Exxon Mobil (XOM) has been taking on debt as it leads the oil majors in the investment shift from the oil sands to the shale gas sector. With its eye on the lucrative liquefied natural gas (LNG) market, it could win big as an early mover. But like the oil sands business, gas shale is a capital-intensive business. As it picks up shale assets, Exxon Mobil's operating margins are as tight as an oil tanker turning around in a bathtub. Nonetheless, Exxon Mobil's transition from an oil major into unconventional resources is on a solid track.
Both the shale gas and oil sands sectors are betting on an energy export gateway to Asia. And both have promised economical extraction of previously untapped reserves. While oil sands projects have been plagued with cost overruns, shale projects are ratcheting down costs. This high margin natural gas play will take shale gas and convert it into liquefied natural gas for export to Asia. Exxon is positioning itself at the entry of the gateway by buying up shale gas reserves throughout North America and investing in LNG projects on the west coast to convert the cheap gas into LNG for export to Asia.
Securing a profitable foothold in the LNG market requires substantial gas reserves.
Exxon has a lot of competition for gas reserves from other deep pocketed energy majors. As a result, premiums are rising. Premiums on natural gas assets have been bid up to as high as 97 percent, according to Bloomberg. Notably, Malaysia's Petronas (PTG, Bursa Malaysia) is offering $22 per share, or $5.16 billion, for Calgary's Progress Energy Resources (PRQNF.PK), a 97 percent premium on the stock price. Exxon has just swept up Alberta's Duvernay and Montney shale assets through its $3.1 billion acquisition of Celtic Exploration (CEXJF.PK).
Exxon Mobil's profit margins are shrinking as it incurs record capital expenditures but its bet on LNG is a sound one. The margins between Canadian gas and Asian LNG are very attractive, even in a volatile price environment for natural gas. In six months, Canadian gas prices have more than doubled from under $1.50 in April to over $3 in October. A colder than expected winter could send prices up to $4 or $5 gigajoules. These prices still offer attractive margins to Asia, which will pay $16 gigajoules for LNG.
Worldwide capital expenditures on LNG projects will reach $169 billion over the next five years, predicts Douglas-Westwood in its most recent five-year forecast, but more LNG will also go into production in this period as LNG producers begin to realize a return on investment. In a lower energy price environment, especially in an over supplied North American energy market, acquisitions and project start ups in low-cost fuel sources such as shale will be important future revenue streams. Exxon's recent buying spree in unconventional resources has been taking place in Canada. U.S. investments include Bakken and Marcellus.
Exxon is counting on its U.S. subsidiary XTO Energy (XTO), an oil and gas producer with expertise extracting attractive margins from tight rocks in shale gas projects. Exxon's $35 billion purchase of XTO could be one of its most profitable. Exxon is already benefiting from its shale assets. In addition to LNG, natural gas fueled petrochemical plants are a huge market. The lower shale gas prices are causing oil-fueled plants to shut down. Exxon will benefit further by building its own ethane-fed plant.
Exxon has a more capital-intensive period ahead developing LNG plants. In North America, the Asian gateway is British Columbia's northwest coast. Exxon is one of a handful of energy concerns to announce LNG projects there. To be economical, LNG makers require a lot of low-cost gas assets. To be sure, Exxon will be making more gas shale buys to feed its LNG terminals.
Exxon's strategy to shore up its stock price by shoring up its LNG assets is working. LNG players are enjoying a premium in the market. ConocoPhillips (COP) has received a boost from its interest in 17 shale gas blocks put up for auction in China. The development of an LNG market in Asia could tighten LNG margins but if the current demand scenario prevails it is not likely to put too much pressure on the wide margins in Asian LNG plays. The return on investment on shale gas assets has a lot of room to improve. EOG Resources (EOG) has just received a windfall in discovering its Eagle Ford shale project may have twice the recoverable reserves estimated.
Exxon's LNG play is a smart strategy, but a tight squeeze on profits. The LNG terminals will not be generating revenue for a few years. Shorter term, with energy prices predicted to continue to hover in lower territory, Exxon will continue to feel tightening in its margins in its upstream oil business. Significantly, crude from unconventional resources is already helping margins in the downstream oil business.
Exxon is receiving some earnings pickup in its downstream business. Lower natural gas prices are helping refining margins. Indeed, in the third quarter, high refining margins offset any decline in oil and gas output. The refining margins benefited from cheap crude from oil sands and shale basins. Earnings on global refining doubled to $3.2 billion. Exxon has announced expansion plans for petrochemical and refinery plants.
The extra earnings zip from the downstream business will be required. Increased oil production in the United States and Canada continues to put downward pressure on oil prices. West Texas Intermediate (WTI) is trading at a discount to other crudes and oil pipelines are full. Interestingly, as Exxon Mobile turns itself into an LNG player, Russia's Rosneft (RNFTF.PK) has usurped its place as the largest oil major with its $55 billion purchase of BP but Exxon is still extracting more value from its investments in exploration. But Exxon's slowdown in finding oil reserves can be overlooked when one considers the huge margins in producing LNG on British Columbia's west coast and shipping it to Asia.
With the help of shale gas and oil sands, the oil and gas boom in North America will continue to put pressure on prices. The competition will stiffen to scoop up assets in unconventional resources as more margin expanding opportunities such as shale gas emerge. Exxon's early mover advantage secures it a firm foothold in the global LNG market.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.