XTO Energy (XTO)

Fort Worth, Texas-based XTO Energy, Inc. (XTO) is a major independent oil and gas player engaged in the acquisition, development, exploitation, and production of oil and gas properties in the U.S. The company's operations are focused on the East Texas Basin, the Arkoma Basin (Arkansas and Oklahoma), the San Juan Basin (New Mexico and Colorado), the Hugoton Basin (Oklahoma and Kansas), the Anadarko Basin (Oklahoma), the Green River Basin (Wyoming), the Permian Basin (Texas and New Mexico), and a number of other fields in Alaska's Cook Inlet and northwestern Louisiana. As of year-end 2007, XTO had 11.29 trillion cubic feet equivalent (Tcfe) in proved reserves, of which more than 83% was natural gas and about 72% was developed. The company's year-end proved reserves were 32% above the year-earlier level and has set itself the target of 22 Tcfe of proved reserves by year-end 2011.

XTO Energy's strategy is to acquire low-risk oil and gas properties and exploit them using various techniques to increase the recovery of oil and gas from the reservoir. The company focuses on long-lived reserves, mainly in areas where there are opportunities to add reserves through step-out drilling (drilling to expand the outer limits of the field), infill drilling, and multiple-pay horizons. While many companies employ a similar strategy, few have been as successful as XTO.

XTO Energy has consistently posted some of the strongest operational and financial results among the independent oil and gas producers. Over the last seven years, XTO has added over 7.5 Tcfe of reserves at industry-leading costs, with roughly half of those reserve additions coming through the drillbit. Proved reserves and production over the six year period from 1999 to 2005 increased at compounded annual growth rates of 24.4% and 22.4%, respectively. In 2006, the company's reserves and production grew approximately 13% and 15% year-over-year, while the 2007 growth rate was 32% and 19%, respectively. Last year, XTO replaced 513% of its production at a cost of $2.03 per Mcfe. XTO's finding costs for organic reserve additions were in the range of $1.64 per Mcfe, reflecting exceptional economics of the company's low-risk inventories. Much of the company's recent production and reserve growth was driven by the success in its East Region (a.k.a. The Freestone Trend and the Cotton Valley Field of Louisiana) and Barnett Shale of North Texas, where most of its upside potential remains. During the second quarter of 2008, XTO drilled two horizontal wells in the Cotton Valley Field, one at 21 million cubic feet per day (MMcf/d), and the other at 10 MMcf/d. In all, the company has now completed three deep wells in Cotton Valley in 2008.

The company is maintaining its growth momentum through a combination of acquisitions and active drilling. In its acquisition program, XTO has historically purchased assets in and around its core areas that have established production and reserve bases. The 2006 Antero acquisition for $685 million is a case in point. The acquisition significantly increased the company's production and leasehold acreage in the core area of Barnett Shale and brought in approximately 440 billion cubic feet equivalent (Bcfe) in proved natural gas reserves, with a reserve upside in the 400 to 500 billion cubic feet range. In early 2006, the company acquired producing properties from TOTAL for $300 million. These assets are located in the company s Eastern Region and bring in approximately 120 Bcfe in proved reserves (95% natural gas, 60% proved developed). In mid-2006, XTO acquired Peak Energy Resources for $107 million. The acquired company operates gas-producing properties and owns unproved properties in the Barnett Shale in the Fort Worth Basin. In July 2007, the company further strengthened its position by acquiring a portion of Dominion Resources exploration and production operations for $2.5 billion. The acquisition brought in proved reserves of approximately 1.06 trillion cubic feet of gas equivalent, 64% of which are proved developed. Approximately 23% of the Dominion proved reserves are in the South Texas region, with the rest in the Rockies. In October 2007, XTO added over 200 Bcfe in proved reserves through the acquisition of 24,000 net acres in the Barnett Shale area for approximately $550 million. Further, in December last year, XTO bought $200 million in energy assets from Plains Exploration & Production Co. located in the San Juan Basin (New Mexico) and in Barnett Shale (Texas).

