Natural Gas Set to Gain as Exxon Bets $28.5 Billion (Update2)

(Updates third paragraph with final price.)

By Reg Curren

March 29 (Bloomberg) -- Exxon Mobil Corp. is making a $28.5 billion bet on natural gas, this year’s worst-performing energy commodity, just as hedge funds amass their biggest wager on prices falling.

If history is a guide, the acquisition of XTO Energy Inc. may make Irving, Texas-based Exxon the winner. Its purchase of Mobil Corp., announced in December 1998, came three weeks before crude bottomed at $10.35 a barrel and then surged to $25 a year later. While speculators have helped drive gas down 31 percent this year, everyone from Goldman Sachs Group Inc. to ConocoPhillips says prices are headed higher.

The combination of faster economic growth, demand for cleaner-burning fuels and higher coal prices may spur demand from factories, power plants and chemical makers, which account for 60 percent of gas consumption. Goldman Sachs, which cut its forecast this month, projects a price of $6 per million British thermal units in 12 months, up more than 50 percent from $3.842 on the New York Mercantile Exchange today.

Demand will rebound with the economy, ConocoPhillips Chief Executive Officer Jim Mulva told investors and analysts March 24 at a conference in New York. “We see natural gas prices in the short term somewhere in the neighborhood of around $5, but ultimately longer term, we see it more in $6 to $8,” he said.

This year, the only Reuters/Jefferies CRB Index commodity that has fallen more is sugar, down 37 percent. Speculators had sold a net 186,983 futures contracts worth about $7 billion in the week ended March 16, based on Commodity Futures Trading Commission data and April futures prices. Inventories rose 11 billion cubic feet to 1.626 trillion in the week ended March 19, 8 percent more than the five-year average, according to the Energy Department.

Growing Economy

The industry is setting up for a recovery, with the U.S. economy forecast to grow 3 percent this year and next, according to 53 responses to a Bloomberg survey.

Since Exxon Mobil agreed to buy Fort Worth, Texas-based XTO on Dec. 14, Total SA in Paris, Tokyo’s Mitsui & Co. trading company and U.S. coal miner Consol Energy Inc. in Canonsburg, Pennsylvania, have purchased stakes in U.S. fields that contain shale gas.

Output from shale wells, in fields where rock formations are fractured and injected with water, sand and chemicals to release trapped gas, drove production gains last year. Advances in drilling technology are cutting production costs. Shale purchases over the past two years exceed $48.4 billion, according to data compiled by Bloomberg.

Shale Deposits

XTO gets more than 20 percent of its production from the Barnett shale deposit in Texas, the largest in the U.S. It’s also planning to boost drilling in the Marcellus Shale, a formation in parts of Pennsylvania, New York and West Virginia.

“It’s not a price play, obviously, because we never do that,” Exxon CEO Rex Tillerson said in a conference call with investors and analysts on Dec. 14, when the purchase was announced. “It’s an efficiency play. And as you know, we believe you get a lot of efficiency benefits out of scale.”

Houston-based ConocoPhillips, the third-largest U.S. oil company, plans to accelerate development of the Eagle Ford shale formation in Texas, Mulva said.

Gas prices in North America will probably stay in “the range of $4 to $8” per million Btu, Marvin Odum, president of U.S. operations for The Hague-based Royal Dutch Shell Plc, said at a conference in New Orleans on March 24.

For now, gas is disappointing investors. Futures prices peaked at $15.78 per million Btu in December 2005 and rose as high as $13.694 in July 2008, before the recession caused prices to collapse to a seven-year low of $2.409 in September 2009.

Competing With Coal

The price slide may have made the fuel competitive with coal for U.S. electricity generators for the first time since September, according to Cameron Horwitz, an analyst at SunTrust Robinson Humphrey in Houston.

Coal costs for electricity producers, after factoring in variables including the variety of coal, power-plant efficiency and storage, may exceed $4.20 per million Btu, based on data compiled by Bloomberg.

U.S. gas demand may rise as much as 12 percent over the next 10 years as President Barack Obama turns his attention to climate change, Chris Goncalves, director of Washington-based Navigant Consulting Inc., said in London on March 22.

Gas is the least-polluting fossil fuel, producing about half the carbon dioxide of coal when burned, according to the Energy Department.

U.S. gas production reached 26.3 trillion cubic feet in 2009, up 2.2 percent from the previous year, while industrial demand slumped 7.7 percent in the recession, Energy Department data show. Stockpiles hit a record 3.837 trillion cubic feet at the end of November.

Supply Gains

“The ability to get more natural gas supply on line is going to mitigate upward price pressure even as the economy recovers,” said Jason Schenker, president of Prestige Economics LLC, an Austin, Texas-based energy consultant who expects gas futures to average about $4.85 per million Btu in 2010. “It’s possible we could move lower from current price levels over the next couple of months.”

Liquefied natural gas may also damp gains as imports rise 45 percent in 2010 to about 1.8 billion cubic feet per day, according to Energy Department estimates.

The number of gas drilling rigs working in the U.S. may be about to level off, said Chad Friess, an analyst with UBS Securities in Calgary. There were 941 rigs working in the U.S. last week, an increase of 42 percent from a seven-year low in July, according to Baker Hughes Inc.

“The U.S. rig count may be approaching a plateau, given resilient gas production and receding prices,” he said in a March 4 report.

Price Shock

Speculators and consumers of the fuel may be setting themselves up for a price shock by underestimating the strength of the U.S. economy and ignoring the 2.21 trillion cubic feet of gas sucked from storage this past winter, when demand peaked, said Tom Orr, the research director at Weeden & Co., a brokerage in Greenwich, Connecticut.

“A lot of economically sensitive companies are moving up now, like DuPont and Dow,” Orr said. “I wouldn’t short gas here because you’re going to work through some of the oversupply as the economy continues to recover.”

On Jan. 26, DuPont Co., the third-biggest U.S. chemical maker, reported profit that topped analyst estimates on increased orders for automotive plastics and electronics materials. Dow Chemical Co. shares have more than tripled in the past year.

“When Exxon bought Mobil in the ‘90s you saw a spate of big boys getting bigger,” said Scott Hanold, an analyst at RBC Capital Markets in Minneapolis. The XTO purchase signals a $6.50 long-term average price for natural gas, Hanold said.

“You’re probably near the bottom,” he said. “Prices are depressed because of the near-term glut of gas. While it’s pretty bearish now, you will see it improve.”

--With assistance from Mario Parker and Joe Carroll in Chicago, Edward Klump in Houston, Jim Polson, Moming Zhou and Jack Kaskey in New York and Ben Farey in London. Editors: Bill Banker, Joe Link

To contact the reporter on this story: Reg Curren in Calgary at rcurren@bloomberg.net

To contact the editor responsible for this story: Dan Stets at dstets@bloomberg.net

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