Exxon Mobil’s (Exxon) Unrelenting Pursuit of Natural Gas

question 113

Essay

Exxon Mobil’s (Exxon) Unrelenting Pursuit of Natural Gas


Believing the world will be dependent on carbon-based energy for many decades, Exxon continues to pursue aggressively amassing new natural gas and oil reserves.
This strategy is consistent with its core energy extraction, refining, and distribution skills.
As the world’s largest energy company, Exxon must make big bets on new reserves of unconventional gas and oil to increase future earnings.
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Exxon has always had a reputation for taking the long view. By necessity, energy companies cannot respond to short-term gyrations in energy prices, given the long lead time required to discover and develop new energy sources. While energy prices will continue to fluctuate, Exxon is betting that the world will remain dependent on oil and gas for decades to come and that new technology will facilitate accessing so-called unconventional energy sources.

During the last several years, Exxon continued its headlong rush into accumulating shale gas and oil properties that began in earnest in 2009 with the acquisition of natural gas exploration company XTO Energy. While natural gas prices have remained well below their 2008 level, Exxon used the expertise of the former XTO Energy personnel, who are among the most experienced in the industry in extracting oil and gas from shale rock, to identify the most attractive sites globally for future shale development. In 2010, Exxon acquired Ellora Energy Inc., which was active in the Haynesville shale fields in Texas and Louisiana, for $700 million and properties in Arkansas’s Fayetteville shale fields from PetroHawk Energy Corp. In 2011, Exxon bought TWP Inc. and Phillips Resources, which were active in the Marcellus shale basin, for a combined $1.7 billion. Exxon is betting that these properties will become valuable when natural gas prices again rise. By mid-2011, Exxon Mobil had added more than 70 trillion cubic feet of unconventional gas and liquid reserves since the XTO deal in late 2009 through acquisitions and new discoveries. Exxon is now the largest natural gas producer in the United States.

The sheer size of the XTO acquisition in 2009 represented a remarkable departure for a firm that had not made a major acquisition during the previous 10 years. Following a series of unsuccessful acquisitions during the late 1970s and early 1980s, the firm seemed to have developed a phobia about acquisitions. Rather than make big acquisitions, Exxon started buying back its stock, purchasing more than $16 billion worth between 1983 and 1990, and spending about $1 billion annually on oil and gas properties and some small acquisitions.

Exxon Mobil Corporation stated publicly in its 2009 annual report that it was committed to being the world’s premier petroleum and petrochemical company and that the firm’s primary focus in the coming decades would likely remain on its core businesses of oil and gas exploration and production, refining, and chemicals. According to the firm, there appears to be “a pretty bright future” for drilling in previously untapped shale energy properties—as a result of technological advances in horizontal drilling and hydraulic fracturing. No energy source currently solves the challenge of meeting growing energy needs while reducing CO2 emissions.

Traditionally, energy companies have extracted natural gas by drilling vertical wells into pockets of methane that are often trapped above oil deposits. Energy companies now drill horizontal wells and fracture them with high-pressure water, a practice known as “fracking.” That technique has enabled energy firms to release natural gas trapped in the vast shale oil fields in the United States as well as to recover gas and oil from fields previously thought to have been depleted. The natural gas and oil recovered in this manner are often referred to as “unconventional energy resources.”

In an effort to bolster its position in the development of unconventional natural gas and oil, Exxon announced on December 14, 2009, that it had reached an agreement to buy XTO Energy in an all-stock deal valued at $31 billion. The deal also included Exxon’s assumption of $10 billion in XTO’s current debt. This represented a 25% premium to XTO shareholders at the time of the announcement. XTO shares jumped 15% to $47.86, while Exxon’s fell by 4.3% to $69.69. The deal values XTO’s natural gas reserves at $2.96 per thousand cubic feet of proven reserves, in line with recent deals and about one-half of the NYMEX natural gas futures price at that time.

Known as a wildcat or independent energy producer, the 23-year-old XTO competed aggressively with other independent drillers in the natural gas business, which had boomed with the onset of horizontal drilling and well fracturing to extract energy from older oil fields. However, independent energy producers like XTO typically lack the financial resources required to unlock unconventional gas reserves, unlike the large multinational energy firms like Exxon. The geographic overlap between the proven reserves of the two firms was significant, with both Exxon and XTO having a presence in Colorado, Louisiana, Texas, North Dakota, Pennsylvania, New York, Ohio, and Arkansas. The two firms’ combined proven reserves are the equivalent of 45 trillion cubic feet of gas and include shale gas, coal bed methane, and shale oil. These reserves also complement Exxon’s U.S. and international holdings.

Exxon is the global leader in oil and gas extraction. Given its size, it is difficult to achieve rapid future earnings growth organically through reinvestment of free cash flow. Consequently, megafirms such as Exxon often turn to large acquisitions to offer their shareholders significant future earnings growth. Given the long lead time required to add to proven reserves and the huge capital requirements to do so, energy companies by necessity must have exceedingly long-term planning and investment horizons. Acquiring XTO is a bet on the future of natural gas. Moreover, XTO has substantial technical expertise in recovering unconventional natural gas resources, which complement Exxon’s global resource base, advanced R&D, proven operational capabilities, global scale, and financial capacity.

In the five-year period ending in 2010, the U.S. Energy Information Administration (EIA) estimates that the U.S. total proven natural gas reserves increased by 40% to about 300 trillion cubic feet, or the equivalent of 50 billion barrels of oil. Unconventional natural gas is projected by the EIA to meet most of the nation’s domestic natural gas demand by 2030, representing a substantial change in the overall energy consumption pattern in the United States. At current consumption rates, the nation can count on natural gas for at least a century. In addition to its abundance, natural gas is the cleanest burning of the fossil fuels.

A sizeable purchase price premium, the opportunity to share in any upside appreciation in Exxon’s share price, and the tax-free nature of the transaction convinced XTO shareholders to approve the deal. Exxon’s commitment to manage XTO on a stand-alone basis as a wholly owned subsidiary in which a number of former XTO managers would be retained garnered senior management support. By keeping XTO largely intact in Fort Worth, Texas, Exxon was able to minimize differences due to Exxon Mobil’s and XTO’s dissimilar corporate cultures.
-How would you describe Exxon Mobil's long-term objectives, business strategy, and implementation strategy? What alternative implementation strategies could Exxon have pursued? Why do you believe it chose an acquisition strategy? What are the key risks involved in ExxonMobil's takeover of XTO Energy?

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