In February this year, XTO announced the acquisition of $1 billion worth of oil and gas properties in Texas, Louisiana, New Mexico and Colorado. Additionally, the company added about 76,000 net acres in the emerging shale plays to develop its drilling inventory. The company is also quite active in the Fayetteville Shale. The April 2008 acquisition of leasehold acreage and gathering infrastructure from Southwestern Energy Company is a case in point. XTO already had a nice position in the Fayetteville prior to this transaction and the $520 million acquisition has added over 55,000 net acres, thereby providing the company a nice contiguous operating position with which to expand from. The Southwestern deal has expanded XTO's position in the shale play to more than 300,000 net acres. The acquisition will increase the number of drilling rigs from one to eight by the end of this year. During the same month, the company purchased 152,000 net acres of Marcellus Shale leasehold in western Pennsylvania and West Virginia from Linn Energy for $600 million.

The more noteworthy recent transaction is the acquisition of Hunt Petroleum for $4.2 billion that brings in properties in east Texas, central and northern Louisiana, and the Gulf Coast region. Additionally, the company made purchases totaling approximately $2.1 billion - an $800 million buy of 12,900 acres adjacent to its current operations in the Barnett Shale and the acquisition of another $1.3 billion in producing properties in its Eastern and San Juan regions as well as acreage in the Marcellus, Fayetteville, Barnett and Haynesville shales. With this acquisition, XTO's overall position in the Barnett Shale play now includes about 280,000 net acres. Of this, approximately 55%, or 155,000 acres, is situated in the premier core area of the play where the geology offers the best productivity. The company has also strengthened its Bakken Shale position, where in May 2008 it acquired 352,000 acres of leaseholds in Montana and North Dakota. XTO has added a further 100,000 acres to that, to make it one of the top three acreage holders in the Bakken, which is considered among the best oil plays in the U.S.

Year to date, XTO has spent a total of approximately $10.6 billion in acquiring assets which complement and expand its operated positions across the nation, by adding 2.3 Tcf of reserves, 440 million cubic feet of daily production, and 1.4 million net undeveloped acres. XTO is projecting $2.4 billion in cash flows out of the acquisitions, which is approximately twice the cash flow that the whole company generated in 2004. We believe that this combination of internal development efforts and asset acquisitions will help the company sustain its impressive production-growth profile. In 2007, the company spent approximately $2.7 billion on exploration and development activities, with the current-year budget being $3.5 billion (up from $3 billion). XTO's production grew approximately 19% in 2007 and management is targeting a growth rate of at least 29% (up from 23%) in 2008 and a further 22% in 2009.

It is also important to note that XTO has a far lower risk profile than many of its exploration and production (E&P) peers. During the 3-year period (2005 to 2007), the company spent just over 1.6% of its capital budget on conventional exploration activities. The company's success is attributed to its expertise at developing techniques to recover more reserves from its assets, low risk infill drilling, extending wells to other producing horizons and extending the limits of oil and gas fields through low risk exploration.

Recent News

XTO Energy will release its third quarter 2008 results on November 5. We have lowered our 2008 ($4.00 vs. $4.40) and 2009 ($4.80 vs. $5.76) EPS estimates ahead of the quarterly results to reflect the challenging commodity-price environment.

On September 3, XTO Energy completed the acquisition of privately held Hunt Petroleum Corporation. The company had announced the $4.19 billion stock-and-cash deal on June 10. As per the terms of the agreement, XTO will pay $2.6 billion in cash and 23.5 million shares valued at approximately $1.6 billion, or $67.50 each, for Hunt. Roughly 70% of Hunt's properties are situated in east Texas, central and northern Louisiana, while the rest are spread over the Gulf Coast and in the Gulf of Mexico, with a small percentage in the North Sea. XTO estimates that the deal will add proved reserves of 1.052 Tcf of natural gas equivalent to its holdings, of which 62% is proved developed. After the completion of the transaction, XTO's production base will increase by 197 million cubic feet of natural gas, 8,500 barrels of oil and 2,300 barrels of natural gas liquids.

On July 22, XTO reported significantly better-than-expected second-quarter 2008 recurring earnings of $553 million or $1.07 per diluted share (our estimate was $0.95 per diluted share), compared to $432 million or $0.91 per diluted share in the year-earlier period. The year-over-year positive earnings comparison was driven by increased production volumes and improved realizations. We have adjusted the reported earnings of $1.11 per diluted share for a one-time item of $0.04 per diluted share. Total revenue for the quarter increased 46% year-over-year to $1.94 billion. The company also increased its 2008 and 2009 output forecasts and lifted its capital budget for the year.

