Anadarko 2Q Earnings: Lower Oil Prices To Offset Production Growth

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Anadarko Petroleum

Anadarko Petroleum (NYSE:APC), is scheduled to announce its 2015 second-quarter earnings after markets close on July 28. [1] We expect lower crude oil prices to weigh significantly on the company’s financial results. Benchmark crude oil prices have fallen sharply over the past 12 months on rising supplies amid slower demand growth. The average Brent crude oil spot price declined by more than $48 per barrel, or almost 44% year-on-year, during the second quarter. This is expected to result in thinner operating margins on Anadarko’s spot crude oil sales. However, higher net oil and gas production, primarily driven by the development of the Wattenberg field and other onshore assets in the U.S., coupled with a 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 2014, Anadarko had proven reserves of almost 2.86 billion barrels of oil equivalent. We currently have a $85/share price estimate for Anadarko, which is around 20% above its current market price.

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Currently, most of Anadarko’s total hydrocarbon production – more than 78% – comes from its onshore assets in the U.S. The company’s net hydrocarbon production from its U.S. onshore assets, adjusted for divestitures, has grown at more than 14.5%  CAGR between 2009 and 2014. This compares to the company’s overall production growth rate of around 8% CAGR over the same period. Last year, Anadarko achieved almost 16.5% year-on-year growth in its U.S. onshore production. However, this year, in view of the changed crude oil price environment, the company plans to slow down the development of its hydrocarbon reserves in the region to generate better returns in a more favorable oil price environment. It is currently looking at a modest (1% y-o-y) decline in its full-year net production from the region. However, most of that decline will be coming from less-profitable, natural gas production, as the company plans to increase its liquids (crude oil and natural gas liquids) production from the U.S. onshore assets by around 4.5% year-on-year to 257 thousand barrels per day (MDB). [2]

The growth in liquids production will be primarily driven by the ongoing development of the Wattenberg field. 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 20.1% 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. [3]

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. [4]

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Notes:
  1. News Release, anadarko.com []
  2. Scotia Howard Weil Energy Conference, anadarko.com []
  3. APC 2015 Capital Program and Guidance Conference Call, anadarko.com []
  4. Anadarko 2014 10-K Filing, sec.gov []