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ChevronTexaco Sends Bullish Signal on Prices with Unocal Purchase

In putting together the acquisition of Unocal Corp., ChevronTexaco Corp.'s top management sent a clear bullish signal that they expect sustained high oil and natural gas prices going forward, analysts noted last week.

While most of the majors have held their record earnings close, preferring to buy back shares and offer more dividends, ChevronTexaco decided to use a lot of its cash and newly repurchased shares to strike a deal.

The Unocal transaction makes "strategic and financial sense if commodity prices stay high for the next few years," said Goldman Sachs analyst Arjun Murti. However, Bear Stearns noted that a $1 movement in the per-barrel price of oil translates into an 8% shift in earnings for ChevronTexaco, compared with an average of 4.5% for the five largest oil companies.

Wood Mackenzie calculated that ChevronTexaco expects oil to remain around $30/bbl as an average price over the 14-year life of Unocal's existing oil and natural-gas reserves. However, Sanford C. Bernstein & Co. said the transaction implies that ChevronTexaco expects oil to remain in the high $40s/bbl. "I'm still dumbfounded by this deal," said analyst Neil McMahon. "It is a bet on inflating oil prices," he said.

The transaction is a cash-and-stock transaction of $16.9 billion, and ChevronTexaco also agreed to assume $1.6 billion in debt. The deal is structured as 75% stock and 25% cash, putting an overall value at $62/share. Unocal shareholders may elect to receive either 1.03 shares of ChevronTexaco stock or $65 in cash for each share of Unocal they own. Both of the selections will be subject to proration.

ChevronTexaco's bid to purchase Unocal ended months of speculation about the El Segundo, CA-based company. Besides ChevronTexaco, Italy's Eni SpA and China National Offshore Oil Corp. also had been rumored to be bidding for Unocal.

"Unocal is a unique independent with supermajor assets that are an excellent fit with our existing portfolio and our long-term strategies -- to grow profitably in core upstream areas, build new legacy positions and commercialize our large undeveloped natural gas resource base," said ChevronTexaco CEO Dave O'Reilly. "It is an attractive transaction that provides value in both the near and long term."

Unocal's production fell 8% in 2004, with a lot of the decrease tied to asset sales in the Lower 48. This year, Unocal expects to see 4% production growth worldwide. Its top assets are said to be in Southeast Asia, but it also holds substantial reserves offshore in the Gulf of Mexico.

For ChevronTexaco, Unocal offers worldwide oil and natural gas reserves, with proved reserves of about 1.75 billion boe. The reserves are expected to increase ChevronTexaco's reserve base by about 15%, as of the end of 2004 and increase its output by 18%. Natural gas reserves would increase by about 5% to roughly one-third of the oil-equivalent total. ChevronTexaco expects the transaction to be accretive to its prospective production growth rate.

The combination of the two companies will place ChevronTexaco in the top tier of natural gas producers and marketers in Asia. Unocal also markets through the Bontang liquefied natural gas (LNG) plant in Indonesia, complementing ChevronTexaco's current LNG production in Australia, as well as planned development of natural gas fields in the greater Gorgon area of Australia and the shipment of LNG to markets in Asia and North America.

In the Gulf of Mexico, where ChevronTexaco already holds a solid hand, it will add Unocal's interests in Mad Dog, St. Malo, K2 and Puma in the deepwater, and its portfolio of exploration acreage will further strengthen ChevronTexaco's offshore profile.

During a conference call, O'Reilly noted that most of Unocal's assets are in natural gas, "both in terms of production and in terms of reserves and resource base. And these are overseas. These gas values are not directly tied to the crude prices that you see on the strip every day. They are long-term contracts.

"Some of them are sensitive to and related to general energy markets, but many of them are long-term contracts and don't have the same degree of fluctuation or volatility that you see. So we are not buying today's crude price. We are buying a company with long-term assets and with a great potential primarily centered in Asia and in the gas markets."

Once the transaction closes, O'Reilly said ChevronTexaco would sell about $2 billion of Unocal's assets, but he declined to offer details on what might be sold. ChevronTexaco also estimates annual savings from operational synergies and reduced corporate expenses of $325 million before taxes. Following regulatory approval, the full integration of the two companies is expected to be completed in six months.

"We...intend to combine operations and achieve synergies quickly and efficiently," O'Reilly said. He noted that the two companies "share common roots in the oil fields of California, and we believe we have highly compatible business cultures and values."

Following the announcement, UBS Securities analyst William Featherston noted that Unocal's stock price is up 48% over a year ago, "outperforming peers by 20% on speculation that the company was on the block. The Unocal deal isn't a harbinger of E&P consolidation in our view. Rather, this transaction was unique in that Unocal effectively put themselves on the block, and its most attractive asset was its Asian portfolio, not U.S. gas."

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