Will These Oil Majors Regret Investing in Natural Gas?

Will These Oil Majors Regret Investing in Natural Gas?

Natural gas prices remain low in the United States, and that's meant pain for energy majors that have made domestic natural gas a strategic priority. This is evident in the recent struggles for ExxonMobil , which is suffering in the unfavorable environment for natural gas.

ExxonMobil famously purchased XTO Energy, the nation's largest holder of natural gas reserves, in 2009 for a staggering $41 billion, and the company now has egg on its face in light of the fact that its natural gas operations are serving as a drag on results.

Did ExxonMobil make a tragic mistake paying so much for XTO Energy? And, will other majors regret investing in natural gas as well?

Hindsight is 20/20

At the time of the acquisition, ExxonMobil appeared to make a savvy decision, positioning itself at the ground floor of what was predicted to be the great natural gas revolution in the United States.

Four years later, and ExxonMobil looks foolish for having paid such a huge amount of money for XTO. As Exxon readily admits, natural gas prices were roughly twice as high when the deal was completed as they are now.

At the company's annual shareholder meeting, Chief Executive Officer Rex Tillerson said "While we anticipated at the time of the merger that it would be non-accretive in the near-term, because we expected that natural gas prices had not yet bottomed out, they stayed low much longer than we expected".

Poor natural gas pricing in the United States, in addition to other headwinds such as lackluster refining results, combined to bring Exxon's second-quarter net income down 57% year over year. On a per-share basis, Exxon earned $1.55 in the quarter, representing the company's lower quarterly EPS number since September 2010.

To be fair, Exxon isn't the only oil major to have over-estimated the recovery in domestic natural gas prices. Competitor Chevron is also diving head-first into natural gas, noting that natural gas now comprises 22% of global energy demand.

The company estimates that as global populations expand, under-developed economies emerge, and the world's thirst for energy grows, natural gas will play an increasing role in the global energy mix. Chevron produced 5.07 billion cubic feet of natural gas per day in 2012, and will increase production exponentially over the next decade.

Specifically, the company points investors to its major projects in Australia and Africa, including the Gorgon Project which includes a 15 million metric-ton-per-year liquefied natural gas facility.

Importantly, Chevron's focus on natural gas outside the United States has spared it some of the pain currently afflicting ExxonMobil.

Chevron's own second-quarter results disappointed, but its 26% drop in quarterly profit wasn't as bad as Exxon's quarter. Moreover, Chevron shares have registered gains twice as big as Exxon's in the years since the XTO deal, rising 60% since the acquisition was announced versus 30% gains for Exxon.

Did Exxon make a $41 billion mistake?
In my estimation, only in the short term. U.S. natural gas prices remain at depressed levels, making Exxon's push into domestic natural gas look foolish today. But this seems like a simple matter of poor timing, rather than a mistake on the whole.

While $41 billion is certainly a huge sum of money, a juggernaut like ExxonMobil has the financial resources to endure, even if it did overpay for XTO Energy. And, the trend toward natural gas in America means that prices likely won't stay at such low levels for long. Sooner or later, as demand keeps rising, prices should follow suit.

Meanwhile, Chevron's focus on developing natural gas outside the United States means it's being spared some of the pain. For investors not willing to wait for the domestic natural gas turnaround, Chevron looks like a better near-term bet. But, the long-term vision of U.S. natural gas remains sound, in my opinion, and ExxonMobil should provide strong results for years to come.

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The article Will These Oil Majors Regret Investing in Natural Gas? originally appeared on Fool.com.

Robert Ciura has no position in any stocks mentioned. The Motley Fool recommends Chevron. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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