Monday, December 14, 2009

Exxon to Buy XTO: Validates North American Natural Gas

In a consolidation of the letter "X" on the Big Board, Exxon (NYSE: XOM) has agreed to purchase XTO Energy (NYSE: XTO).  The purchase values XTO at $31 billion ($51.69/share), but since it is a stock for stock transaction, the numbers will slide around before closing.

This is big for lots of reasons.  First, it is an acknowledgement from the biggest of the supermajors that domestic natural gas is for real.  The big guys (supermajors) have been letting the kids (natural gas independents) play in the sandbox, but this move is an admission that it's time for the big boys to take over.  Previously we've seen joint ventures between big players and independents, but this is completely different. 

It might also kick off a wave of consolidation.  The market analysts has been talking about consolidation for the past year as gas prices and rig counts plummeted.  That it hasn't come to fruition is something of a surprise.  Exxon is the big dog in the industry.  How will the other dogs in the pack respond?  If the moderate XTO price is an indication, other independents might fall. 

Ultimately, this move is an acknowledgement that natural gas is going to be a big part of the energy future.  By making this acquisition, Exxon is getting away from its past business strategy.  To me, that is a direct comment that the landscape is shifting towards gas.  Exxon may have made a good deal for lots of different reasons. 

The Financial Times has a good piece on this too.


Anonymous said...

First I'm not saying shale gas is doomed I'm just saying it's looks like at these lower prices the true value of these shale gas plays is starting to show.

Exxon buying XTO because Exxon thinks shale gas is the next big thing? Well yes and no. Yes because you need an Exxon to push gas prices up and No, because of current and probably midterm low gas prices if the current players keep trying to increase production and revenues at these unsustainable rates to make them profitable. I think XTO sees this and is selling before the preverbial shit hits the fan.

Why would XTO sell for only $51.96 a share if shale gas is so profitable at these prices? I think the boys at XTO are starting to see the true profitablity of these shale gas plays. Just look at XTO's lastest financials which shows even though they have inceased production their revenues have decreased but the average price for gas they received didn't change that much.

Exxon made a great deal because they can book big reserves and sit on them or drill to hold until gas prices increase and make these plays viable again.

I may be wrong, but I can't figure out why XTO would sell for only 51.96 a share if shale is so profitable at these low prices.

Robert Hutchinson said...

Good points. I figured the biggest reason we didn't see consolidation was because of low stock prices, given the peak they achieved the summer of 2008. Unless it is a truly distressed situation the buyout valuations would not be compelling.

To me it sheds light on another question. How do you create a sustainable business in the NG industry? (Other than owning land, of course) To maintain production and continue to explore, the producers need to nearly outspend their cash flow every year. That's not a sustainable model (although it has a history of working well for a while in lots of industries).

While the stock market likes bottom line profitability, my eyes tend to focus more on cash flow. That is what can be elusive in this business.