Consol gas buy could be wrong deal at right price

March 15, 2010

Consol Energy is joining the shale gas party. And its $3.5 billion deal to buy assets from Dominion Resources looks like a bargain. But the investors who knocked Consol’s share price are rightly skeptical. By hedging its energy bets, the coal company risks confusing investors and sealing in a conglomerate discount.

Consol should at least feel happy with its negotiating prowess. True, it has paid slightly over the odds for proven gas reserves. When ExxonMobil bought XTO late last year it stumped up just $2.96 per thousand cubic feet. Consol is paying about 15 percent more. But Dominion’s territory on the Marcellus shale is largely virgin land. Consol should be able to triple production over the next five years.

On a per-acre basis, Consol’s deal looks even better. It is paying roughly half the price that Mitsui did for assets from Anadarko Petroleum in February.

While the price is right, the strategy may not be. Sure, shifting partly from coal to gas makes good sense. Coal stands to be the big loser from actions to reduce greenhouse gas emissions. Gas-powered electricity generators have plenty of spare capacity and spew out much less carbon dioxide than rival coal stations.

But investors are better placed to achieve this diversification for themselves. Consol is virtually alone among large coal producers to pursue gas. The result is a punishing discount to peers. Its gas assets are valued on the market at $2.41 per thousand cubic feet, compared with $3 or more for rivals, according to Raymond James. Consol’s coal, meanwhile, is trading at 4.4 times 2010 operating cash flow versus 6.5 times for the competition.

Investors in most industries find it hard to love companies that are neither fish nor fowl. After this deal, 35 percent of Consol’s output will be in gas. As the blend grows more evenly weighted, the company risks losing out on even more shareholder value.

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I wouldn’t count out coal just yet…

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