Oil and Gas Giants Capitalizing on Slump in Gas Price

Peter is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The world’s leading oil and gas firm, Exxon Mobil (NYSE: XOM), is looking to acquire Canadian Celtic Explorations for $2.92 billion. After the acquisition, Exxon will add 650,000 acres of unconventional fuel assets located in British Columbia and Alberta to its portfolio. The deal will increase Exxon’s natural gas and liquids production by 72 million cf/d and 4,000 b/d, respectively.

It will also require the approval of Canadian authorities, who are currently considering the China based offshore giant CNOOC (NYSE: CEO)’s takeover bid of Nexen. In a surprising move, the country has recently rejected the Malaysian state-owned Petronas’s $5.2 billion takeover bid for Progress Energy Resource . In a recent visit to China, Canadian Prime Minister Stephen Harper famously said, “We want to sell our energy to people who want to buy our energy,” which investors thought outlined the government’s strategy. Unfortunately for Petronas, the opposite has happened. This has further created doubts over CNOOC’s bid and raises questions over Canada’s willingness to accept capital inflows in its massive energy reserves from Asian countries, or just how independent Canada is from the U.S.

But Exxon, which already has had significant operations in Canada for the past 70 years, is not going to cause a political storm like the one created by its Chinese peer. While Exxon is aiming for expansion in British Columbia, it is planning to withdraw from the $50 billion West Qurna-1 project in southern Iraq and has reportedly informed U.S and Iraqi authorities. The project, on which Exxon and Royal DutchShell (NYSE: RDS-A) were working together, is now looking less profitable.

The company is moving ahead with its planned acquisitions in the shale gas sector. Its $41 billion takeover of Houston based gas giant XTO Energy three years ago remains one of the biggest acquisitions in the sector ever. Besides this, Exxon has acquired considerable North American shale acreage in the past few years in the Bakken fields and Marcellus Formation. In September, Exxon paid $1.6 billion to Denbury Resources for its Bakken acreage located in North Dakota and Montana, increasing Exxon’s Bakken assets by 50%.

The slump in natural gas prices has hit the relatively smaller gas producers such as Anadarko Petroleum (NYSE: APC) and Chesapeake Energy (NYSE: CHK) harder.  Given the high debt ratio of these natural gas producers, 50% for APC and 63% for CHK, coupled with the fall in gas prices (which touched a 10 year low), these firms are finding it increasingly difficult to explore and drill into their acreage.

The weak bargaining power of firms operating in the natural gas sector has created an opportunity for larger multinational oil and gas firms, such as Exxon and Royal Dutch Shell, to improve their shale portfolio. Natural gas prices are bound to bounce back once the problems associated with oversupply are alleviated.  Gas wells are far easier to stop and restart than oil wells are, so the pricing is more self-regulating.  According to Shell’s own estimates, gas prices are expected to double by 2015 on account of rising domestic demand for fuel in the U.S. That’s when Exxon and Shell’s current investments will pay off.

Unlike Exxon, Shell has a massive $1 billion a year shale gas investment program in China, which has more confirmed shale gas reserves than any other country. No other foreign firm has ever made an investment plan for China of this size and scale. The company is also currently working on Shale gas exploration in Diyarbakir, Turkey, in collaboration with the state-owned Türkiye Petrolleri Anonim Ortaklığı (TPAO).

In North America, Shell acquired shale acreage located in Texas from Chesapeake for $1.9 billion, while it has ongoing operations in Pennsylvania after the $4.7 billion takeover of East Resources in 2010. Besides Shell, Chesapeake also sold some of its shale assets to Chevron (NYSE: CVX) at an undisclosed price, which has taken Chevron’s net acreage in the Delaware Basin, New Mexico to more than 940,000 acres.

Earlier this year, both Shell and its rival Chevron acquired shale gas exploration rights in Ukraine, a country believed to possess 42 trillion cubic feet of unconventional gas reserves, for a minimum investment of $170-$200 million.

<table> <tbody> <tr> <td> </td> <td> <p><strong>Exxon</strong></p> </td> <td> <p><strong>Shell</strong></p> </td> <td> <p><strong>Chevron</strong></p> </td> </tr> <tr> <td> <p><strong>P/E</strong></p> </td> <td> <p>9.85</p> </td> <td> <p>8.24</p> </td> <td> <p>8.54</p> </td> </tr> <tr> <td> <p><strong>EPS</strong></p> </td> <td> <p>9.49</p> </td> <td> <p>8.4</p> </td> <td> <p>13.43</p> </td> </tr> <tr> <td> <p><strong>Yield</strong></p> </td> <td> <p>2.50%</p> </td> <td> <p>4.70%</p> </td> <td> <p>3.10%</p> </td> </tr> <tr> <td> <p><strong>ROA</strong></p> </td> <td> <p>9.48%</p> </td> <td> <p>7.11%</p> </td> <td> <p>11.27%</p> </td> </tr> <tr> <td> <p><strong>ROE</strong></p> </td> <td> <p>29.02%</p> </td> <td> <p>15.29%</p> </td> <td> <p>21.59%</p> </td> </tr> </tbody> </table>

Exxon, Shell, and Chevron are expanding rapidly in unconventional gas, and this will without a doubt pay off in the years to come. So far, shares of Exxon and Chevron have been up 10.3% and 7.7% while Shell’s stock has fallen by 5.2% since the beginning of the current year. Exxon Mobil has given twice as much ROE than its peers, but it has a relatively lower yield. It should also be noted that Exxon Mobil has the highest exposure to the American natural gas sector, making its current valuation low compared to its future potential revenue stream.  The whole sector will benefit by the opening up of new reserves around the developing and emerging world.   Chevron’s mounting ecological problems in Ecuador, along with their refinery failure in Richmond, CA, could cost them dearly in the longer-run. 

Holding a mix of Royal Dutch Shell for their relationship with China, as well as Exxon-Mobil to leverage their excellent mix of oil and natural gas reserves while exiting from one of the more dangerous places in the world, is a good strategy for investors wanting to maintain both yield and exposure to the growing need for energy by the emerging markets in Asia and South America.

PeterPham8 has no positions in the stocks mentioned above. The Motley Fool owns shares of Denbury Resources and ExxonMobil and has the following options: long JAN 2013 $16.00 calls on Chesapeake Energy, short JAN 2014 $15.00 puts on Chesapeake Energy, long JAN 2014 $20.00 calls on Chesapeake Energy, and long JAN 2014 $30.00 calls on Chesapeake Energy. Motley Fool newsletter services recommend Chevron. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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