I try not to get overly excited about M&A announcements, but today’s major transaction in the energy space deserves all the attention that it is getting. My enthusiasm for Exxon‘s (XOM) acquisition of XTO Energy (XTO) goes beyond my long-held liking for both of these companies. XTO Energy is a major exploration and production (E&P) company, with a focus on so-called unconventional natural gas reserves, such as shale gas.

The development of and production from unconventional sources has been a clear success story over the last few years on the U.S. domestic front. The emergence of massive shale gas reservoirs is not due to a new discovery in the sense of exploration success, but more in the sense of evolutionary improvements that have enabled the industry to tap the enormous resource potential of natural gas trapped inside shale rock.

The Barnett Shale field in Texas is the most developed of these shale plays, while the Haynesville Shale play in East Texas/North Louisiana is currently being developed. Another very prospective shale play at a very early stage is the Marcellus shale in Pennsylvania. The massive resource potential and lack of exploration risk in these shale plays make them very attractive assets for exploration and production companies.

The abundant supplies of natural gas, and the resultant weak prices, are more due to these ample newfound unconventional natural gas sources than recession-hit demand. In fact, the emergence of this new source has forced a number of industry players to revise their long-term plans for the U.S. market.

Exxon’s purchase today of XTO Energy is a stamp of approval from a very credible industry player on the long-term value of such unconventional natural gas resources. Exxon has been essentially absent from the M&A market despite having more financial firepower than any other company in the world. While we have seen a few asset transactions by the oil majors in the shale gas space over the last few years (BP and Statoil had purchased a few shale assets), this is by far the largest deal in the industry.

It could very well be the onset of a major M&A wave in the U.S. E&P sector. All the global oil majors are in excellent financial health and desperately in need of growth assets in promising fiscal jurisdictions. Other major unconventional natural gas producers, such as Chesapeake Energy (CHK), EnCana (ECA), and EOG (EOG), share many of the same assets as XTO Energy and will be closely looked at in the coming days.

Market Outlook Remains Constructive

While we lack any major exposure to the E&P group in our portfolio, we will be looking broadly at this group for additions going forward.

But beyond today’s news story, I remain constructive in our market outlook. I continue to believe that the market’s impressive gains from the March ’09 lows have a fundamental underlying basis.

Relatively favorable trends in the labor market, as evident from November’s better-than-expected payroll numbers, and the recent positive momentum on the retail sales front all point to a fast-improving economy.

While it would be difficult to replicate this year’s record performance, we see no danger of a major/sustained pullback. We expect the broad contours of the economy to get clearer and more visible as we go along, helping maintain a positive bias towards the upside.

Portfolio Updates

We did not make any changes to our portfolio(s) last week.

Zacks Investment Research

1. (XTO) Natural Gas Prices Up on Huge EIA DrawdownThe federal government’s Energy Information Administration (EIA) reported a bigger-than-expected decline in natural gas supplies....
2. (XTO) Natural Gas Stockpiles Up SlightlyLast week, the federal government’s Energy Information Administration [EIA] reported a lower-than-expected rise in natural...
3. (XTO) Natural Gas Storage at New All-Time HighLast Thursday, we received a mildly bearish report from the federal government’s Energy Information Administration...
4. (XTO) Natural Gas Storage Hits New HighIn its weekly release yesterday, the Energy Information Administration [EIA] reported a bigger-than-expected 69 billion...
5. (XTO) Natural Gas Inventory Builds at Slower PaceYesterday, we received a mildly positive report from the federal government’s Energy Information Administration (EIA),...
6. (XTO) Natural Gas Inventories Rise Less Than ExpectedIn its weekly release yesterday, the Energy Information Administration (EIA) reported a less-than-expected 69 billion...

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