Exxon deal shakes natural gas sector

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The world's largest public energy company is making an enormous bet on a commodity most had counted out.

Exxon Mobil Corp. said Monday it will pay $31-billion (U.S.) in an all-share buyout of XTO Energy Inc., a Fort Worth, Tex.-based energy concern with major production of hard-to-extract unconventional natural gas.

At a time when gas prices are still languishing, and the prospects of a recovery remain distant, the XTO deal serves as a major validation of a strategy pursued by smaller companies - including several in Canada - who have bet that new gas reserves trapped in dense rock will profitably underpin the North American energy sector for decades to come.

The huge deal, Exxon's largest-ever acquisition of a pure oil and gas producing company, delivered an immediate boost to share prices across the industry, while helping to cement the Irving, Tex.-based giant's strategic shift from oil production to natural gas and its reputation as a counter-cyclical investor.

In coming years, the acquisition is expected to help reshape the way natural gas is produced around the world. Exxon assumes control of a company whose significant technical expertise in new petroleum sources can be used to breathe new life into global gas production. XTO has specialized in the development of shale gas, an unconventional energy source that requires unique technical procedures to crack apart dense underground reservoirs before it can be brought to surface.

Though some observers have doubted the economics of shale gas, which remains a relatively new energy source, the Exxon purchase has already raised the value of nearly a dozen companies with major shale gas holdings, including Canada's EnCana Corp. and Talisman Energy Inc., whose profile could now be elevated in the eyes of other global energy superpowers.

"It's kind of like the Pope blessing the exercise. You couldn't have a more credible enterprise sanctifying the unconventional industry in North America," said Martin Molyneaux, managing director of institutional research at Calgary's FirstEnergy Capital Corp.

"This will cause a rethink for everybody. It pretty much revalues the whole industry up and down the value chain both in Canada and the United States."

It also triggers a guessing game about which companies will be next. Many of the world's largest oil and gas producers have yet to make significant inroads into shale gas, whose development has been dominated by smaller companies who have perfected the technology to tap it.

Some expect Exxon's entrance to set in motion a reshaping of that industry, and spur the convergence of energy titans into an energy play that is set to soar along with natural gas itself, whose global use Exxon estimates will increase 55 per cent by 2030.

"There's not too many people that will stand up against what Exxon's technical view is," said Shane Fildes, BMO Nesbitt Burns' global group head for energy, who expects further acquisitions to follow.

"Do I think there's going to be more? Yeah. Do I think it's going to be tomorrow? Probably not. But does this change the strategy of a Shell, a BP, a pick-your-large-cap? I'd say yeah. It has to."

Until now, the U.S. shale gas plays have been driven by independent producers such as XTO, Chesapeake Energy Corp., EOG Resources Inc., and Devon Energy Corp.

But cheap current prices and the long-term value embedded in the North American unconventional gas fields could tempt other supermajors, including Royal Dutch Shell PLC, BP PLC and Total SA, said Fadel Gheit, New York-based analyst with Oppenheimer and Co. "The buyers will be the large integrated oil companies, and the sellers will be the large [exploration and production]companies," he said. "None of the majors have enough [exposure to the shale gas] … Right now, they are running out of options."

Based on Exxon's valuation of XTO's reserves, companies such as EnCana, Chesapeake and EOG could be worth fully 30-per-cent more than their current market values.

But Exxon, which has signalled its shift to gas, made clear Monday that it sees that XTO deal as a long-term bet, and not one that will pay immediate dividends. "They are very bullish on natural gas for the long-term, but very bearish in the short term," Mr. Gheit said.

In a conference call with analysts, Exxon CEO Rex Tillerson said the acquisition is meant to build the company's asset base for the next 20 to 30 years, and will complement its foreign unconventional gas assets, including its participation in the Montney and Horn River shale plays in northeastern British Columbia.

He said the company is forecasting that natural gas demand will significantly outpace demand for both oil and coal over the next two decades, driven by growing consumption of electricity. Natural gas is increasingly the fuel of choice for power providers because it emits less greenhouse gas pollution than coal, and is more economical than coal or nuclear for smaller power plants.

But Mr. Tillerson would not comment on what U.S. gas price the company was anticipating, nor whether Exxon would accelerate production from the shale plays where XTO had major stakes. Shale gas constitutes only 30 per cent of XTO's current output, but a major percentage of its nearly 14 trillion cubic feet in reserves, a huge portfolio that spans shales in Texas, Louisiana, Arkansas, Pennsylvania and Montana.

Yet some doubt that even the promise of massive reserves will prompt others to follow Exxon's lead. "Natural gas is not very popular these days and with good reason. Prices, in our view, will stay low for a long time," said Pavel Molanchov, an analyst with Raymond James Financial Inc.

"Exxon is making a very long-term bet, and the jury is going to be out for a long time on whether this is a good deal or bad deal."