A Closer Look At Anadarko’s Key Business Drivers

One of the largest independent oil and gas companies in the U.S., Anadarko Corp.(NYSE:APC), is primarily involved in the exploration and production of crude oil, natural gas liquids and dry natural gas, along with the transportation and marketing of these hydrocarbons. Its assets portfolio includes positions in onshore resource plays in the Rocky Mountains region, the southern United States and the Appalachian basin. The company is also an independent producer in the Deepwater Gulf of Mexico, and has production and exploration activities globally, including positions in high potential basins located in East and West Africa, Algeria, Alaska and New Zealand. The valuation of an independent oil and gas company largely depends on a few key business drivers such as hydrocarbon production, proved reserves, cash operating margins, and capital expenditures. In this article, we see how these drivers have been trending for Anadarko over the past few years.

We currently have a $111/share price estimate for Anadarko, which is almost in line with its current market price.

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Hydrocarbon Production

Anadarko’s second quarter hydrocarbon production stood at 848,000 barrels of oil equivalent per day (MBOED). Most of the company’s total hydrocarbon production (~80%) currently comes from its onshore assets in the U.S. Anadarko’s net hydrocarbon production from its U.S. onshore assets has grown at more than 13.3% CAGR between 2009 and 2013. This compares to the company’s overall production growth rate of around 6.5% CAGR over the same period. ^[1] Within its U.S. onshore portfolio, the company’s acreage in the Wattenberg field, where it operates over 5,200 wells, stands out as being the most lucrative.

This year, Anadarko plans to drill over 360 horizontal wells in the Wattenberg field, employing as many as 13 horizontal operated rigs on an average. During the second quarter, Anadarko’s oil equivalent sales volume from the Wattenberg field grew by 39 MBOED compared to the previous quarter. This made up almost 75% of the total quarter-on-quarter hydrocarbon sales volume growth from its U.S. onshore assets. Going forward, the company expects to grow its net hydrocarbon production at 5-7% CAGR in the long run, with sales volume from the Wattenberg field expected to grow at 20% CAGR until at least 2018. We currently forecast Anadarko’s net hydrocarbon production to reach around 1,215 MBOED by 2021, implying a CAGR of 5.7%. ^[2]

Proved Reserves

The amount of proved hydrocarbon reserves is an extremely critical metric for any oil and gas exploration and production company. It directly impacts the company’s production growth outlook, as it represents the total quantity of technically and economically recoverable oil and gas reserves owned by the company at a given point in time.

Anadarko’s proved hydrocarbon reserves stood at 2,792 million barrels of oil equivalent at the end of last year. This implies that the company held enough reserves at the end of 2013 to be able to produce oil and gas for the next 10 years at 2013 production rates. More importantly, despite the sharp growth in annual hydrocarbon production rate (around 6.5% CAGR between 2009 and 2013), the company has been able to grow its proved reserves base quite consistently. The company’s average reserve replacement ratio for the last five years has been over 151%, which implies that on average, it added 51% more hydrocarbons reserves to its proved reserves base than the amount of oil and gas it produced each year during this period. This speaks volumes of the successful exploration program and long term sustainability of Anadarko’s core business. The table below summarizes the company’s proved reserves (in millions of barrels of oil equivalent) and reserve replacement ratio for each of the last five years. ^[1]

Cash Operating Margins

According to our estimates, Anadarko’s cash exploration and production (E&P) margins have increased from around 41.7% in 2009 to 59.4% last year. Most of the increase in the company’s cash E&P margins during this period has come from higher price realizations, improving sales volume-mix and the growing proportion of Wattenberg production. Since Anadarko’s price realizations primarily depend upon the global benchmark crude oil prices and spot Henry Hub natural gas prices in the U.S., in this article, we will just be looking at the other two factors in detail. ^[1]

Anadarko derives all of its natural gas production from the U.S., where a supply glut has led to severely depressed domestic natural gas prices by international standards. Therefore, despite lower finding, development and lifting costs per barrel of oil equivalent (BOE) of natural gas, the production of liquids (crude oil and natural gas liquids) has become a far more lucrative source of revenue for upstream oil and gas companies in the U.S. Last year, Anadarko sold liquids at an average price of around $84.5 per barrel, compared to just around $21 realized per BOE of natural gas. Therefore, the company has been increasing its focus on liquids production to drive margin growth. As a result, the proportion of liquids in Anadarko’s total sales volume has increased from 38.6% in 2009 to 43.5% last year. Going forward, we expect the company’s sales volume-mix to improve further with liquids making around 45% of its total hydrocarbon production in the next couple of years. ^[1]

Apart from better sales volume-mix, the growth in Anadarko’s Wattenberg production is also boosting its consolidated E&P margins. This is because the company generates the highest, more than a 100%, rate of return on the development of its acreage in the Wattenberg field. This can be primarily attributed to its land grant advantage in the region. Anadarko holds fee ownership of mineral rights under approximately 8 million acres in the U.S. Rocky Mountains region. The acreage passes through southern Wyoming and portions of Northeast Colorado and Utah. It is commonly referred to as the land grant.

By owning mineral rights, Anadarko not only gains from lower operating costs in the land grant area, but it also earns royalty income from third-party operations in the area. During the 2014 annual investor conference held in March, Anadarko pointed out that for each operated well with an estimated ultimate recovery (EUR) of around 350,000 barrels of oil equivalent, the land grant increases its before-tax net present value (NPV) by $2.2 million or more than 45%. What’s even more significant is the fact that the land grant area covers a large part of Anadarko’s 350,000 net acres in the Wattenberg field, which is the primary growth driver for the company. ^[3]

The contribution of Anadarko’s Wattenberg operations to its total sales volume has grown from around 9.4% in 2010 to 14.3% during the second quarter of this year. Going forward, the company expects to grow its hydrocarbon sales volume from the Wattenberg field at around 3-4 times the company’s total sales volume growth target of 5-7% CAGR. Therefore, the weight of Wattenberg production in Anadarko’s total sales portfolio is expected to increase, which would exert downward pressure on its total unit operating costs resulting in thicker consolidated E&P margins. According to our estimates, Anadarko’s 2014 first six months adjusted E&P margins improved by around 80 basis points y-o-y. ^[4]

Capital Expenditures

Anadarko’s annual capital expenditure has increased from just over $4.5 billion in 2009 to more than $8.5 billion in 2013 on increased investments in development and exploration activities. As the company continues to develop the U.S. onshore plays and supporting midstream infrastructure, we expect its 2014 capital expenditure to be north of $8.5 billion as well. However, proceeds from the recent 10% stake sale in the Mozambique gas project and other asset sales in China will partly offset its net capital expenditures this year. ^[1]

Going forward, we expect Anadarko’s upcoming new projects in the Gulf of Mexico and Mozambique to drive its gross annual capital expenditures even higher in the long run. The company estimates the gross cost of building the first two LNG (liquefied natural gas) trains in Mozambique along with the wells and supporting subsea infrastructure to be around $15 billion. However, it has been observed in the past that large-scale LNG projects are generally marred with start-up delays and cost escalations. This poses a downward risk to the company’s rate of return on invested capital in the long run.

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1. Anadarko Annual SEC Filings, sec.gov [↩] [↩] [↩] [↩] [↩]
2. Anadarko Announces Second Quarter 2014 Results, anadarko.com [↩]
3. Anadarko Investor Conference, anadarko.com [↩]
4. Anadarko 2014 Q2 Earnings Call Presentation, anadarko.com [↩]