Higher oil and gas prices are an unlikely source of margin pressure for an oil and gas producer, but that appears to be a major contributor to XTO Energy's (NYSE: XTO ) quarterly cost creep.
For one, XTO is a consumer of fuel and CO2 in its compression and production activities. Compared to last year, those expenses are up by low-double digits on a per-foot basis. No, XTO isn't a cobbler -- production is about 80% natural gas, so we talk about production in terms of cubic feet, rather than barrels. Make sense? Peachy.
The other way that rising energy prices crimp earnings is through the "taxes, transportation, and other" line on the income statement. This figure leaped higher because as prices rise, so, of course, do production taxes and transportation costs. This petroleum pinch partially explains why, with production and operating cash flow both up by one-third, adjusted earnings only ticked 12% higher.
Management was quick to argue that the company isn't facing a margin squeeze, however. Yes, cash flow margins dipped to 63%, but XTO expects that to bounce back to a more normal 65% for the rest of the year. XTO has excelled in such machine-like fashion that I'm willing to give it the benefit of the doubt. The lack of operating leverage in the quarter may have surprised some, but this is not a company in dire straits.
I think the bigger takeaway from XTO's conference call is that it's hitting the acquisition trail hard. Earlier this year, the company snapped up Fayetteville shale acreage from both Contango Oil & Gas (AMEX: MCF ) and Southwestern Energy (NYSE: SWN ) . More recently, I extolled XTO's extension into the Marcellus shale via the Linn Energy (Nasdaq: LINE ) deal. The company noted that if things go right in the latter, they could be looking at finding costs of $0.05 a foot. Fabulous.
But XTO's not applying the brakes just yet. The company has raised a bunch more cash and is prepared to drop another couple of billion on the right assets. XTO has built its entire energy empire via diligent acquisition and development, so don't underestimate the firm's potential for similar feats going forward.