Anadarko Petroleum Revised To $85 Per Share

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Anadarko Petroleum

We recently revised our price estimate for Anadarko Petroleum (NYSE:APC) to $85 per share based on the new long-term crude oil price forecast.We now expect crude oil prices (Brent) to average around $63 per barrel this year and increase at a decreasing rate to around $93 per barrel by 2021, implying a 7-year, full-cycle average price of around $80 per barrel, significantly lower than 2014 average price of about $99 per barrel. (See: What’s Driving Our Long-Term Forecast For Oil Prices?)  Below, we outline the three key trends, apart from oil prices, driving our valuation estimate for Anadarko Petroleum.

See Our Complete Analysis For Anadarko

Growing Wattenberg Operations

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The Wattenberg field, located in the Rocky Mountains Region, is the centerpiece of Anadarko’s growth story. The company operates approximately 5,800 vertical wells and 750 horizontal wells in the field, with the recent drilling program focused entirely on horizontal development. It drilled 369 horizontal wells in the field in 2014 alone, growing net oil and gas production from its acreage in the field by around 62 thousand barrels of oil equivalent per day (MBOED) or almost 57% year-on-year. Liquids production grew at an even faster rate (up 79%) to 109 MBD. Because of this explosive growth, the contribution of Anadarko’s Wattenberg operations to its total sales volume has grown from around 9.4% in 2010 to 20.3% last year. Going forward, we expect this trend to continue, since the company plans to increase its focus on the development of its reserves in the Wattenberg field, which is the most lucrative part of its overall asset portfolio in the U.S. onshore region. This year, Anadarko has allocated 50% of the total capital expenditure planned for the U.S. onshore region to the development of its acreage in the Wattenberg field. [1]

The strategy makes sense because the growth in Anadarko’s Wattenberg production also boosts its consolidated exploration and production (E&P) margin. 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. Therefore, as the weight of Wattenberg production in Anadarko’s total sales portfolio increases, it would exert downward pressure on its total unit operating costs and thereby help partially offset the impact of lower crude oil prices on its margins in the short to medium term. [2]

Slower Production Growth

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 being one of those companies in this down cycle. [3]

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. [4]

Efficiency Improvements

One of the key takeaways from Anadarko’s most recent 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. [3]

Overall, our current price estimate for Anadarko reflects the combined effect of all these factors and our 2015 full-year cash earnings per share (EPS) estimate for the company stands at -$1.75, compared with the consensus estimate of -$1.96 per share reported by Reuters.

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Notes:
  1. APC 2015 Capital Program and Guidance Conference Call, anadarko.com []
  2. Anadarko 2014 10-K Filing, sec.gov []
  3. Anadarko 1Q15 Earnings Conference Call, anadarko.com [] []
  4. Anadarko Announces First-Quarter 2015 Results, anadarko.com []