Anadarko Petroleum: Oil Price Scenarios That Could Significantly Impact Its Valuation

Anadarko Petroleum (NYSE:APC) is a large independent exploration and production company based out of Texas, Unites States. 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 2014, Anadarko had proven reserves of almost 2.86 billion barrels of oil equivalent. In this article, we take a look at how the two extreme scenarios for long-term crude oil prices could impact the company’s valuation. ^[1]

We currently have a $80/share price estimate for Anadarko Petroleum, which is almost in line with its current market price and reflects our base-case valuation estimate for the company. We estimate its 2015 diluted cash earnings per share (EPS) to be at -$1.19, compared to the consensus estimate of -$1.37.

See Our Complete Analysis For Anadarko Petroleum

Crude Oil Price Scenarios

Crude oil prices have been extremely volatile of late. After falling sharply by more than 60% in a short period of slightly over six months, oil prices have risen by over 33% from their lows over the past couple of months. In hindsight, the sharp decline in oil prices makes sense because of slowing demand growth and surging tight oil production in the U.S., but the billion dollar question is, what will they do next, and how would that impact the valuation of oil companies. We currently expect oil prices (Brent) to average around $75 per barrel for this year, below the global marginal cost of production due to the current oversupply scenario, and increase gradually towards the $85 per barrel mark over the next two years, as the supply becomes tighter due to the recent cutbacks in capital spending by almost all major oil companies and the growth in demand picks up to more normalized levels.

But there could be a much sharper, V-shaped recovery in global oil prices if the growth in demand for oil products picks up significantly on the back of lower oil prices and simultaneously, tight oil production in the U.S. declines because of a sharp, sustained slowdown in drilling activity. However, we believe that oil prices cannot sustain above the $100 per barrel mark for long under normal geopolitical conditions, unless the Organization of Petroleum Exporting Countries (OPEC) decides to sacrifice on some of its market share for better prices. This is because oil production in the U.S. can quickly start growing again at an annual rate of around 1 million barrels per day if oil prices sustain above the $100 mark and that would once again create an oversupply scenario, which will weigh on benchmark oil prices. But if for some reason there is a change in the OPEC’s stance and it takes some of its oil off of the market, that would provide a significant boost to oil prices and Anadarko Petroleum, one of the leaders in the shale oil industry, would gain significantly from that.

On the other hand, if the OPEC maintains its current stance and the growth in demand for crude oil does not pick up because of a continued slowdown in economic activity in China — the world’s second largest oil consuming nation and the key driver of demand growth over the past few years – or because of a rapid increase in the penetration of alternative fuels due to advancements in biofuels or fuel cell technologies, the recent decline in oil prices could sustain for a much longer period. In addition, the expected service cost deflation, which would reduce the average cost structure of the oil industry, could also result in a more robust non-OPEC supply growth despite the slump in oil prices. If this comes true and the demand growth remains weak, oil companies could be in for a prolonged period of depressed commodity prices, at least until the U.S. shale oil boom subsides. The chart below reflects our assumptions regarding how these two extreme oil price scenarios could impact Anadarko’s average crude oil and condensates price realization.

Impact On Profitability

Apart from average price realization for crude oil and natural gas liquids, global benchmark crude oil prices also impact the profitability of an oil company’s exploration and production operations. However, the magnitude of impact largely depends on the company’s sales mix. As in, what percentage of its sales revenue comes from crude oil and natural gas liquids, versus dry natural gas. This is because in some markets, like the U.S., natural gas prices are decoupled from crude oil prices and depend on the local demand-supply dynamics. In the case of Anadarko Petroleum, almost 75% of exploration and production sales revenue comes from crude oil and natural gas liquids. Therefore, the impact of changes in benchmark crude oil prices on the company’s profitability is more profound, compared to most of the large integrated oil companies like ExxonMobil (NYSE:XOM) and BP Plc. (NYSE:BP). The below chart reflects our estimate of the potential impact of the two extreme crude oil price scenarios on Anadarko’s adjusted E&P EBITDA margin.

Capex and Growth Impact

In addition to average price realization and profitability, crude oil prices also impact an oil company’s capital expenditure and growth plans. This is because better (worse) crude oil prices mean higher (lower) profitability, which drives higher (lower) returns and increased (decreased) capital expenditures by an oil company. For example, last year, Anadarko’s crude oil sales volume grew by almost 17% y-o-y, but it plans to grow oil production by just around 5% this year, employing 33% less capital. While most of its producing assets are still profitable at current oil prices, the company has taken a conscious decision to sacrifice on near-term production growth to maximize returns when oil prices rebound. Now, we forecast net capital expenditures as a % of revenue, so the absolute net capex figure increases (decreases) automatically with increase (decrease) in oil prices and production because that pushes revenues higher (lower). Therefore, there is only a slight increase (decrease) in our net capex driver in both the scenarios, reflecting the long-term shift in oil price dynamics and return projections. The chart below reflects our assumptions regarding the impact of the two extreme oil price scenarios on Anadarko’s crude oil production in the long run.

To view our detailed analysis of the impact of a potential V-shaped recovery or a sustained decline in oil prices on Anadarko’s valuation, click here.

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1. Anadarko Petroleum 2014 10-K, sec.gov [↩]