Exxon-XTO Deal a Bet On Natural Gas as Go-To Global Power Source

(MoneyWatch)  ExxonMobil's acquisition of XTO Energy, an independent oil and gas producer and major player in unconventional gas, is not only a ringing endorsement for demand in natural gas. It's a bet that the world, especially developing nations, will turn to natural gas to meet its power generation needs. Meaning, as global demand for electricity increases, natural gas -- not coal -- will be the most well-suited fuel source to meet those needs.

It's also an indication Exxon sees the U.S. implementing some kind of climate-change policy that will seek limits on greenhouse gas emissions.

Exxon CEO Rex Tillerson said as much (about nat gas at least) in a conference call with investors Monday, where he discussed its $31 billion all-stock purchase of XTO, the company's biggest acquisition in more than a decade. Exxon also will assume $10 billion in debt as part of the deal. Under the terms of the agreement, Exxon is issuing 0.7098 new shares for each XTO share, a 25 percent premium to XTO shareholders, according to statement released by Exxon on Monday.

Exxon's recently released Outlook for Energy: A view to 2030 report, expects the world to use 35 percent more energy in 2030 than in 2005. And it sees an increase in demand for electricity and fuels used for power generation. Power generation will account for about 40 percent of all energy demand in 2030, up from 36 percent in 2005 and 26 percent in 1980, the outlook said.

"Natural gas is a well-suited fuel source (to meet that demand), Tillerson said during the conference call. "There is the lower environmental impact ... capital efficiency and flexibility."

So, why not coal? Coal is one of the cheapest sources of electricity, afterall. If Congress passes climate-change legislation, which will place limits on greenhouse gas emissions, coal is no longer the low-cost leader. Coal is a carbon intensive fuel and under proposed legislation, companies would have to purchase emissions credits if they emit more than the prescribed limit. Exxon expects the cost of carbon dioxide to be hover around $30 per ton over the next 10 years, which would make natural gas the most economic alternative for new-build power plants.

Exxon sees coal plants switching over to natural gas as prices rise. Exxon also notes nuclear and wind are now competitive and will be part of mix. The integrated oil company believes carbon capture and storage, which would clean-up coal plants, has promise. But as CO2 emissions prices rise to $60 a ton, new-build plants with CCS technology will be too expensive, the outlook states.

The company also expects natural gas supply to increase, particularly in the United States, where unconventional gas supplies will meet more than 50 percent of gas demand by 2030.

All of this brings us to XTO.

XTO is heavily vested in unconventional gas -- resources trapped in shale rock, coal bed methane and tightly compressed sands -- with operations in a number of fields including Marcellus, a geologic formation that extends through the Appalachian Basin in the Eastern United States. Technological improvements have made it commercially viable to access to this once hard-to-reach gas.

With its purchase of XTO, Exxon will become holder of the largest unconventional portfolio in the industry, David Rosenthal, Exxon's vice president of investor relations said in a Dow Jones report. Exxon will create a new division to manage development and production of unconventional resources, once the deal is completed, the company said in its release.

Exxon already has some unconventional gas plays as well as conventional gas and liquefied natual gas assets. Tillerson said "all of these resources will be needed to meet demand."