refining is one of the possible future solutions and a market on which EXXON can successfully compete. In this sense, we need to increase spending in research and development in this area, with the possibility to gain momentum by innovation: discovering more efficient ways of refining oil, commercializing them to companies interested in producing gasoline with less crude oil used.

In terms of chemical production, research and development expenses should remain high in 2006 as well. The reason for this is that the chemical industry is an industry always in need of new products, products that can operate more efficiently, with less costs etc. We can look, for example, at the efforts we should dispose of in the polymers and plastic materials sectors. Our direct competitors in these fields spend a lot of time and money into discovering better products. Innovation is a key to success in the chemical industry and EXXON should be in the frontline of innovatory processes.

At the same time, I evaluate that we can decrease the spending in research and development in the exploration and drilling sectors. Basically speaking, the company is generating a level of income that is in no need of being forced. With $82 billion in the first three months of 2005, a significant growth since the first quarter of 2004, EXXON has reached a saturation level that can be easily maintained in 2006. Additionally, moderation should be the word of order here: the company should maintain current exploratory levels until it grows stronger in other markets, such as the chemical industry or the gasoline market.

A very important segment of research and development expenses needs to be covered by financing research in discovering methodologies to upgrade refineries and in developing pollution reducing equipment. In October 2005, EXXON had to pay a $8.7 million civil penalty, while at the same time spending $9.7 million on community environmental projects. In my opinion, these are unnecessary costs that can be eliminated in the future with an adequate financing for research and development in environmental protection and pollution reduction.

The marketing segment also needs an increased attention in 2006. For example, on the gasoline market, EXXON brands such as Mobil or Esso are already well-known throughout the world. Nevertheless, the specificity of the industry brings about the necessity to constantly promote these brands. How is an Esso gas station different from a Shell or Texaco one? EXXON needs to think out marketing campaigns deemed to bring out the main competitive advantages over other companies on the market: excellent service, better quality gasoline (going hand in hand with the spending in research and development in this segment, previously discussed), qualified personnel. These assets need to be constantly in the attention of the consumer.

Additionally, we have the smaller EXXON brands to consider. On the Run, the franchise system, or Speedpass are smaller brands in the EXXON portfolio on which increased marketing spending needs to be considered.

If properly attended to, both in terms of time and financial resources, these brands can bring in the future a more consistent contribution to overall company revenues.

Finally, there are general and administrative expenses to be referred to. The level of revenues, as well as the company's profit, is sufficiently high so as not to bring any additional issues related to unexpected general or administrative expenses. We are to expect general and administrative expenses to be more or less the same as in 2005, with the exception of human resources related expenses. This is because I am proposing an Incentive Bonus Plan (40%) to be given to the management staff for attaining objectives proposed in the company's strategy and budget.

In my opinion and this was previously mentioned at some of the points in this evaluation, EXXON should already embark on a transition phase. This will imply repositioning some of its activities, paying more attention to others that only generate minimal revenues nowadays, but could be an important source of income in the future etc. This is a very delicate process, because it means relocating and training some of the employees in order to cover the new areas of activity and thinking out a long-term development plan. In order to be able to cover this strategy, the management team will have to be keen in respecting the most important point in a strategy aimed at reaching this diversification objective.