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Deal a 'vote of confidence' for battered sector

Long-suffering natural gas producers and investors are hoping Exxon Mobil Corp.'s surprise move on XTO Energy Inc. is a step toward a turnaround in prices.

The energy supergiant's $31-billion (U.S.) acquisition of XTO has raised hopes that Exxon foresees strong natural gas prices and could, by bringing its considerable heft to bear, help boost gas's sagging fortunes.

Though it has staged a minor rally in the last week, natural gas remains far behind oil, which has recovered strongly from the beating it took through the early part of this year.

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But some believe Exxon could help, by bringing the discipline of a larger company to a sector that has seen a frenetic pace of development by dozens of smaller players.

The argument: "This is positive because they're going to take a more measured pace," said Shane Fildes, BMO Nesbitt Burns' global group head for energy. "It's not going to be the gold rush that we've seen and that means supply isn't going to grow as fast."

That argument gained weight when Exxon chief executive officer Rex Tillerson said yesterday his company would be disciplined in its approach to production growth.

"As you know, we are not volume-growth driven; we are profitability driven," he said.

And while Mr. Tillerson also said Exxon does not invest based on long-term price assumptions, there is little doubt among most analysts that Exxon's move indicates it expects gas prices, which have languished due to oversupply, to regain strength.

Gas futures currently trade just over $5 per thousand cubic feet (mcf). But at Exxon's current bid price, the deal values XTO's proven reserves at about $3 per mcf, suggesting the company believes gas prices will average at least $7 per mcf over the longer term to justify the takeover price, said Pavel Molanchov, analyst with Raymond James Financial Inc.

The deal comes as a "vote of confidence in both the medium-term and longer-term outlook for the natural gas market," said Derek Burleton, director of economic analysis at Toronto-Dominion Bank.

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There is, however, a counter-argument. Mr. Fildes has also heard a significant "hugely bearish" scenario, that Exxon could dampen prices by helping speed the development of gas fields and worsening the supply glut that has hurt their recovery this year.

It's a belief that has the support of Peter Tertzakian, a prominent Calgary energy economist with ARC Financial.

"Longer-term, you can't expect that prices are going to go up because Exxon Mobil bought. I would argue the reverse," said Mr. Tertzakian, chief energy economist with ARC Financial, who points out that Exxon brings to bear a lower cost of capital than almost any other industry player.

"As large companies innovate and develop these sorts of gas fields, that tends to bring the real price of a commodity down," he said. "If you look at gas over the last 200 years, the real price has actually progressively gone down, not up."

Exxon's impact, however, may be blunted by the simple fact that XTO, despite being one of the top 10 gas producers in the U.S., holds only a small market share. The company produces 2.42 billion cubic feet per day, or about 4 per cent of U.S. total daily use. In the meantime, there is simply more supply of natural gas than there is demand.

"If there's too much gas out there, I don't care who is drilling the stuff. There's just not enough market for the gas," said Ralph Glass, an economist with Calgary-based AJM Petroleum Consultants. "Having Exxon with all their bucks isn't going to change it. In fact, it might make it worse."

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Betting on big gas

Natural gas prices have fallen sharply over the past year, as inventories bulge. Exxon Mobil is betting on a long-term turnaround.

DAILY NATURAL GAS PRODUCTION*

In billions of cubic feet per day

Exxon Mobil

U.S.: 1.26

Non-U.S.: 7.52

XTO

U.S.: 2.33

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Asia Bureau Chief

Nathan VanderKlippe is the Asia correspondent for The Globe and Mail. He was previously a print and television correspondent in Western Canada based in Calgary, Vancouver and Yellowknife, where he covered the energy industry, aboriginal issues and Canada’s north.He is the recipient of a National Magazine Award and a Best in Business award from the Society of American Business Editors and Writers. More

Global Energy Reporter

Shawn McCarthy is an Ottawa-based, national business correspondent for The Globe and Mail, covering a global energy beat. He writes on various aspects of the international energy industry, from oil and gas production and refining, to the development of new technologies, to the business implications of climate-change regulations. More

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