Dominion last week sold nearly all of its U.S. onshore exploration and production (E&P) properties in a two-way deal that will send its Permian Basin, Antrim Shale and Black Warrior Basin operations to Loews Corp. for $4.025 billion and its Rocky Mountain, Gulf Coast, San Juan Basin and South Louisiana assets to XTO Energy for $2.5 billion. Together, the operations held 3.51 Tcfe of proved reserves at year-end 2006.
Loews will add about 2.5 Tcfe to its reserves base; XTO will add more than 1 Tcfe. Closing on both sales is expected to occur in August.
With the divestitures, which were announced last Monday, "sales proceeds for more than 85% of reserves to be sold are known," said Dominion CEO Thomas F. Farrell II.
Only Dominion's Midcontinent properties remain to be sold, and that process is expected to begin in July and be completed by the end of the year, Farrell said. The Midcontinent operations, located primarily in Oklahoma, had proved, probable and possible reserves of 780 Bcfe, 435 Bcfe and 966 Bcfe, with average daily production of 120 MMcfe in 2006.
For Loews, the Dominion purchase will lead to the creation of a new gas-focused E&P subsidiary. Besides its tobacco and financial interests, Loews owns about 75% of the natural gas pipeline franchise Boardwalk Pipeline Partners LP and 51% of Diamond Offshore Drilling Inc.
In a conference call, Loews CEO James Tisch said that for his family's diverse companies, the deal was too good to pass up.
Natural gas "will be a fuel of choice for years to come in a world that is worried about global warming and greenhouse gases," said Tisch. "We're seeing a reserve base in the United States that is, at best, staying flat, and we're seeing reduced importing of natural gas from Canada."
With only liquefied natural gas to shore up future domestic demand, "if prices just stay where they are, we'll do very well with this investment."
The only thing Loews plans to do with the Dominion assets at this point is create a new subsidiary and work the properties, Tisch said.
"We did not buy on the premise that we will do something different," Tisch said. "We bought because there's a lot of value in the package. No. 1, it's got long-lived assets, 20 years or more, and I wouldn't be surprised if the gas we produce 20 years from now generates more income from its present value basis than gas produced next year.
"We also like the fact that this is 'factory type drilling' with a high success rate," Tisch said. "In the spectrum of E&P companies there are the wildcatters who spend $100 million in the Gulf of Mexico and the other extreme, which is close to where this company is, to [methodically develop known reserves as] factory type drilling. We think we can increase the reserves as well as get cash flow from this investment, and that over time it will increase in value."
Loews also gains a fair amount of Dominion's E&P expertise. Timothy Parker, a Dominion senior vice president of E&P, will oversee the assets that Loews is buying. Some of Dominion's E&P staff also is expected to move with the purchase.
"The company's late-'80s and early-'90s distress purchases of a rig fleet that we know today as Diamond Offshore Drilling demonstrate [Loews] savvy in the energy sector," said Motley Fool analyst Toby Shute. The "announcement of a significant investment in onshore natural gas assets is another intriguing move."
For Fort Worth-based XTO, the Dominion purchase will be transforming as well.
"This is an opportune time to get into the Rockies," said CEO Bob R. Simpson during a conference call. "The chatter right now is on the blowout in the [Rockies] basis, but with the Rockies Express coming in, it will drop that down in 2008 and even more in 2009. We think the current blowout will be fixed relatively quickly."
Simpson said the basins in which XTO will gain assets "are the basins we would have wanted to expand to. It sets us up for that expansion and it matches very well with our operations."
XTO's management now plans to review the entire company portfolio and will consider dropping some of its mature properties, including the Dominion assets, into a master limited partnership (MLP). The partnership would have an initial capitalization of more than $500 million.
"We sat on a lot of things, we were disciplined in the last couple of years when the market was somewhat overheated," said Simpson. "We were waiting, and we think this is one to take the full swing at. In the aggregate, this is very exciting, very valuable, and it has lots of upside.
"We promised we wouldn't buy anything that wouldn't enhance our growth, and we wanted to have assets that contributed to that growth and not dilute it," he said. "This can carry its weight and accelerate the overall growth of the company and bring lots of value. One of the important features is that it has a lot of undeveloped acreage that comes with the acquisition that gives it additional potential beyond what we see today."
"While Rockies gas prices on the spot market have traded below $1.00/Mcfe recently, [XTO] management stated in its conference call its bullishness on the region," said Friedman, Billings, Ramsey & Co. Inc. analyst Andrew Coleman in a note to clients. "Given the company's track record, we like the move...Management's track record has earned XTO its premium to the peer group, and the company's announcement that it will consider forming a $500 million MLP from its long-lived assets will also widen that gap."
The "New Dominion," said Farrell, will produce 2008 operating earnings of $6.00 or more per share, "and we are confident that we can achieve long-term average annual earnings per share growth of at least 4% to 6% thereafter."
Dominion decided to sell its E&P operations last year to refocus on its utility operations (see NGI, Nov. 6, 2006). In late April, the company sold its offshore E&P business to a subsidiary of Italy's Eni SpA for $4.76 billion (see NGI, May 7). Last month, Dominion agreed to sell its Canadian properties to Calgary-based energy trusts Paramount Energy Trust and Baytex Energy Trust for US$583 million (see NGI, June 4).
Dominion will retain its Appalachian operations, which include 1 Tcfe of proved reserves. The operations are considered lower-risk and fit well strategically with Dominion's natural gas gathering, pipeline and storage system.
"Given the above-average growth rate in our Virginia service territory, the incentives provided by the new hybrid regulatory model, the superior growth opportunities in our pipeline and storage business, and improving conditions in markets served by our merchant power fleet, the New Dominion should deliver long-term earnings per share and dividend growth above the average of our industry peers," said Farrell.
Dominion's adjusted credit metric targets "now reflect a reduced risk profile as a result of our E&P asset dispositions and recent legislative changes to reregulate electric markets in Virginia," he said. The $3.2-3.5 billion range of estimated debt reduction "lays the groundwork for us to achieve/maintain a high triple-B credit rating over the next few years. Every dollar not used for debt retirement can be committed to the repurchase of common stock."
To assist financial analysts, Dominion posted an update to its indicative model of 2008 operating earnings at www.dom.com/investors/ir.jsp.
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