Managerial Economics: XTO Energy Inc - Case Study Example

Managerial Economics Managerial Economics On December 14 the worlds largest resource base oil company, Exxon Mobil Corp. purchased XTO Energy Inc. striking a deal at $41 billion that also includes debt of $10 billion and thus, the company entered into a non conventional source of energy producing shale based gas. It will be worthwhile at this juncture to go through each company’s main line of activities in more detail. XTO Resource Base XTO is one of the leading producers of gas from shale and other geological formations—the technology through which US has been able to increase its gas output substantially and that can boost production elsewhere too. As per the report of Dahlman Rose & Co., XTO is in all major unconventional plays of which tight gas is made of 45% of daily gas production and shale gas comprises of 30% of XTO daily gas production. XTO’s resource base at that time was equivalent to 45 trillion cubic feet of gas which included shale oil, shale gas, coal bed methane, and tight gas. These will have a complimentary effect on ExxonMobil’s resources in the U.S, Germany, Poland, Argentina, Hungary, and Canada. (ExxonMobil bets…) Exxon Mobil’s long term goal is to continue with leadership position in the field of oil and gas exploration not in US but also in world. Oil and gas are now identified as scare resources. These resources are not likely to last for a long time. Exxon has been all along in conventional exploration with forward integration in refining the crude oil and producing various derivatives to meet the US demand. The profitability of the firm depends upon the availability of basic resources (read crude oil) at economic price but owing to no new oil discoveries and stricter environmental laws, Exxon’s growth plan was languishing for a long time. When rivals of Exxon were putting money in new acquisitions during oil boom, the critics were heavily criticizing Exxon for not having any new growth plan. The acquisition of XTO should be seen in above light as it came after a long time and when gas prices were ruling at its lowest at $5.33 per million British thermal units. It should not be forgotten that only in recent past, in June 2008, gas prices they were ruling nearly $13. Exxon’s guiding principles as mentioned in their website speaks out “Exxon Mobil Corporation is committed to being the worlds premier petroleum and petrochemical company. To that end, we must continuously achieve superior financial and operating results while adhering to high ethical standards.” (Our guiding principles) It was in spirit of above guiding principles the acquisition of XTO has to be identified. Producers like XTO have been in trouble because of weak price of gas and due to heavy borrowing that they made for their exploration programs. Several other producers too face similar constraints. Demand and Supply The demand of gasoline throughout the world is increasing at rapid pace due to increased consumption and thereby the price of crude oil. The principle of demand and supply applies as there is not corresponding increase in supply of crude oil. The crude prices reached to the sky high at $145 per barrel in the month of June 2008 mainly due to the increased demand and again crumbled down to $30 per barrel due to onset of recession in the subsequent months. Soon international crude oil prices recovered and reached to the steady state level of around $90 per barrel. (Baye, Michael 2010) Natural gas price did not recover to that extent again for the reason of less demand in the market. The reason of high demand of crude oil in comparison to natural gas is its use in public transportation and personal vehicles. U.S consumes almost 20% of the worlds oil and Two-thirds of this is meant only for transportation. Natural gas is not used in transportation in most of the developed countries. Price Elasticity in Crude oil and Natural Gas The demand for crude oil is price inelastic. That explains the reasons of high volatility of crude oil price in the international market. (Baye, Michael 2010). Recent crisis at Libya is an ample proof of price inelasticity which pushed the oil price from $90 to $115-120 range within short time. Natural gas too has witnessed the pattern of price inelasticity over last few years. Due to industry restructuring, natural gas prices are now decided by competitive market forces based on its demand and supply equation. (Baye, Michael 2010) Between 2000 and mid-2001 a scarcity in supply of natural gas led to the increase in the price. It was remarkable in the sense that this phenomenon was seen in a completely competitive environment and natural gas producers were making full utilization of their productive assets. (U.S Natural…) In recent years, Exxon’s