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Exxon's XTO bid a bet natgas/oil ratio will narrow

NEW YORK (Reuters) - Exxon Mobil’s $30 billion bid for XTO Energy on Monday could signal confidence the price of cleaner burning natural gas will rally against crude prices to more normal levels in the mid-term.

High inventories, light summer demand, and near record high natural gas production in 2009, coming mostly from growth in shale gas output, kept gas prices under pressure for most of this year, with quotes in September sinking to a 7-1/2-year low below $2 per million British thermal units.

The weak fundamentals drove down natural gas prices relative to crude to more than 25 -- meaning crude prices in absolute terms were trading at more than 25 times higher than gas -- after the price ratio between the two markets hovered between 7 and 8 for most of the decade.

But the ratio has since narrowed to 13 as crude prices slipped to $70 a barrel from recent highs above $80 due to high inventories, while gas prices moved back above $5 as winter weather arrived to drive up demand again.

“Natural gas prices are actually very low relative to crude on an energy equivalent basis. It could be that Exxon is playing that gap,” said Earl Sweet, managing director at BMO Capital Markets in Toronto.

THE LONG VIEW

Analysts also said the bid makes sense for Exxon longer-term, noting demand for gas, which produces about half the carbon dioxide of coal, is likely to increase worldwide as nations struggle to meet climate change objectives.

“Gas supplies have gotten ahead of demand, but as the gas market expands, conditions are likely to tighten. Exxon doesn’t invest for (only) 18 months,” said Stephen Smith at Stephen Smith Energy, a consulting firm in Mississippi.

Analysts say gas, which burns much cleaner than coal or oil, should be the favored fossil fuel in coming years as countries transition to even cleaner alternative fuels.

XTO, based in Fort Worth, Texas, is one of the leading developers of unconventional resources including shale gas or gas trapped in sands with low permeability that require advanced drilling techniques to recover.

These resources have emerged as a potentially huge new resource play in North America, and their development has so far been dominated by independent U.S. exploration and production companies. But now oil majors like Exxon are starting to look for reserves around the world.

“This is a comfortable plan B for an oil producer. They already know a lot about gas, and it makes them a little less dependent on the petroleum market,” said Tim Evans, energy analyst at Citi Futures Perspective in New York.

TWO DIFFERENT MARKETS

While oil and natural gas prices don’t always move in tandem, they are loosely linked by competition for a share of winter heating and summer cooling demand.

Oil is more globally-focused, with prices impacted by OPEC production, political instability and worldwide growth prospects, while gas is still primarily a domestic market, with most of the gas burned in North America produced there.

Crude oil by-products like heating oil and residual fuel can be used instead of gas in dual-fired burners that produce heat or power for homes and factories.

“Most of the time, the two markets (oil and gas) move independently, and right now oil is certainly expensive,” Citi Futures’ Evans said, noting heating oil was trading at a substantial premium to gas even with high inventories.

But if the economy improves and gas production slows as predicted next year, gas prices are expected to improve.

The January crude-to-gas ratio in 2011 and 2012 is quoted between 11 and 12 based on New York Mercantile Exchange forward futures prices on Monday.

Reporting by Joe Silha; Editing by Marguerita Choy

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