Chevron-Atlas Deal a Precursor of Things to Come

Chevron may have shined a light on the future of energy production. The second largest U.S. oil company plans to buy Atlas Energy, which has access to an estimated 9 trillion cubic feet of natural gas in the Appalachian Basin.

Many analysts are calling the move a no-brainer, meaning that shale gas developers have limited access to capital and are looking to their big brothers in the oil sector for help. And the oil conglomerates, which have had their hands tied in the United States, now see shale gas as a potentially rich vein that can add to their bottom lines over time.

"Natural gas focused exploration and production stocks are not adequately discounting the unexpected," says Harry Rady, a hedge fund manager in San Diego. "Mergers and acquisitions seem to be gaining momentum in the space that could be one of the many unexpected variables that will drive stock prices higher." He says that the sector is promising and more such deals could be in the offing.

Indeed, the U.S. Energy Information Administration is predicting that total domestic natural gas production will grow from 20.6 trillion cubic feet in 2008 to 23.3 trillion cubic feet in 2035, with shale accounting for a quarter of that expansion. Meantime, Aruvian Research is reporting that -- globally -- natural gas-fueled cars, which now total 5 million, will rise 5.5 percent by 2015.

As for Chevron, if the deal is approved by regulators, it would have the rights to 9 trillion cubic feet of natural gas, which includes about 850 billion cubic feet of proved natural gas reserves. Nearly all of that is in the Marcellus Shale region of the Appalachian basin that is awash with shale gas.

To get this access, it is paying $3.2 billion in cash while acquiring another $1.1 billion in Atlas' debt. Bloomberg data says that Chevron is paying 14 times the profits earned by Atlas, all before interest and taxes. That compares to 11 times profits for similar deals.

In fact, Chevron joins ExxonMobil Corp. which bought XTO Energy last year for similar reasons. BP, Royal Dutch Shell and Statoil are all positioning themselves for what could become a "gold rush" and a heavy move into shale production in the United States. Shell, for example, is buying most of East Resources for $4.7 billion in cash while Consol Energy is acquiring shale exploration assets from Dominion Resources for $3.5 billion.

"This acquisition is the right opportunity for Chevron," says George Kirkland, Chevron's vice chairman in a formal release. "We are acquiring a company that has one of the premier acreage positions in the prolific Marcellus. The high quality resource, competitive cost structure in the Marcellus, strong growth potential of the asset base and its proximity to premier natural gas markets make this targeted acquisition a compelling investment for Chevron." 

Gold Rush

Opportunities abound for shale explorers throughout the United States. Shale is a sedimentary rock that is less porous than sandstone where traditional natural gas is found. While developers have always known that such formations are filled with gas, it has only been in recent years that retrieving those resources has been technologically feasible. With horizontal drilling, producers can move laterally beneath cities and neighborhoods to extract the product.

The Potential Gas Committee, a research arm of the natural gas and petroleum industries, has said that the country's natural gas reserves are 35 percent greater than two years ago. Reserve levels now stand at more than 2,000 trillion cubic feet, it says, which is the most they have been in 44 years. Eric Potter of the University of Texas has given estimates that 5,500 wells in the Barnett Shale region in Dallas will generate $100 billion for the Texas economy over several years.

That's a big reason why ExxonMobil bid on XTO Energy last year. It has the resource equivalent of 45 trillion cubic feet of shale gas, shale oil and coal-bed methane. By betting on natural gas, ExxonMobil and other oil giants are saying that fossil fuels will remain paramount but that tighter air quality restrictions are coming; natural gas emits far fewer emissions than either oil or coal.

But potential problems loom. To produce gas from shale, tons of water and chemicals must be pumped deep down into the wells to loosen it. And that has created concerns among many communities and environmental groups that say the process contaminates the groundwater.

To that end, the U.S. Environmental Protection Agency has asked shale developers to voluntarily divulge what chemicals they are using to pry loose the shale. While some of them consider such information proprietary, others say that doing so is necessary to quell what could become a huge uproar over water quality in affected communities.

Still, the administration and some environmental groups recognize that natural gas is the cleanest burning fossil fuel. And with the demand for energy expected to grow in the coming decades, shale gas will play more of a role. ExxonMobil, in fact, says in its annual energy outlook that it anticipates natural gas to grow faster over the next 20 years than either oil or coal.

"The energy outlook issued by Exxon Mobil Corporation underscores the pressing need to do all we can to develop all economic fuel sources, including America's own oil and natural gas resources," says the American Petroleum Institute.

Shale developers need the capital and Big Oil is seeking new revenue sources. With that, expect similar deals to the one announced by Chevron and Atlas.

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