Anadarko Petroleum: The Year 2014 In Review

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Anadarko Petroleum

Anadarko Petroleum (NYSE:APC) has made some great progress this year. The company has been able to push its production growth higher, primarily through the accelerated development of its acreage in the Wattenberg field, improve its sales volume/mix for better margins, and put the long-pending legal dispute with Tronox behind it. The company’s stock price has increased by around 6% year-to-date, despite the recent sharp decline in crude oil prices.  In this article, we review the key trends and events – apart from the volatility in oil prices – that drove Anadarko’s stock price this year.

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 Mountain 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 $91/share price estimate for Anadarko, which values it around 20x our 2014 cash diluted earnings per share (EPS) estimate of $4.45 for the company.

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Higher Production

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 just 7% CAGR over the same period. The spectacular growth from U.S. onshore assets continued this year as well. During the first three quarters of this year, Anadarko achieved more than 15% year-on-year growth in its U.S. onshore production, spending a majority (~65%) of its gross capital expenditures on the development of its key assets in the area. A large chunk of this capital has been pumped into the Wattenberg field, which forms the centerpiece of Anadarko’s U.S. onshore development plan. [1]

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  average.  During the third quarter, Anadarko’s oil equivalent sales volume from the Wattenberg field grew by 88 MBOED*, compared to last year. This made up almost 84% of the total year-on-year hydrocarbon sales volume growth for the company. [1]

Anadarko expects to grow its hydrocarbon sales volume from the Wattenberg field at 20% CAGR in the long run. We believe that this target is achievable due to a combination of favorable factors. These include rising drilling efficiencies, an 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 next year. 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. [2]

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 growth potential from the field significantly and is also expected to drive more than $500 million in cost savings for the company through reduced trucking and water sourcing requirements. [2]

Better Margins

The growth in Anadarko’s Wattenberg production is also boosting its consolidated exploration and production (E&P) margins. This is because the company generates the highest 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 and covers a large part of Anadarko’s 350,000 net acres in the Wattenberg field. The land grant not only reduces Anadarko’s operating costs in the Wattenberg field – because of lower royalty rates – but it also boosts its returns through royalty income from third-party operations in the area.

The contribution of Anadarko’s Wattenberg operations to its total sales volume has grown from around 9.4% in 2010 to 22.3% during the third 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 and thereby help partially offset the impact of lower crude prices on its margins in the short to medium term. According to our estimates, Anadarko’s 2014 first nine months adjusted E&P margins improved by around 320 basis points y-o-y. [1]

Tronox Settlement

In addition to a stellar operational performance, Anadarko also finally put the Tronox lawsuit behind it this year after signing a $5.15 billion agreement to settle fraud claims arising from its 2006 acquisition of Kerr-McGee. The largest-ever environmental cleanup recovery signed by the U.S. Department of Justice resolved the lawsuit filed against Anadarko and its Kerr-McGee unit by Tronox’s creditors. [3]

In 2006, Kerr-McGee spun off its chemicals business to form Tronox. Just a few months later, Anadarko acquired Kerr-McGee for $18 billion. Tronox inherited huge environmental liabilities from its parent that forced it into bankruptcy in 2009. Soon after filing for bankruptcy, the company filed a lawsuit against Kerr-McGee accusing it of deliberately setting it up for failure. When Tronox emerged from bankruptcy in 2011, a litigation trust was formed to pursue the lawsuit against Anadarko and Kerr-McGee. Tronox transferred 88% of its interest in the lawsuit to the federal government.

The settlement agreement crossed the final hurdle last month after it received the approval of a federal judge. Most of the settlement’s proceeds, about $4.5 billion, are earmarked for cleaning up some 2,000 sites in the U.S. contaminated by Kerr-McGee’s decades-old jet and rocket fuel manufacturing and uranium mining operations. The rest will pay for legal claims filed by people who got sick from the pollution. We believe that this settlement will greatly help Anadarko increase its focus on unlocking greater value from its core activities of the exploration and production of hydrocarbons. [4]

*MBOED: Thousand barrels of oil equivalent per day

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Notes:
  1. Anadarko Announces Third Quarter 2014 Results, anadarko.com [] [] []
  2. Anadarko Investor Conference, anadarko.com [] []
  3. Anadarko Petroleum Settles U.S.-wide Clean-Up Case For $5.15 Billion, reuters.com []
  4. Federal Judge Approves Anadarko Settlement Over Tronox, wsj.com []