Natural Gas Stocks: What Exxon's Purchase of XTO Energy Really Means

Sam Subramanian PhD, MBA

The near-term fundamentals for natural gas can hardly be called attractive. Heading into the depth of the winter season, U. S. natural gas inventories are running 13% above their five-year average.

The recession slashed industrial demand for natural gas in the U. S. through 2009. The price of natural gas has averaged just over $4 per MMBTU this year, well below the $15.38 per MMBTU high set in December 2005.

Sustained levels of low prices have forced some producers to shut their uneconomic wells. Meanwhile, some Congressional lawmakers have been pressing the idea of increasing regulatory oversight for certain types of natural gas drilling.

Exxon's Big Natural Gas Plunge

Against this backdrop of doom and gloom, Exxon Mobil (XOM) is making a massive wager on the future of onshore natural gas. The integrated oil titan has struck a deal to buy a major natural gas producer XTO Energy (XTO) for $41 billion. Exxon is paying a 25% premium to XTO stockholders. The XTO purchase stands to boost Exxon's resource base by about 10%.

Exxon's $41 billion XTO Energy purchase reflects a strategic focus on natural gas and implies a bullish case for natural gas stocks.

Exxon has compelling reasons for pursuing this transaction. XTO's assets fit well with Exxon's technical expertise in unconventional gas and provide ample opportunities to unlock value. The acquisition puts Exxon's cash hoard to good use and enhances its ability to increase production ... at a price that makes economic sense.

Investors Should Pay Attention to this Natural Gas Deal

I believe it is worthwhile for investors to take note when Exxon, arguably the best-managed integrated oil company, makes a major move. After all, Exxon is not a deal machine. And, the one mega purchase Exxon pursued in buying Mobil has worked exceptionally well for Exxon's shareholders.

Regardless of how one slices and dices the deal, Exxon's purchase of XTO Energy is a major wager made by Exxon on natural gas becoming the fuel of choice as governments around the world look to combat global warming. And it is for this reason that investors should take note.

Exxon's Andrew Swiger recently stated that the use of natural gas will increase twice as fast as the demand for crude oil and that natural gas will surpass coal as the second-largest energy source as global energy demand increases 30% by 2030. Kenneth Cohen also of Exxon has commented that U. S. carbon legislation will prompt power producers to switch from coal to natural gas increasing demand for the latter.

Investing in Natural Gas and Natural Gas Stocks

If Exxon is right with its bet, the $2.51 per MMBTU bottom in the price of natural gas set on September 3 could well turn out to be an enduring one.

Additionally other major oil companies like Chevron (CVX), Royal Dutch Shell (RDS-B), ConocoPhillips (COP), and BP (BP) are likely to catch up to Exxon's natural gas strategy by pursuing acquisitions of their own. Potential targets include Canada-based EnCana (ECA), Oklahoma-based Devon Energy (DVN) and Texas-based EOG Resources (EOG).

These factors can have significant bullish implications for natural gas and natural gas stocks.

If you agree Exxon is likely to prove right with its bet, having a portion of your assets invested in natural gas investments may not be a bad idea.

There are numerous ways to play natural gas. They include investing in commodity-based exchange-traded products like U. S. Natural Gas (UNG) and iPath DJ-UBS Natural Gas (GAZ) as well as exchange-traded funds like First Trust ISE-Revere Natural Gas Index Fund (FCG) and SPDR S&P Oil & Gas Exploration & Production (XOP) that own shares of natural gas producers. Mutual fund investors can go with Fidelity Select Natural Gas (FSNGX).

And, pruning investments in coal producers like Peabody Energy (BTU) and Arch Coal (ACI) or exchange-traded fund Market Vectors Coal ETF (KOL) would also be in line.

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