Higher Production, Lower Oil Prices To Drive Anadarko’s Third Quarter Earnings

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Anadarko Petroleum

One of the largest independent oil and gas exploration and production companies in the U.S., Anadarko Corp. (NYSE:APC), is set to announce its 2014 third quarter earnings after markets close on October 28. We expect lower crude oil prices to weigh on the company’s year-on-year earnings growth. The average West Texas Intermediate (WTI) crude oil spot price declined by almost 8% year-on-year during the third quarter on rising supplies and falling global demand growth estimates. However, spot Henry Hub natural gas prices were up more than 11% y-o-y during the last three months, which should partially offset the impact of lower crude oil prices. In addition to higher natural gas prices in the U.S., we expect Anadarko to also benefit from better sales volume mix compared to last year. This is because we expect the ongoing development of the company’s liquids-rich U.S. onshore assets to drive most of the growth in its hydrocarbon production during the quarter.

Anadarko primarily operates in three segments: oil & gas exploration and production, midstream and marketing. Its asset 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. At the end of 2013, Anadarko had proven reserves of almost 2.8 billion barrels of oil equivalent.

We currently have a $111 price estimate for Anadarko, which is more than 20% above its current market price.

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See Our Complete Analysis For Anadarko

U.S. Onshore Assets To Drive Production Growth

Currently, most of Anadarko’s total hydrocarbon production (~75%) comes from its onshore assets in the U.S. The company’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 7% CAGR over the same period. Most of the growth has come from increased horizontal drilling in the Wattenberg, Eagle Ford, East Texas/North Louisiana and the Marcellus shale plays. [1]

More importantly, the production of liquids (crude oil and natural gas liquids) from Anadarko’s U.S. onshore assets has increased at a much faster rate. In 2013, liquids made up ~32% of the company’s total hydrocarbon production from the U.S. onshore assets, compared to just around 23% in 2009. Liquids generally sell at much higher prices compared to the equivalent amount of natural gas. To give some perspective, Anadarko realized around $21 per BOE of natural gas sold last year, compared to ~$85 per barrel of liquids sold. Moreover, since development costs have remained relatively flat at around $13/BOE since 2009, the company’s upstream margins have improved significantly over the last four years. [1]

This year, Anadarko plans to grow its U.S. onshore production by around 8% over last year, while increasing the proportion of liquids to more than 37%. The company plans to spend around $5.5 billion, which is ~65% of its total capital budget for the year, in order to achieve this target. A large chuck of this capital would be pumped into the Wattenberg field, which forms the centerpiece of Anadarko’s U.S. onshore development plan.

The Wattenberg field is a liquids-rich area where Anadarko operates over 5,200 wells. Recently, the company’s drilling program in the field has been entirely focused on horizontal development. It drilled 335 horizontal wells last year, which led to a 21% y-o-y jump in sales volume from the field. Anadarko has identified around 4,000 potential drilling locations in the Niobrara and Codell formations of the Wattenberg field that are expected to provide substantial opportunity for continued activity. This year, the company plans to drill over 360 horizontal wells in the 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 ~75% of the total quarter-on-quarter hydrocarbon sales volume growth from its U.S. onshore assets. [2]

Anadarko expects to grow its hydrocarbon sales volume from the Wattenberg field at 20% CAGR in the long run. We believe that the target is achievable due to a combination of favorable factors. These include rising drilling efficiencies, increased number of operated rigs, and improving midstream infrastructure. The company is working on more than doubling its oil takeaway capacity from the Wattenberg field to almost 90,000 barrels of oil per day by 2015. It also plans to expand the gas processing capacity from around 400 million cubic feet per day (mmcfd) to over 1,000 mmcfd by 2016. [3]

Furthermore, the asset swap deal signed by Anadarko in the Wattenberg field will also allow it to leverage this midstream infrastructure even better over the coming years as its development efforts in the region will be more concentrated around the supporting infrastructure. In October 2013, Anadarko exchanged certain oil and gas properties in the Wattenberg field with a third party. Under the terms of the transaction, each party exchanged approximately 50,000 net acres. The transaction increased Anadarko’s production by 8,000 barrels of oil equivalent per day (BOE/d) since October 2013 and is expected to drive more than $500 million in cost savings for the company through reduced trucking and water sourcing requirements. [1]

*MBOED: Thousand barrels of oil equivalent per day

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Notes:
  1. Anadarko SEC Filings, sec.gov [] [] []
  2. Anadarko 2014 Q2 Earnings Call Presentation, anadarko.com []
  3. Anadarko Investor Conference, anadarko.com []