ExxonMobil $41 Billion Purchase Of XTO Energy

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Tony Daltorio, Investment U Research

Over the past three years, small domestic independent oil and natural gas producers have increased US natural gas supplies from an estimated 30 years’ supply to 100 years’ worth, thanks to techniques they developed that help them extract gas from shale rock on a budget.

Yet large U.S. oil companies barely paid attention, much less invested in the new technology or the businesses utilizing it. Instead, they let European competitors gobble up the opportunities.

And for a while there, ExxonMobil (NYSE: XOM) seemed to follow the American crowd, building up a sizable global portfolio of liquefied natural gas overseas but missing out on the U.S. boom…

Until this year, when it purchased XTO Energy (NYSE: XTO) for $41 billion, including $10 billion in net debt and a resource base equivalent of 4.5 trillion cubic feet of gas, much of which is trapped in shale rock, tight sands and coal bed methane.

By doing that, Exxon instantly established a major footprint in the U.S.’ most promising shale plays, including Marcellus, Haynesville and Bakken. And it plans to utilize them to the max.

That’s why it recently established a department to manage global development and production of oil and gas from unconventional deposits, with a particular focus on rapidly developing and deploying technology and operating practices.

For a company that prides itself on its superior technology, this could get interesting, especially considering that tapping shale gas still presents major challenges, including environmental concerns from local authorities in the U.S.

Fortunately, Exxon has a disciplined management team with a stellar track record so far and an even brighter future…

Setting And Strategy

Exxon knows very well that developing large oil production in Western nations is a tough job.

It also knows that its current size hampers any significant attempts to grow. In fact, Exxon hasn’t boosted its annual reserve replacement ration over 100% in recent years.

But that was because it was focusing on oil. By buying up natural gas reserves instead, it once again has the chance to seriously expand its domain and its revenue.

And despite its seeming willingness to let European competitors acquire all of the promising American locations, Exxon’s management actually acted more wisely than outsiders could have guessed.

That included committing a mere 40% of earnings on capital investments while energy prices climbed in 2006 into 2008, a time when its peers spent 85% – 100% on the same.

But when prices finally fell, Exxon went into action, purchasing its largest deal in ten years in a perfectly timed bid… while every other major oil company held off on making any such deals.

Exxon Looks Forward To A Cleaner, Brighter Future

Though Exxon likes to brag that it doesn’t play prices, XTO looks like one big contrarian bet on natural gas prices… something that investors should pay attention to considering that gas prices tumbled from $13 per million British thermal units to $5 on industry breakthroughs and a pullback in U.S. demand.

But XTO’s price tag implies that it could climb to $7 over the long term as industries lean more towards natural gas, which produces 30% less carbon than oil and 50% less than coal, with plenty of proven reserves to rely on as well, making it an attractive resource all around.

Yet right now, the 12-month average of Henry Hub futures contracts sits around $5.80 per million BTUs, and ranges no higher than $7 in the next two years… leaving plenty of room for profit still.

Exxon fully recognizes that, especially since energy consultants PFC Energy believes that the unconventional gas technology developed within the U.S. could work just as well elsewhere.

If true, PFC estimates the method would more than quadruple reserves, making it just that much easier to rely on and that much smarter for Exxon to invest in, considering the company’s international reach.

Expanding its tradition strategy of investing in large, long-term, highly efficient assets, Exxon CEO Rex Tillerson says the XTO purchase “is about the next 20-30 years.”

And over the next 20-30 years, we’re more than likely going to see Exxon’s shares climb higher thanks to this one acquisition and the many doors it opens up.

Good investing,

Tony Daltorio