Exxon Strikes A Good Deal

The Wall Street Journal, as it must, put out a quick piece about ExxonMobil overpaying for XTO Energy. Their analysis was confused and off-the-mark. It sounds like a good, opportunistic strategic deal that should be in the interest of ExxonMobil shareholders and perhaps also for those concerned about the global environment.

The paper contends that ExxonMobil's deal values XTO's natural gas resources at $17.50 per barrel-of-oil equivalent (BOE) versus the implied value of $14.90 shown in XTO's disclosures. This dubious premium is 17.4%, less than the 25% premium implied in the total deal value. However, it's the wrong number to look at in the first place. The report talks about "proven reserves," which are those that have been demonstrated to exist and to be recoverable with conventional technology at current prices. This is the most conservative measure of XTO's asset base, but it should only be a fraction of the resource base.

The press release itself talks about the energy assets of XTO Energy including"...shale gas, tight gas, coal bed methane and shale oil." These resources are unconventional resources, as opposed to reserves. ExxonMobil's alternative to the acquisition would be to create a worldwide unit to explore for and acquire these resources, and then to develop the extraction technology. That would take time and lots of expense. Why build this capability when natural gas prices are at cyclical lows, and XTO has proven technical and organizational capabilities, which is the other real asset that ExxonMobil is buying?

ExxonMobil, as well as the other global majors, have really not over invested in their fundamental businesses in recent years, as they have focused on using free cash flows to buy back shares and increase dividends. In one transaction, the company has tipped the balance towards investing in a cleaner-burning, hydrocarbon fuel that will, along with oil, still account for the lion's share of global production and consumption into the medium-term future. What better transaction than this from a fundamental viewpoint?

The December ExxonMobil Energy Outlook for 2030 indicates the average annual growth rate in worldwide demand for natural gas to be 1.8% per year, which is much faster than the demand for petroleum. So, in this transaction, the company has significantly enhanced its reserve and resource positions in the fuel that the world economy will demand. It all makes perfect strategic and economic sense. Given the culture in the global oil patch, it's unlikely that this transaction materialized out of the air, and I would venture to guess that it's good for both organizations. Looks like a good deal to me.