In the past few months several energy companies have expanded their holdings of natural gas resources. Exxon Mobil (XOM), for instance, bought natural gas company XTO Energy (XTO) in December for $41 billion, while Total SA of France and BP PLC of Britain have purchased rights to gas fields in Texas. Earlier this week, a private company anonymously shelled out $320 million for Petrohawk Energy Corp.’s (HK) rights to gas fields in Louisiana.
Monday brought news of Consol Energy’s (CNX) $3.48-billion purchase of Dominion Resources’ (D) natural gas and oil exploration and production business. As part of the deal, the Pittsburgh-based coal and natural gas producer will acquire 1.46 million oil and gas acres and 9,000 wells that are forecasted to generate 41 billion cubic feet of gas equivalent this year. With the purchase, Consol becomes one of the largest participants in the Marcellus shale formation.
Dominion, which is part of our Income Portfolio, wanted to focus more on areas of its business that offer regulated rates of return. According to Dominion’s estimates, the regulated parts of its business will account for 70 percent of its operating earnings next year; in 2006, they generated less than 45 percent.
The diminished exposure to natural gas will certainly help Dominion cut back on its risk related to fluctuating commodity prices. Natural gas prices have a history of being volatile and that has certainly been true in recent months. The Henry Hub natural gas price fell approximately 75 percent in about a year since the beginning of financial crisis, from $12.69 per million BTU in June 2008 to $3.01 in September 2009. Since then, the price has climbed 77 percent to $5.33.
The increasing interest among energy companies in natural gas comes, in part, from the regulatory uncertainty surrounding coal. Tighter restrictions on emissions and mining would adversely affect coal producers, and the lower emissions of natural gas have made this energy source an attractive alternative. Coal, which is used to generate approximately 50 percent of the country’s electricity, has historically been cheaper, but the collapse in gas prices has convinced some utilities to rely more on gas: Natural gas is now the source for roughly 25 percent of the country’s electricity production.
It is our belief, though, that shale gas is not a long-term solution to America’s energy needs. Studies show that, on average, production falls by 65 percent after a field’s first year, and that over time it becomes more and more difficult to extract natural gas from these wells. The sale to Consol Energy includes the rights to 491,000 acres in Pennsylvania and West Virginia, which means Dominion will be divesting itself from its direct exposure to shale gas in the Marcellus shale formation. This gas field, which covers parts of Ohio, Pennsylvania, New York and West Virginia, has attracted significant interest from other energy companies lately.
The proceeds from the deal will be used by Dominion to finance its infrastructure development plans, which include a pipeline in an area covering the Marcellus Shale formation. This gives the company some exposure to the area, but in a less volatile manner.
In terms of its regulated businesses, Dominion is investing in upgrades for 13 of its power stations in Virginia, allowing it to generate 400 more megawatts by 2013. Over the past few years the company has completed upgrades on a number of its plants and the result has been an increase in capacity of 300 megawatts.
In terms of other potential concerns for investors, Dominion will continue to pay its dividend. Last year, the company raised its dividend to an annual rate of $1.83 from $1.75, and confirmed that its target payout ratio for 2010 is 55 percent. It is believed that none of this will be affected by the recent deal. Shares yield 4.5 percent at current levels, and could be primed for a rally as investors shift their risk tolerances for stronger, more stable companies that weren’t in favor in 2009’s market rally. We rate the shares a buy.