Anadarko Petroleum: Oil Price Recovery And Efficiency Gains To Drive Higher Returns

Anadarko Petroleum (NYSE:APC) recently announced its 2015 first-quarter results. As expected, the company’s profitability and operating cash flows were significantly impacted by lower price realizations. Not only did the benchmark crude oil prices fall by more than 50% during the first quarter, but even the Henry Hub spot prices for natural gas in the U.S. declined sharply because of oversupply. Although the company’s sales volume growth was quite impressive, with volumes from its key growth asset – the Wattenberg field – growing by around 85 thousand barrels of oil equivalent per day (MBOED) year-on-year, lower commodity prices more than offset that. As a result, Anadarko swung to a first-quarter loss of about $365 million or $0.72 per share, on an adjusted basis. However, going forward, we expect efficiency gains and a sustained recovery in commodity prices to drive higher returns for the company in the long run. ^[1]

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 2014, Anadarko had proven reserves of almost 2.86 billion barrels of oil equivalent. Based on the recent earnings announcement, we have revised our price estimate for Anadarko to $92 per share, which is almost 5% above its current market price.

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Lower oil prices strap independent oil and gas companies for cash, as their profitability and cash flows per barrel of oil drop significantly. This also reduces their ability to reinvest in their business, which is extremely capital-intensive in nature, and completely derails existing growth plans. However, companies that have the financial strength and the optionality to see through the commodity cycle trough, emerge out of it much stronger and leaner than they entered it. Anadarko is on its way to be one of those companies in this down cycle.

During the first three months of the year, Anadarko’s net oil and gas sales volume, adjusted for the impact of divestitures, grew by more than 16.6% year-on-year. However, that could largely be attributed to the growth momentum that continued from last year, as the company expects the impact of the significant reduction in drilling activities – in response to the sharp drop in oil prices – to start reflecting in its sales volume figures as soon as the current quarter itself. Anadarko guided for a mean sales volume figure of 857 MBOED for the second quarter, down almost 7% sequentially. The company made it clear during the earnings conference call that it does not intend to pursue volume growth just for the sake of growth, and that it has the financial flexibility to prioritize value over volume and rest the growth engine until there is a substantial, sustained recovery in oil prices. Therefore, there won’t be much to cheer about for the company’s shareholders at least for the next couple of quarters. That said, when oil prices do make a convincing recovery from current levels, Anadarko will be in a great position to make the most out of it. That’s primarily because of the company’s sharp focus on driving efficiency gains that will not only help it produce more for less, but also enhance its financial flexibility to pursue new, bigger growth opportunities. ^[2]

One of the key takeaways from Anadarko’s first-quarter earnings release was the significant improvement in drilling and completion efficiencies in most of the U.S. onshore plays it operates in. During the earnings conference call, Anadarko officials mentioned that they were able to deliver 15% and 14% reduction in drilling and completion costs per well in the Wattenberg field and the Eagle Ford shale, respectively. A large part of this reduction in costs could be attributed to the employment of the most efficient drilling rigs and frac crews to do fewer wells and lower service costs, which are both cyclical in nature. However, some of the efficiency gains were also driven by process improvements in drilling and completion techniques. The company officials said that they see significant scope to continue to drive efficiency gains through process improvements in the long run, which essentially means a sustained decline in capital costs per well and consequently per unit production. These efficiency gains are expected to ease the path towards cash flow neutrality for Anadarko, thereby increasing its financial flexibility. We have therefore revised down our long-term capex forecast for the company, while maintaining approximately the same level of production growth estimates. This is one of the key reasons driving the change in our price estimate for Anadarko to $92 per share. ^[1]

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1. Anadarko Announces First-Quarter 2015 Results, anadarko.com [↩] [↩]
2. Anadarko 1Q15 Earnings Conference Call, anadarko.com [↩]