Unlike Conoco's, Exxon's Natural Gas Bet Could Prove Fruitful

Exxon Mobil Corp. (XOM) is placing a $31 billion wager on the future of natural gas with its planned acquisition of XTO Energy Corp. (XTO). A similar move a few years ago by another major oil company ended in tears.

In December 2005, ConocoPhillips (COP) agreed to purchase U.S. natural-gas producer Burlington Resources for about $36 billion, accruing significant debt at a time when gas prices were at all-time highs. Then-Exxon chief executive Lee Raymond mocked the deal, saying that buying at the top of the cycle was bad timing, and he was right. When energy prices collapsed in recent years, ConocoPhilips ended up writing off billions related to that purchase, and now seeks to shed $10 billion in assets in an effort to shore up its finances.

Exxon's acquisition could turn out differently than Conoco's, in part because the timing is better. Raymond's successor, Rex Tillerson, made his move when the natural gas market is recovering from a recent bottom that rattled producers and punctured their valuations. Even after the premium added by the deal announcement, XTO shares traded 32% lower than their $70.22 peak in June 2008.

Exxon is also far stronger than Conoco was at the time of the Burlington purchase. By using its valuable stock, the world's largest publicly traded oil company is taking a much smaller company with stock instead of taking on debt to finance the deal. An Exxon executive said during a conference call Monday that XTO would not materially impact any of the company's key financial indicators.

"Since they are using stock, that is totally a different equation," said Lysle Brinker, an analyst with IHS Herold. Brinker added that XTO's assets have a much larger growth potential than Burlington did at the time of the Conoco deal.

Exxon's move is also a different kind of bet--based on an unexpected evolution both in natural gas exploitation and the relationship between energy and the environment.

Irving, Texas-based Exxon is not only betting that natural gas prices are going to be higher in the long term; it is also betting that global thirst for the commodity will grow at a much faster pace than that for any other type of energy, especially as policymakers demand cleaner-burning fuels to curb climate change. Natural gas is the cleanest-burning hydrocarbon.

Exxon is also hoping that XTO's expertise will enable it to tap shale resources--which produced an unprecedented boom in gas production in the U.S.--all over the globe, especially in eastern Europe, where they could provide a profitable alternative to Russian gas. XTO is a major player in extracting natural gas from unconventional places, such as shale rock, in the U.S.

"Exxon is assuming gas will rebound above $7," said Pavel Molchanov, an analyst at Raymond James. But the real value creation will come from transferring XTO's skill set elsewhere, Molchanov said.

Exxon shareholders reacted negatively Monday, amid concerns about the dilution that would result from an all-stock transaction and amid concerns in some corners that Exxon had paid too much. The stock shed 4.3% to close Monday's session at $69.69. UBS analyst William Featherston said in a research note that the company's management seems to be sacrificing near-term returns in a bid to pursue growth in unconventional resources.

It's going to take several years to know if ExxonMobil will be able to transfer the technology successfully to its global operations, but overall the strategy seems "reasonably sound," Brinker said.

-By Isabel Ordonez, Dow Jones Newswires; 713.547.9207; isabel.ordonez@dowjones.com

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