The Next Natural Gas Takeover Target?

| December 17, 2009

Exxon Mobil (XOM) shocked the investment world this week.  The world’s largest publicly traded oil company has agreed to buy XTO Energy (XTO) in an all stock deal for $31 billion.  XTO is one of the largest natural gas producers in the U.S.

This is just the latest sign of the growing importance of natural gas.

Natural gas has long been viewed as an environmentally friendly alternative to higher carbon emitting oil and coal.  However, it only provides heat to about half of U.S. homes and generates just 20% of our electricity.  Power utilities haven’t fully embraced natural gas because of the massive volatility in natural gas prices.

Here’s what I mean.

In 2005, prices topped $15 per million BTUs after hurricanes Katrina and Rita.  Two months later they fell to under $7.  More recently, in July 2008, prices surged to more than $13.  But, increasing supplies of natural gas this year caused prices to plunge under $3 in September.

Prices are again moving higher… they closed at $5.462 on Wednesday.

Major gas producers say the wide swings in natural gas prices are a thing of the past.  Several huge discoveries of natural gas in the U.S. and Canada have greatly increased supplies.  And, as any Economics 101 student knows, greater supply means lower prices.

The U.S. government may also soon make natural gas more attractive.

Most experts believe Congress will pass legislation making it more expensive to emit carbon.  This would severely hurt demand for coal which emits more carbon than natural gas in generating electricity.

Right now, coal is the primary fuel used to make electricity in the U.S.  But, legislation of this kind would almost certainly cause the power generating industry to transition to natural gas.

In this context, it becomes clear why XOM would fork over $31 billion for a natural gas producer.  They see natural gas becoming the most cost-effective means of generating power.  And, as power generating utilities demand more and more natural gas, XOM will be there to supply it.

This gave me a great investment idea.

If XOM is buying a natural gas producer, then other oil producers are soon to follow.  In other words, quality natural gas producers are likely takeover targets now.  That means there’s a nice potential profit to be made in the stocks of natural gas producers.

But, which ones are most likely to be acquired?

Three names coming up a lot are large gas producers Chesapeake Energy (CHK), Devon Energy (DVN), and Anadarko Petroleum (APC).  But, there’s one I like better than these… Range Resources (RRC).

Here’s why.

XOM made it clear with its bid for XTO that it thinks the future of natural gas production lies in shale formations.  Shale is a kind of sedimentary rock in which natural gas has been found in huge quantities throughout the U.S.

According to the Colorado School of Mines, the amount of natural gas in U.S. shale formations is the equivalent of 320 billion barrels of oil.  (That’s more than Saudi Arabia’s entire oil reserves!)

Until recently, these huge shale gas reserves were not considered a realistic source of energy.  It was impossible to get the gas out of the shale with existing drilling technology.

But, that’s all changed in just the past decade.

A couple of new techniques have made it possible to tap these huge reserves.  The first is hydraulic-fracturing where water and chemicals are injected into the shale rock to release the gas molecules.  The other is horizontal drilling which enables drillers to fan out horizontally and recover gas from larger areas.

RRC is a major player in two of the largest shale gas formations in the U.S.  The company owns 100,000 acres in the North Texas Barnett Shale formation.  And, they own 900,000 acres in the Marcellus Shale formation in Pennsylvania.

These properties are believed to contain over 23 trillion cubic feet equivalent of natural gas.  That’s more than eight times the company’s proven reserve base.

Huge potential shale gas reserves like this are bound to be attractive to other major oil producers.  With a market cap of just $7.8 billion, RRC would be easier to digest than the larger gas producers.

If you want to play the natural gas producer takeover lottery, RRC is a good way to go.  Take a closer look to see if it makes sense for you.

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Category: Commodities

About the Author ()

Robert Morris is the editor of Penny Stock All-Stars, an investment advisory focused on discovering small-cap and micro-cap stocks that are destined to become the market’s next Blue Chips. The Wall Street veteran and small-cap stock specialist is also a regular contributor to Penny Stock Research. Every week, Robert shares his thoughts with our readers on a variety of penny stock-related topics. In addition to Penny Stock Research, Robert also writes frequently for two other free financial e-letters, ETF Trading Research and the Dynamic Wealth Report. He’s also the editor of two highly successful and popular investment advisories, Biotech SuperTrader and China Stock Insider.

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