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The Commodity Investor Q&A

By Matt Badiali, editor, S&A Resource Report
Wednesday, December 16, 2009

ExxonMobil recently offered to pay $32 billion for natural gas producer XTO Energy, a 25% overnight payout for XTO shareholders.
XTO Energy is one of the premier "unconventional" natural gas companies in the U.S. (We discussed unconventional gas here and here.)
Unconventional gas is trapped in shale. Shale is a sedimentary rock made of fine particles of clay and mud deposited at the bottom of ocean basins or giant lakes. The shale that oil and gas companies like has a lot of old plants and algae mixed in. Over time, that kind of shale makes natural gas and sometimes oil.
There are several premier shale plays in the U.S., like the Barnett in Texas, the Marcellus in Pennsylvania, and Haynesville in Arkansas. XTO holds leases in all of them.
Exxon's Big Oil peers began buying into shale plays years ago. Both Chevron and ConocoPhillips bought in 2005. Gas price forecasts were rising and the prices they paid reflected it. But Exxon really hasn't jumped in... until now.
Exxon is notoriously tight with its cash. That's one reason why it's hugely popular with value investors like Stansberry Research's own Dan Ferris. So did Exxon get a good deal? I think so...
Price per MCFE*
XTO Energy
*Thousand cubic feet of natural gas equivalent
The overall outlook on natural gas is pessimistic. Basically, there's more gas in storage than we can realistically use up this winter and even more production in our future. If we don't figure out a way to use it, the glut will continue to depress prices. (You can read more on this topic here.)
So why would Exxon buy XTO now? Let's take a closer look...
Exxon's offer is $32 billion in stock. That doesn't take into consideration XTO's $10 billion in net debt. So we'll use $42 billion as the buy price.
On paper, Exxon is buying 13.8 trillion cubic feet of natural gas reserves. But XTO actually has another 14 trillion cubic feet of natural gas that it can't call reserves. The SEC defines oil and gas reserves as "economic" today. Unconventional gas is not economic until it's drilled. You have to fracture the rock to get it out. But shale wells are remarkably consistent, so we know the gas is there.
All-in, Exxon paid $42 billion for 27.8 trillion cubic feet of gas. That works out to $1.50 per MCF... about 50% lower than the recent bottom and 72% below today's prices at $5.50.

When you look at it that way, you can see how brilliant Exxon is at this stuff. Even if gas prices fall all the way down to their record lows, Exxon got a good deal... and so did XTO shareholders.
There are plenty of cheap natural gas producers out there. I put together a table of a few I think might make good buyout targets if Exxon's deal kicks off a trend...
Enterprise Value
Price Per MCFE
Ultra Petroleum
$8 billion
Chesapeake Energy
$28 billion
EOG Resources
$25 billion
Enterprise value is the market cap plus debt, minus cash. It's how Exxon valued XTO. As you can see, these giant gas companies are similar to XTO by that measure. This is where I'd start looking for my next natural gas investment.
Good investing,

In The Daily Crux
Market Notes
Stimulus plans working... FedEx and UPS hit new highs.
Tech fund XLK makes a new high... up 30% since July.
Largest U.S. lumber producer surges... Weyerhauser jumps 4.2% to fresh high.
Earnings today... Hovnanian, Joy Global, Paychex.
Market Watch
Symbol Price
S&P 500 1221.53 +1.3% +10.1%
Oil 37.77 +1.5% -2.8%
Gold 135.20 -0.1% +13.4%
Silver 27.93 +0.4% +47.9%
US-Dollar 80.67 -0.8% +8.1%
Euro 1.32 +0.6% -12.1%
Volatility 19.39 -9.2% -8.2%
Gold Stocks 564.53 +1.3% +10.6%
10-Year Yield 3.00 +1.4% -9.6%

World ETFs
Symbol Price
USA 122.56 +1.3% +10.2%
Canada 30.44 +1.3% +13.8%
Russia 21.63 +2.3% +16.7%
India 37.73 +1.9% +20.0%
Israel 16.47 +0.9% +9.7%
Japan 10.58 +1.0% +7.4%
Singapore 13.88 +1.0% +19.2%
Taiwan 14.72 +1.6% +17.8%
S. Korea 56.56 +1.7% +22.8%
S. Africa 70.85 +3.9% +22.9%
China 45.06 +1.4% +0.1%
Lat.America 52.82 +1.4% +6.7%

Sector ETFs
Symbol Price
Oil Service 136.18 +1.5% +14.8%
Big Pharma 64.13 +0.6% -3.3%
Internet 72.13 +0.7% +22.3%
Semis 16.03 +2.1% +28.9%
Utilities 31.21 +0.3% +1.6%
Defense 18.51 +1.3% +10.1%
Nanotech 9.99 +1.3% +0.0%
Alt. Energy 9.95 +1.4% -4.4%
Water 18.31 +1.1% +12.2%
Insurance 16.07 +1.2% +18.3%
Biotech 20.58 +1.1% +27.1%
Retail 19.65 +0.1% +28.4%
Software 24.59 +0.9% +24.1%
Big Tech 53.73 +1.0% +21.9%
Construction 12.99 +2.1% +13.3%
Media 13.57 +1.1% +25.0%
Consumer Svcs 67.26 +0.8% +23.3%
Financials 54.87 +2.4% +5.2%
Health Care 64.22 +0.7% +1.3%
Industrials 63.25 +1.6% +19.7%
Basic Mat 73.57 +1.6% +21.6%
Real Estate 55.24 +1.4% +23.8%
Transportation 91.17 +1.4% +25.6%
Telecom 22.48 +1.1% +17.1%

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