Exxon’s carbon tax hedge is way out of the money

July 8, 2010

Exxon Mobil’s $31 billion hedge is way out of the money. Gas prices have tumbled since the U.S. oil giant agreed to pay that amount for the gas producer XTO. That doesn’t make the deal a bust. A carbon tax might make the XTO purchase look smart — but Exxon benefits for as long as Congress twiddles its thumbs.

To his credit, Exxon Chief Executive Rex Tillerson has made little attempt to mask the grim economics of the natural gas market. If anything, these have worsened since December when Exxon broke a decade-long deal fast and gobbled up XTO. Since then, the already depressed gas price has fallen nearly another 20 percent. The very technical success of drillers uncovering ever larger quantities of shale gas is proving their financial undoing.

The failure of the U.S. Congress to place a price on carbon — which promised to catapult demand for clean-burning gas — is a bigger worry still. Exxon’s own number-crunchers assume a $30 a tonne price for carbon over the next 10 years, leading electric utilities to ditch coal for natural gas.

Since December’s XTO deal, however, what minimal Republican support existed for a climate bill has nearly disappeared. With unemployment high, members of both parties of Congress seem hesitant to push a bill that might be accused of destroying jobs. So it may be years before XTO contributes to Exxon’s industry-beating return on equity.

Yet Tillerson may not be too perturbed. XTO represents less than 10 percent of Exxon’s market capitalization — which chiefly comprises carbon-spewing oil assets. The heads of Exxon’s other businesses are unlikely to be praying for climate legislation. The company’s downstream and refining business already has lost over $200 million since the start of 2009 and a price on carbon would likely add to the pain.

What’s more, the XTO bet doesn’t need to pay off any time soon. Unlike fast gushing deep-water oil, XTO’s shale wells would last for 40 years at current rates of production. By holding on to leases as cheaply as possible and drilling on the most promising wells, Exxon can keep shale businesses from being too much of a drain.

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