Production during the quarter increased 29% year-over-year and 4% sequentially to 2.20 Bcfe per day. Average daily gas production increased 35% year-over-year to 1.80 Bcf, daily oil production increased 11% year-over-year to 51,279 barrels, and daily natural gas liquids (NGL) production increased 3% year-over-year to 15,574 barrels. The average price realization of natural gas during the quarter increased 7% year-over-year to $8.51 per Mcf, whereas average NGL price realization was up 43% to $58.87 per barrel. The average oil price for the quarter increased 36% year-over-over to $90.89 per barrel.

On the call, management guided towards unit costs for the remainder of 2008, as shown in the table below.

Expenses ($/Mcfe)

2008 (Low/High)

Production

$1.00

$1.05

Taxes, transportation and other

$0.85

$0.95

Exploration

$0.05

$0.10

D,D&A

$2.20

$2.40

Accretion of asset retir. Oblig.

$0.02

$0.04

General and administrative

$0.25

$0.30

Interest

$0.55

$0.60

During the quarter, operating income increased 39% year-over-year to $1.01 billion, while cash flow from operations was up 41% year-over-year to $1.23 billion. Long-term debt increased to $8.0 billion, representing a debt-to-capitalization ratio of 47.1% versus 41.5% as on March 31, 2008.

Company outlook

XTO plans to spend approximately $3.5 billion (up from $3 billion previously) on capex in 2008, which is expected to be funded by cash flow from operations. In addition, $600 million (up from $500 million) will be spent on the construction of pipeline infrastructure as well as compression and processing facilities. The tax rate for the year is expected to be approximately 37%. Overall, the company plans to boost 2008 production volumes by at least 29% (increased from 23% previously) over that of 2007. Further, the company set an annual production growth target of 22% in 2009, with a preliminary development budget of $4.6 billion. XTO has allocated another $700 million for pipeline infrastructure, compression and processing facilities. The company plans to utilize about 120 operated drilling rigs in 2009.

On July 22, XTO announced more than $2 billion in acquisitions. It paid $1.3 billion for properties in its eastern and San Juan regions and acreage positions in the Marcellus, Fayetteville, Barnett, and Haynesville shale areas. XTO estimates proved reserves on the properties to be 185 Bcfe of natural gas, of which 60% is proved developed. The properties will add 20 million cubic feet of natural gas equivalent per day to XTO's production. Among the shale properties, the company added 280,000 undeveloped acres for future use. In another transaction, XTO paid about $800 million for 12,900 acres next to its Barnett Shale operations. The acquired acreage is estimated to contain proved reserves of over 300 Bcfe of natural gas (25% proved developed). With this acquisition, XTO's overall position in the Barnett Shale play now includes about 280,000 net acres. Of this, approximately 55% (or 155,000 acres) is situated in the premier core area of the play where the geology offers the best productivity.

On July 15, XTO Energy closed its previously announced acquisition of oil producing properties and underdeveloped acreage from the privately held Headington Oil Company in a $1.85 billion stock-and-cash deal. The company expects proved reserves on the properties to be 68 million barrels of oil equivalent, of which 60% are in the proved developed category. The purchase includes 352,000 net acres of Bakken Shale leasehold in Montana and North Dakota. The purchase consideration in this transaction includes $1.06 billion of cash and 11,742,391 shares of XTO valued at nearly $790 million, or $67.35 per share. The transaction is expected to increase XTO's production by 10,000 barrels of oil equivalent per day.

On July 1, XTO Energy closed its previously announced acquisition of producing properties, leasehold acreage, and infrastructure from Linn Energy for $600 million. The company expects proved reserves attributable to this acquisition to be 145 Bcfe. The purchase includes 152,000 net acres of Marcellus Shale leaseholds in western Pennsylvania and West Virginia.

On April 3, XTO Energy entered into a definitive agreement to acquire producing properties, leasehold acreage, and gathering infrastructure from Southwestern Energy Company for about $520 million. The company expects proved reserves attributable to this acquisition to grow to 160 Bcfe this year and at least 325 Bcfe by year-end 2009. The purchase includes 55,631 net acres of Fayetteville Shale leasehold, which expands XTO's position in the shale play to more than 300,000 net acres.

On February 12, XTO announced the acquisition of $1 billion worth of oil and gas properties in Texas, Louisiana, New Mexico and Colorado. The transaction will add 212 Bcfe to the company's reserves, of which approximately 60% are proved developed. The acquisition brings in production of about 35 million cubic feet of natural gas equivalent per day (MMcfe/d). In the emerging shale plays, the company added 76,000 net acres to develop its drilling inventory.

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