Anadarko Earnings: Lower Oil Prices To Offset Higher Production, Better Mix

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Anadarko Petroleum

One of the largest independent oil and gas exploration and production companies in the U.S., Anadarko Petroleum (NYSE:APC), is set to announce its 2014 fourth quarter earnings after markets close on February 2. We expect lower crude oil prices to weigh significantly on the company’s year-on-year earnings growth. Benchmark crude oil prices have declined sharply over the past few months on rising supplies and falling demand growth estimates. The average Brent crude oil spot price declined by more than 30% year-on-year during the fourth quarter. This is expected to result in thinner operating margins on Anadarko’s spot crude oil sales. However, higher production, primarily driven by increased development of the Wattenberg field and other onshore assets in the U.S., coupled with better volume-mix, is expected to partially offset the impact of lower oil prices on the company’s overall performance.

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 $91/share price estimate for Anadarko, which is around 15% above its current market price.

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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 in 2014 as well. During the first three quarters of the year, Anadarko achieved more than a 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 in 2013, 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. The company planned to drill over 360 horizontal wells in the field in 2014, 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 the year-ago quarter. 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 Volume-Mix

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. In 2013, Anadarko sold liquids at an average price of around $84.50 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% in 2013. 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. This is expected to partially offset the impact of lower crude prices on its unit profitability in the short to medium term. [3]

*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 Annual SEC Filings, sec.gov []