XTO's Rising Reserves

Though I seem to have misplaced my lucky quarter, I'll hazard a guess that the long-term trend in natural gas prices in the U.S. is positive. Though the market still harbors mixed sentiments regarding the future direction of energy prices, I'm starting to drill for value in the energy industry.

Last summer, former Fool Stephen Simpson was interested in several oil and gas exploration and production (E&P) companies, including Occidental Petroleum (NYSE: OXY  ) and Apache (NYSE: APA  ) . He also favored E&P company XTO Energy (NYSE: XTO  ) , which has now crossed my radar as well.

XTO issued a press release today confirming that it believes it will have established 8.4 trillion cubic feet equivalent (Tcfe) of proven reserves by the end of fiscal 2006. This amounts to a 10% increase from the prior year's 7.6 Tcfe. XTO was able to increase its proven reserves mainly through developing existing properties, rather than acquiring new ones.

Growth in proven reserves is a major way for XTO to continue to grow the company's operating cash flows, but it's not enough. Free cash flow, a more important measure for shareholders, will increase only if XTO is able to efficiently develop its natural gas properties. That's where XTO has excelled, finding and developing its reserves at a lower cost than most of its peers.

Management, at its latest analyst meeting, presented data from Credit Suisse to show that costs to find and develop those reserves were roughly $1.65 to $1.80 per thousand cubic feet of gas equivalent (Mcfe). The average E&P company's finding and development (F&D) cost is estimated to be closer to $3.25.

With natural gas prices trending higher over the past several years, most producers have benefited, regardless of their cost structures or F&D costs. However, the cheaper a producer like XTO can develop its reserves, the more free cash flow it can use to grow the business. One only has to look at XTO's stock chart to gain a serious appreciation for the company's operations.

While XTO's growth in reserves will slow from its historical 31% compounded growth rate, the combination of its low-cost development model and moderate growth should still contribute solidly to the company's bottom line.

Until I find my lucky quarter, XTO is definitely on my watch list.

Further petrochemical Foolishness:

Fool contributor Matthew Crews welcomes your feedback -- really! He has no financial position in any of the companies mentioned. The Motley Fool has a disclosure policy.

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