major growth in its reserves has come from its partnership in exploring the world’s biggest gas field near Qatar. The price of natural gas has not recovered to the extent as that of crude oil. Some of the factors that go in favor of gas are its non polluting nature. With the passage of time it is likely to get more prominence if the world adopts tighter norms on greenhouse gases. Mission statement of the Exxon also clearly states that they would like to play and plan for distant future rather than any near term gain. Merits of Merger In view of the above, merger signifies the following benefits. Merger helps maintain Exxon’s leadership position overall in the field of oil and gas exploration Merger has facilitated Exxon’s entry into “unconventional” source of gas exploration in a single stroke and has made it a largest explorer of gas in US ahead of its rivals like chevron, BP and Shell. Merger has been a win-win situation for both the parties as Exxon has resources to finance the exploration program and sustain the operations and XTO has long experience of exploring the gas from unconventional sources such as shale. Merger has produced a good synergy between two oil giants in harnessing the natural resources which are scarce and must be put to use for optimal use for the benefit of the world in general and US in particular. (Baye, Michael 2010) Though it is difficult to quantify, the future stream of profits that emanate from this merger certainly offset the cost incurred by acquisition when converted into the present value of cash flows. (Baye, Michael 2010) The merger will help optimize several processes that go into making of the exploration program thus benefitting the country and its citizens besides both the company as marginal benefits surpass the marginal costs incurred. (Baye, Michael 2010) Merger has been a boon to the shareholders of XTO because the company was not in a position to use its full potential given the resource constraint. The company was already under huge debt at the time of merger. Demerits of the Merger Exxon’s shareholders have to bear the brunt of this merger for they will not be benefitted in the near term; however, long term benefits to the shareholders of Exxon will offset short term losses. Most of the use of natural gas consumption is in production of electricity. Coal, nuclear, and hydro power are the other competitive sources of fuel for producing electricity. Of these four fuel sources natural gas has the highest operating cost in producing electricity. So mostly it is used to meet peak and intermediate electricity requirements. Source: Energy Information Administration taken from http://www.unctad.org/infocomm/anglais/gas/uses.htm Since natural gas is not used in abundance in transportation in developed countries, its demand is not likely to increase at phenomenal rate in near future unless some legislation forces consumers to use gas as fuel in their vehicles. Full benefit of this merger is likely to accrue to Exxon only when consumption pattern changes dramatically. (Baye, Michael 2010) Post Merger Current and Future Prospects ExxonMobil after merger with XTO has the largest and highest-quality resource base in the industry. With Exxon’s proven managerial capability and financial muscle, operating cost of shale gas production will further come down. The optimum use of all available resources to increase the output will work in favor of XTO. XTO operations will not suffer in want of financial resource which the company was facing premerger. This was the constraint the company was facing in harnessing new acreages. The chances of its growing at the phenomenal rate are pretty high by way of reducing its economic cost, and harnessing its resource base fully. Merger entails a good synergy because nature of industry brings them in common platform. Finally, post merger ExxonMobil has become the largest shale gas producer in U.S and that augurs well with the company’s long term future growth strategy and mission statement. References: 1. ExxonMobil bets on natural gas boom with largest merger agreement in years. online from http://www.pennenergy.com/index/petroleum/display/8039973818/articles/oil-gas-financial-journal/volume-7/issue-1/upstream-news/exxonmobil-bets_on.html [Accessed on 4/9/2011] 2. Baye, Michael R (2010). Managerial Economics and Business Strategy, 7th edition. McGraw Hill & Irwin. 3. U.S. Natural Gas Markets: Mid-Term Prospects for Natural Gas Supply. Online from http://www.eia.doe.gov/oiaf/servicerpt/natgas/chapter4.html [Accessed on 4/9/2011] 4. Our guiding principles. Online from http://www.exxonmobil.com/Corporate/about_who_sbc.aspx [Accessed on 4/9/2011] 5. Natural Gas. Online from http://www.unctad.org/infocomm/anglais/gas/uses.htm [Accessed on 4/9/2011] Read More