ExxonMobil's surprise $31-billion US deal to acquire XTO Energy, the largest natural gas producer in the U.S., is a bold bet on several important fronts.
First, it's a giant bet on U.S. natural gas prices, which have been weak all year, and are likely to remain soft for the foreseeable future, according to most analysts.
Second, it's a bet that U.S. demand for natural gas will gradually outstrip supplies, despite rising LNG imports and abundant new shale-gas reserves, including those of XTO.
Third, it's a wager that natural gas will slowly displace coal -- which now generates about half of all U.S. electric power-- even as competition from renewables like solar and wind grows.
Fourth, it's a bet that returns on natural gas, which have been abysmal for the past several quarters, will at least approach the returns on oil over the long haul.
And fifth, it's a big bet on the U.S., where major energy producers have disinvested in recent years in favour of more exotic locales, and whose economy is still struggling to regain its health while Asian economies flourish.
Of course, ExxonMobil isn't known as a wild-eyed gambler. It's generally regarded as an ultra-conservative player in a tradition-bound, conservative industry.
When assessing a new project or acquisition, the company is legendary for its thoroughness. It crunches the numbers until there's nothing left to crunch.
Then it crunches them again.
That's how ExxonMobil, more than any other top producer, manages to avoid potholes and reduce risk. That's also how it became the most valuable company in the U.S., with a current market capitalization of about $331 billion US.
ExxonMobil also takes the long view. It's hardly a slave to fashion, or quarterly price blips. And it's not reluctant to swim upstream while less cash-rich players seek refuge onshore.
Witness the manner in which ExxonMobil and its Canadian unit, Imperial Oil, have forged ahead with their $8-billion Cdn Kearl oil sands project. While other projects remain on hold, Kearl's backers are plowing ahead, capitalizing on surplus labour and softer prices for steel and other materials.
Initial bitumen production from Kearl is scheduled for the final quarter of 2012, when most analysts expect oil prices to be a lot higher than they are today.
So does ExxonMobil's $31-billion bet on XTO make any sense? Of course it does, provided one takes the long-term view. It's a classic countertrend acquisition strategy. You buy when everyone else is looking for cover.
First, let's look at natural gas prices. Most analysts figure we've already passed the lows for the current cycle, and prices are now on a slow uphill climb as demand rebounds with the global economy.
After averaging nearly $9 US per million BTUs last year on the New York Mercantile Exchange, natural gas prices will average just $4.15 this year, estimates ScotiaMcLeod commodity expert Patricia Mohr.
Still, at the current NYMEX price in the $5 range, the nearby futures contract has more than doubled since September. Many analysts see gas rebounding to the $6 or $7 range a year out, as the economy picks up steam and tighter gas markets take hold.
And what are the odds that natural gas will gradually displace coal for electric-power generation? It's a no-brainer, some industry players say. It's the easiest, most logical way for the U.S. to reduce its carbon emissions in a big way, while also curbing its dependence on foreign energy supplies.
Solar and wind power may be important sources of energy one day, but until they become more cost-competitive, and until the U.S. invests hundreds of billions of dollars to expand and upgrade its electrical grid, they're unlikely to account for more than a small fraction of U.S. energy supplies.
The U.S. government also sees strong growth ahead for natural gas. The U.S. Energy Information Administration predicts worldwide consumption of natural gas will increase by an average of 1.6 per cent a year through 2030, to 153 trillion cubic feet, up from 104 trillion cubic feet in 2006.
Most of that growth is expected to come from the industrial sector, and from expanded use of natural gas to generate power. Electricity generation is expected to account for 35 per cent of global natural gas demand by 2030, up from 32 per cent in 2006. That hardly suggests that fossil fuels are about to be phased out any time soon.
There's another factor behind the timing of ExxonMobil's deal for XTO, I suspect: a growing backlash against shale-gas production among environmental groups in the U.S.
Since producers use hydraulic fracturing -- which involves the injection of vast amounts of water and chemicals at high pressure to break open the shale rocks and allow natural gas to flow -- enviro groups are ringing the alarm bells about the potential threat of groundwater contamination.
This issue has just begun to generate headlines in The New York Times and other mainstream U.S. media[#msg-44289380], and you can expect a lot more to come. For Albertans who have grown weary of the demonization of the oil sands by enviro groups, this will sound familiar.
If the greens are successful in painting shale gas as an environmental threat, the supply overhang will shrink overnight, and natural gas prices will go straight up. Suddenly, the price ExxonMobil is paying for XTO will look cheap.‹
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