Anyone who has read Daniel Yergin’s historical review of the oil industry, The Prize, will know the important role Standard Oil — the company ExxonMobil is derived from — played in organising the oil market from 1870 onwards.
Although some might argue the term ‘monopolising’ is more apt.
What is clear is that until Standard Oil’s arrival, the fledgling Pennsylvania oil market was largely a fragmented, disorganised collection of two-bit producers, prospectors and refiners – all exploring, pumping and producing without concern for market supply fundamentals, reservoir preservation or prices.
Unsurprisingly the market was partial to many a boom and bust in its formative years.
Standard Oil‘s arrival not only standardised the products being delivered — a move epitomised by the emergence of the infamous Standard Oil blue barrel — it helped consolidate the market to a point where prices were easily maintained at an economically viable rate.
Standard Oil achieved this ‘organisation’ via acquisitions focused across the entire production chain: from producers and refiners to transport companies and distributors. Antitrust authorities later forced the breakup of the company in 1911 precisely because of this dominant position.
Back to 2009, and some might say there are some uncanny similarities between the Pennsylvanian oil rush and the shale-gas boom of 2005-2008.
Technological developments in extracting so-called ‘unconventional’ gas cut entry costs to the extent the market became open to almost any independent operator. Fragmentation was a key consequence. And much how over-production in Pennsylvania led to a spectacular oil-price crash, the same might be said of shale-gas production in 2009 and its effect on dampening natural gas prices.
However, on the day Exxon announced its $31bn agreed takeover of XTO Energy — one of America’s largest independent oil and gas producers and a leader in shale gas development — natural gas prices soared higher.
As Stephen Schork of the Schork Report noted in his Tuesday report:
Natural gas prices rose 3.3% on news of Exxon’s mega takeover of XTO, closing the day at 5.332, their third consecutive finish above the 5.000 barrier. Prices spent most of the morning trending lower but remained well above our 5.054 alert. On the other hand prices cleared our 5.396 inflection-point, but peaked 13 ticks above at 5.409.
Could it be, therefore, that the market had in fact been yearning for consolidation for a while? More importantly, could Exxon’s move — as well as being a reflection of the major’s own underinvestment in the area – be a harbinger of more industry consolidation to come at the hands of the majors in particular?
Indeed, as Barclays Capital commented back in September:
The emergence of gas shale production and sharply higher horizontal drilling activity has led to a transformation of gas markets. E&P management teams no longer speak of looming gas shortages but of a 100-year supply of gas and the need to identify new growth markets for gas. We believe that today’s natural gas drilling opportunities have lowered the full-cycle cost of gas supply from $8-plus two to three years ago to $5– $7/MMBtu. We believe most E&P shares discount mid-cycle prices of more than $7/MMBtu.
And as they also noted:
Gas prices need to be high enough to incentivize development of about 15 bcfpd of new production each year. Production from currently producing wells is expected to fall from about 55 bcfpd to about 40 bcfpd 12 months from now. Price expectations must be sufficient to encourage producers to develop about 15 bcfpd of new gas supply annually. Growing shale gas supply will likely cause tight gas drilling activity to decline as some tight gas field economics will be challenged. Onshore conventional gas drilling, which accounted for as much as 10%–12% of production additions in 2008, will likely remain at depressed levels.
Here, meanwhile, is a chart from Barclays Capital showing just how much natural gas production has to be curbed in the next year to keep the market balanced.
If the market isn’t going to balance itself, it makes the majors might be inclined to step in to bring about some order.
Consequently, while Exxon’s XTO Energy deal may have come as a bit of a surprise to those in the equity community, it wouldn’t necessarily have done so to those watching natural gas developments closely.
In fact, as the Climateer Investing’s blog noted back on August 10th:
Here’s where it gets interesting. With the current glut of natural gas the stuff is going to be cheap for a while. That means consolidation in the industry, I’d guess major’s picking off Exploration & Production Co’s.
Related links:
Doth a global natgas glut come (already)? – FT Alphaville
Is Nymex natgas the ‘Yugo’ of the the energy complex? – FT Alphaville
Foreign energy groups buy into US natural gas – FT