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Drew Cameron

XTO AT A GLANCE

P/E ► 13.7 AVG EV/EBITDA ► 5.48 AVG ROA ► 6.7% AVG ROE ► 11.2% AVG Debt to Equity ► 1.08 AVG Current Ratio ► 0.968 AVG Interest Coverage Ratio ► 6.25 AVG

 

 

 

 

 

 

XTO Energy acquires onshore oil and natural gas properties in North America, focusing on regions and reserves with an established production record. The company invests primarily in low risk reserves, and profits by producing more from its properties than previous owners or bidders anticipated. It does not devote a large amount of capital to exploration, instead funneling cash into acquiring and developing existing reserves - in 2006 XTO spent only $22 million on exploration, as compared to competitor Anadarko Petroleum (APC) which spent over $1 billion on E&P that same year.^[1][2]

XTO competes with all other oil and gas companies, and specifically its performance can be measured against other independent U.S. oil production companies like Chesapeake Energy (CHK) and Noble Energy (NBL). In terms of revenues, operating margin, and return on invested capital, XTO is among the top independent producers, earning $5.5 billion in revenue and almost $2.9 billion in operating income in 2007. It holds positions in a number of the United States' largest oil-producing regions, and has successfully invested capital in developing existing properties instead of pushing to acquire new ones.

There are significant risks involved in XTO's business, most notably the volatility of petroleum prices. Natural gas prices have been on the rise since the 1990s, increasing both the value of XTO's reserves and its sales revenue. Should this trend reverse, XTO's operating cash flow and income would decrease, causing investors to lose interest - a costly problem for a firm that depends heavily on external financing to fund the acquisition and development of oil-producing properties.

Business Financials

^[3]

XTO owns and operates land based natural gas and oil wells in the southern and central United States. A majority of its revenue comes from natural gas wells in Eastern Texas/Louisiana and Southern Texas, with the two regions accounting for 60% of the company’s revenue in 2007.^[4]

XTO’s business plan has focused on obtaining more from existing reserves than what other companies anticipated for the properties, rather than on locating new reserves. The company invests a majority of its capital on existing wells and drilling known reserves, avoiding the riskiest part of the industry, exploration. In 2006 XTO spent only $22 million on exploration, much less than its competitors.^[5] Anadarko Petroleum (APC) spent over $1 billion on E&P, while Noble Energy (NBL) spent $168 million on exploration in the same year.^{[6] [7]}

XTO operates primarily natural gas wells, producing 532 million Mcfs of natural gas in 2007, and only 17 million barrels of oil.

Note: An Mcf is one thousand cubic feet of natural gas at room temperature and 14.5 bar. 1 Barrel of Oil is equivalent to 6.04 Mcf. Both barrels of oil and barrels of liquid natural gas have been converted to Mcf of natural gas (Mcfe) to allow for a comparison of production levels.

XTO’s average sale prices differ from the national average as a result of a varying sales distribution for the year and the effects of hedging.

Hunt Acquisition

On June 11th, 2008, XTO announced that it would acquire privately-owned Hunt Petroleum Corporation for $4.19 billion - $2.6 billion cash and $1.6 billion stock. The deal is expected to increase XTO's production by 28-30% over previous estimates.

Trends and Forces

Rising Oil and Natural Gas Prices Increase XTO’s Revenue

As an oil and natural gas supplier, XTO’s revenue rises and falls with commodity prices. The company's growth over the last several years is in line with the increase in commodity prices over the same time. During this period the sale price of oil and natural gas has increased faster than the cost of operation, thus increasing the company's operating margins. From 2005 to 2007 the company’s revenue increased from $3.5 billion to $5.5 billion; at the same time, the average cost per barrel for natural gas increased from $34.1 to $45.37 and for oil from $47.03 to $70.08.^[8] These price increases have come as a result of a greater world demand for energy, as both China’s and India’s economies grow, leading to increased concerns over future supply. The turmoil in oil producing areas as well as the limited supply of oil have raised questions over its future availability.

Hedging Agreements Affect XTO's Income

The company entered into fixed agreements for 43% of its gas equivalent production at weighted average prices of $10.05 per Mcfe and $74.40 per barrel of oil.^[9] Hedging helps to stabilize the company’s revenue against market fluctuations, but the company stands to lose if prices rise faster than predicted, as occurred in 2005 with Hurricane Katrina. In 2005 hedging decreased realized prices for the company by $0.34 per Mcf of natural gas and $5.25 per barrel of oil because the company could not take full advantage of the substantial rise in market price at that time. In 2006 and 2007 hedging worked in the company’s favor as it resulted in an increase in realized prices for natural gas by $1.43 and $1.24 per Mcf and for oil by $.17 and $1.40 per barrel.^[10] If the company’s production were to decrease substantially, it could face penalties for failing to meet the hedging agreements.^[11]

