Exxon Trails BP After $35 Billion XTO Natural-Gas Gamble Amid Supply Glut
Exxon Mobil Corp. (XOM), the largest U.S. natural-gas producer since its acquisition of XTO Energy Inc. last year, is slowing drilling in Texas gas fields amid a supply glut that slashed prices for the fuel.
Chief Executive Officer Rex Tillerson may be pressed at tomorrow’s annual meeting in Dallas to show that the $34.9 billion XTO purchase -- Exxon’s largest transaction since he became CEO in January 2006 -- hasn’t been a bust, said Manuj Nikhanj of Ross Smith Energy Group Ltd.
Since Exxon completed the XTO acquisition on June 28, Exxon shares have lagged Chevron Corp., ConocoPhillips and even BP Plc (BP/), operator of the deep-sea well that triggered the worst-ever U.S. marine oil spill last year. All those companies have benefited to a greater degree than Exxon from rallying crude prices.
“It’s a gas bet that obviously hasn’t worked yet,” Nikhanj, an analyst at Calgary-based Ross Smith, said in a telephone interview. “Exxon isn’t making any money off the commodity that XTO was known for.”
North American energy markets were flooded with gas after new drilling techniques allowed producers to tap into previously inaccessible geologic formations. U.S. gas futures tumbled as much as 30 percent in the months after the acquisition closed in June, and remain down 7.7 percent.
Engineers and Scientists
In the XTO purchase, Exxon gained gas and oil fields from the Texas-Mexico border to North Dakota, as well as a workforce of 3,000 that includes engineers and geoscientists who pioneered techniques for tapping gas encased in shale rock. The acquired assets helped drive a 24 percent increase in first-quarter gas output for Exxon, compared to a 0.6 percent decline in crude production.
The merger also tilted Exxon’s proved reserves from 51 percent oil at the end of 2009 to 53 percent gas a year later, a shift that may signal lower earnings in years to come because gas is 75 percent cheaper than oil, on an energy-equivalent basis.
Exxon, based in Irving, Texas, is taking steps to curb its exposure to low natural-gas prices. XTO, which now operates as an Exxon unit, filed 371 applications to drill wells in Texas during the first four months of this year, a 16 percent decline from the same period in 2010, according to the Texas Railroad Commission, which oversees drilling in the largest oil-and gas- producing state.
Exxon doesn’t plan to reduce the number of rigs drilling wells on XTO projects this year, David Rosenthal, Exxon’s vice president of investor relations, said during an April 28 conference call to discuss the company’s first-quarter results. Drilling will concentrate as much as possible on oil-rich areas “to make sure that we’re maximizing the value of that program,” Rosenthal said.
“The Exxon Mobil and XTO merger brought together two highly complementary organizations whose combined strengths deliver strong shareholder value and open new opportunities for the production of clean-burning natural gas,” Karen P. Matusic, spokeswoman for Exxon, said in an e-mailed statement. “I do not think you can jump to any conclusions based on a couple months of rig data in one state.”
Gas prices have averaged $4.23 per million British thermal units this year, after production from U.S. wells rose 4.8 percent to 21.58 trillion cubic feet in 2010, the highest since 1973, according to the Energy Department in Washington.
“Prices would need to come up to the $5.50 or $6 range for a sustained period to allow for perpetual drilling,” said Rick Smead, a Houston-based energy analyst at Navigant Consulting Inc. (NCI) who has advised gas producers such as Chesapeake Energy Corp. on strategy.
Natural gas has benefited in recent months from rising prices for coal, a competing fuel for power plants and steel mills, said Robert Ineson, senior director of global gas at IHS Inc.’s Cambridge Energy Research Associates. Surging demand for coal in expanding economies such as China pushed prices to a 26- month high, and is prompting some electricity generators to switch to lower-cost gas, he said.
Tillerson, 59, told analysts in March that he intends to dispatch XTO engineers worldwide to assess fields considered unconventional because of the intensive techniques required to harvest the gas or crude. Gas fields in Asia, Europe or Latin America have the potential to generate higher profits than U.S. finds because demand has outpaced local production in those markets, elevating prices, said Brian Youngberg, an analyst at Edward Jones & Co. in St. Louis.
The XTO transaction has brought Exxon new expertise to produce fuels from unconventional formations such as shale or dense sandstone, known as tight sands, said Douglas Ober, chief executive officer at Petroleum & Resources Corp. (PEO), for whom Exxon is the largest holding among $837 million under management.
Exxon already is benefiting from XTO’s expertise, Rosenthal said in the April earnings conference call. “If you look at the objectives we have of improving capital efficiency, improving productivity, and lowering operating costs, we are making good progress and are very pleased with how that’s going,” he said.
In November 2009, Exxon abandoned a $75 million effort to crack open a tight-sand formation in Hungary after striking more water than gas. Exxon’s geologists and engineers had failed to detect an underground aquifer on seismic maps of the prospect, Stephen Schultz, a spokesman for Exxon’s partner in the project, Falcon Oil & Gas Ltd., said at the time.
The Hungarian prospect involved tight sands similar to those in the Freestone Trend in Texas that accounted for 28 percent of XTO’s pre-merger production.
Shale formations have the potential to more than double the world’s gas reserves, the U.S. Energy Department’s Energy Information Agency said in an April 5 assessment, adding 6,622 trillion cubic feet to 6,609 trillion of conventional gas.
The XTO transaction has been more positively received by investors than the $87.7 billion Mobil Corp. transaction in 1999 that was the largest-ever oil industry merger. Exxon’s 16 percent increase since the XTO agreement was announced 17 months ago is more than double the 8.9 percent gain during the same time span after the Mobil deal.
Buying XTO was smarter than spending years trying to build an unconventional drilling business from the ground up and risking failure, Ober said.
“From a financial-returns basis, it’s difficult to say what kind of result they’re getting at this point from XTO,” Ober said. “But from an intellectual-returns perspective, it’s already paying off. This was never really about XTO’s gas fields as much as it was about getting hold of their technology and their people.”
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