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ExxonMobil's XTO Deal Lifts North American Gas Prospects

December 21, 2009
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ExxonMobil Corp. advanced the cause for North American natural gas last week after agreeing to pay $41 billion to acquire unconventional gas powerhouse XTO Energy Inc.

The acquisition, CEO Rex Tillerson said during a conference call to discuss the transaction, isn't about making money tomorrow. It's a long-term transaction, he said, whose value may not be apparent for "10, 20 or even 30 years."

The agreement, subject to XTO stockholder and regulatory approval, would add around 45 Tcfe to ExxonMobil's resource base and lift its gas weighting to 45%. The supermajor would have a substantial unconventional gas and oil resource base in the United States to complement its holdings in Canada, Germany, Poland, Hungary and Argentina, which together would total an estimated eight million acres.

More telling, perhaps, is the significance of ExxonMobil's newly released "Outlook for Energy: A View to 2030," in which the Irving, TX-based producer forecast that unconventional gas would satisfy more than half of U.S. demand by 2030 (see NGI, Dec. 14).

"We have illustrated the very strong growth in natural gas demand that we anticipate to occur over the next several decades, certainly at a much higher rate of demand growth than oil or coal," Tillerson said last Monday. "That's driven largely by a significant growth in demand for power generation. Natural gas is really well suited to meet that growing power generation demand, both from the standpoint of its lower environmental impact, but also its capital efficiency and its flexibility.

"As various parts of the world are trying to meet that demand, gas gives them a lot of flexibility in terms of the increments they can add and the way they can handle varying load demands; gas is really a well suited fuel choice. And that's what underlies that outlook for a very strong growth in gas demand all over the world..."

The resource-rich XTO agreed to a stock deal that would give shareholders a 0.7098 share of ExxonMobil for each share of XTO, which values XTO at $51.69/share, which is a 25% premium to XTO's closing price on Dec. 11. ExxonMobil also assumed $10 billion of XTO debt. Even though ExxonMobil had the cash to pay for the transaction, Tillerson said XTO management wanted the stock deal because of the tax implications for its shareholders.

"We think there's going to be significant demand for natural gas in the future," he said. "It's not a price play, obviously because we never do that. It's an efficiency play. And as you know, we believe you get a lot of efficiency benefits out of scale, out of leveraging best practices and delivering them rapidly into the global portfolio. And that's, really -- that's the important element. That's the opportunity for us -- now...we have to go out and capture it. And that's where the value creation will occur."

During the conference call an analyst suggested that based on the offer price for XTO, ExxonMobil's implied price for gas was "above $7/Mcf to make a good return," which in turn signified that the supermajor was "long-term bullish physically on the natural gas market."

However, Tillerson made no forecasts on near-term gas prices.

"We didn't create a different price deck for this deal, if that's what you're implying," said the CEO. "If you just look back at the unit cost here, on a proved reserve basis, it's under $3 an Mcf equivalent. If you look at that resource base, the 45 Tcf; it's less than $1. And obviously where we're going to extract that value is -- and as you have heard us talk many times, we test our things against a range of possible price environments, but what we know is we have to go out and create efficiencies.

"We have to go out and create added value through technology and extraction techniques and continue to work at that to get better and better and better, so that we create the value. We don't wait on the market to create it."

In the longer term, "we think this is a great transaction for the United States and for the consumers of the U.S. and [it] addresses many of the energy security concerns they have," he said. "The ultimate value of the transaction will be measured over decades. It's not likely to be accretive to near-term earnings per share because of the current price of natural gas."

How long ExxonMobil may have been eyeing XTO remained a question. ExxonMobil is constantly on the look-out for attractive acquisitions, according to Tillerson, but the company is never been quick to pull the trigger on a possible deal. The last mega-purchase in North America was when predecessor company Exxon Corp. paid $77.2 billion to acquire Mobil Corp. in 1998 (see NGI, Dec. 7, 1998).

"The fact that ExxonMobil didn't pay part of the purchase price in cash also tells me ExxonMobil expects natgas prices to remain weak for awhile," said independent energy analyst Patrick Rau. The supermajor "could have theoretically paid the ENTIRE $31 billion stock portion of the deal in cash, but the fact they aren't paying ANY of that in cash suggests ExxonMobil wants XTO shareholders to assume part of the risk in this deal. It could be that XTO shareholders think crude oil prices are going to rise...but I also think it means ExxonMobil is concerned North American gas prices will remain weak."

What made XTO a suitable target for ExxonMobil long-term was not only its solid resources, said Tillerson. The CEO also pointed to XTO's "strong technical expertise and highly skilled employees," which, when combined with ExxonMobil's "advanced research and development and operational capabilities, global scale and financial capacity, would help with a technology transfer to emerging unconventional resources across the globe."

ExxonMobil is banking on XTO's staff remaining in place to move the combined company forward, said Tillerson. Once the transaction is completed, a new upstream organization would be established to enable "the rapid development and deployment of technologies and operating practices to increase production and maximize resource value," he said. The new organization would be located in Fort Worth, TX, where XTO is now headquartered.

XTO Chairman Bob R. Simpson founded predecessor company Cross Timbers Oil Inc. in 1986; it became XTO Energy Inc. in 2001. The name change followed questions about why the company called itself an oil company when it concentrated on natural gas, Simpson said at the time.

ExxonMobil wants to get the transaction completed by the end of June, but there may be some obstacles.

Last week Rep. Edward Markey (D-MA) said the bid by ExxonMobil "raises a number of issues" that need to be reviewed in congressional hearings next year. Markey chairs the House Energy and Commerce Committee's electricity subcommittee, and among other things, Markey said he wants to consider the role of natural gas and unconventional resource extraction techniques, including hydraulic fracturing.

As FBR Capital's trio of analysts said last week, "Big Oil" means a "bigger spotlight."

Unlike ExxonMobil and other major producers, which have "few friends in Congress, the Democratic caucus is concerned about small natural gas producers, and keeping gas prices low is important for manufacturing union and agricultural employment," said the FBR team. "Recently, we have seen the advancing political influence of the natural gas lobby. It is unclear how much influence (if any) ExxonMobil's prominence in the space will have in Congress. However, Congressman Markey's hearing highlights Congress' concern."

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