XTO Has Less Investment Capital than Larger Competitors

The drilling industry requires a large capital investment to drill new wells and to upgrade existing wells. The substantial initial costs of expansion puts XTO and smaller firms at a disadvantage. The limited capital means that for large scale projects or acquisitions XTO must acquire capital through loans, bonds and stock offerings.^[12] The company has a $2.6 billion development budget for 2008, while the larger APC has a planned a capital budget of $4.7 billion for the year.^[13][14]

Continued Growth Depends on New Acquisitions Rather than Oil Exploration and Production

In 2007 XTO had a net increase in proven reserves from acquisitions and development that was 308% of its production for the year.^[15] The company has expanded primarily through acquisitions of smaller competitors. As the company grows larger, the number of desirable firms decreases, and it will become more difficult for XTO to expand in the same manner. To maintain its present growth rate, the company will have to find new ways to cut cost and increase production in its existing holdings.^[16] If acquisitions are not available, the company could increase investment in exploration to promote growth; however, the existing business plan for XTO focuses on investing in proven resources and not exploration, and so a substantial change in its business plan would be necessary. Exploratory drilling is inherently risky, with modern estimates of reserve location proving unreliable. In 2007, 9 of XTO's 61 exploratory wells ended up being non-productive.^[17] The estimates of reserve size also contain uncertainty and adds risk to acquisitions; however, acquiring proven reserves with a successful production history has been more predictable for XTO than exploratory drilling has been.

Competition

XTO has a greater focus than its competitors on developing existing reserves and increasing yields of existing wells. Unlike its competitors, the company spends only a small amount of its annual capital spending on exploration, and primarily in low risk areas.^[18] The company is planning to spend approximately $125 million of its $2.6 billion development budget on exploration.^[19] This represents an increase from previous years, but still falls short of APC’s $1 billion, and NBL’s $168 million spending in 2006.^{[20] [21]}

• Anadarko Petroleum (APC) is a larger oil and natural gas drilling company than XTO. Although its natural gas production does not exceed XTO’s by a substantial amount, in 2007 produced 698 Bcf of natural gas. In 2007 APC produced more oil than XTO, ending the year with 48 million barrels of oil.^[22]
• Apache (APA) is one of XTO's closest competitors. The company operates under a similar business plan, focusing on improving existing wells and not exploration. Apache produced 655 Bcf of natural gas and 90 million barrels of oil.
• Chesapeake Energy (CHK) is another independent drilling company. The company’s production levels are below that of XTO, producing over 500 million cubic feet of natural gas and over 8 million barrels of oil annually.
• Devon Energy (DVN) is an international drilling company focused on natural gas production, collecting 863 Bcf of natural gas and 55 million barrels of oil in 2007.^[23]
• Noble Energy (NBL) produces more oil than XTO, but only about half the amount of natural gas annually. The company produced 250 Bcf of natural gas and 30 million barrels of oil in 2007.^[24]
• Unit (UNT) is a smaller oil and natural gas drilling company than XTO, producing only about a quarter of the oil and a tenth of the natural gas of XTO. The company also operated 676 miles of pipeline in 2006, along with natural gas treatment and processing plants. ^[25] In 2007 UNT produced a million barrels of oil and 43 Bcf of natural gas.

References

1. ↑ | Form 10-k 2007 XTO Page 52
2. ↑ Form 10-k APC 2006 Page 114
3. ↑ | Google Finance: XTO May 5, 2008
4. ↑ | Form 10-k 2007 XTO Page 7
5. ↑ | Form 10-k 2007 XTO Page 52
6. ↑ Form 10-k APC 2006 Page 114
7. ↑ | Form 10-K NBL 2006 Page 64
8. ↑ | Form 10-k 2007 XTO Page 12
9. ↑ Wachovia Capital Markets LLC. XTO Energy September 20, 2006. Page 12
10. ↑ | Form 10-k 2007 XTO Page 12
11. ↑ | Form 10-k 2007 XTO Page 16
12. ↑ | Form 10-k 2007 XTO Page 16
13. ↑ | Form 10-k 2007 XTO Page 4
14. ↑ | Form 10-k 2007 APC Page 48
15. ↑ | Form 10-k 2007 XTO Page 43
16. ↑ | Form 10-k 2007 XTO Page 19
17. ↑ | Form 10-k 2007 XTO Page 11
18. ↑ | Form 10-k 2007 XTO Page 18
19. ↑ | Form 10-k 2007 XTO Page 4
20. ↑ Form 10-k APC 2006 Page 114
21. ↑ | Form 10-K NBL 2006 Page 64
22. ↑ Form 10-k APC 2007
23. ↑ Form 10-k DVN 2007
24. ↑ | Form 10-K NBL 2007
25. ↑ | Form 10-K UNT 2006 Page 36