Apache overview part 2

An individual investment in the upstream petroleum industry is inherently a risky venture.  Millions are laid out to drill a well, or buy a lease or a producing property, and it always a possibility that all that money will be lost.  A very large company with a sound risk management and investment policy can spread this risk out over so many projects and so many individual wells, so as to mitigate risk, just like a large book keeper might lose money here and there, but given adequate scale, the business isn’t overly risky.

Apache is a very large company, producing about 800 mboed (oil+gas+gas liquids, thousand barrel of oil equivalent per day on an energy equivalent basis.)  For a sense of scale, this is about 20% of Exxon’s production.  But as large as they are, there have been huge investments that they have made that have gone badly, and others that have done well.  Because of the thorough reporting in their 10k filings, it is possible to determine which are which.  In this second part of my look at Apache, I’m going to go through the various operating regions and look at what has done well and what has not.

Although Apache may seem like a very  mature company compared to many of their North American peers, it was fairly small, and almost totally producing oil from on-shore North America at the start of the 1990s.  They started to expand into some early overseas ventures and the US Gulf of Mexico in the 1990s, before going on a rather aggressive overseas expansion in the 2000s.  Most recently they have shifted back to a US onshore focus, although so far this recent period has been notable for lackluster financial performance and growth.  Apache breaks down their production into regions as shown below in their May 2014 investor presentation:

Note that the figures from this chart are lower than the figures in the chart above because of the exclusion of Egypt “tax barrels”, non-controlling interest and so on.  In general, oil production in US companies is reported net of any royalties paid to landowners, but not net of any production taxes.  For foreign production sharing contracts, only the company’s share of production is reported.  As I understand it, if there is a special tax on oil production (as is the case in Egypt) it can be a bit more complicated to report it so as to be consistent and comparable with other companies.

North Sea- good or bad investment?

Apache entered the North Sea by purchasing the Forties field from BP in 2003 for $821mm.  This is widely regarded as a good investment.     9/21/11 -Apache agrees  to purchase North Sea assets from Exxon for $1.75b including the Beryl Field.  Production is 19,000 b/d of oil and 58mmcfd of gas.  68mmboe P1 reserves, $25.74 per P1 boe.  For our purposes here, I’ve only gone back to 2005 for all the regions, but if we went back to the start of their North Sea excursion then it would include a lot of negative FCF for 2003 when the purchase was made.  

This chart, as well as the others below, was built from their 10k filings.  The operating income (EBIT) and depreciation were both from Apache, the other numbers were derived and should be considered approximate.  The key takeaway from this chart is the bottom line.  The bottom line is an approximation for free cash flow for the region, by taking EBITDA and subtracting capex.   They don’t report operating cash flow by region so this is the best we can do.  Sometimes the FCF number does not match up with EBITDA-Capex and this is because I have added back in asset sales for the region.  I tried to get most of the asset sales, although I’m sure I have missed some of the smaller ones.  Overall these charts should be used as an approximation to get a sense of the economic performance of each region.

As you can see from the chart, Apache has spent about $560mm more than they have received in the North Sea in the period from 2005 through 2013.  Overall, it’s hard to say whether the North Sea has been a great investment because of the huge outlay in 2011 for the Exxon assets and drilling capex.  In a few years we should have a better picture of how this region is panning out for Apache.

Argentina- A bad but not disastrous investment

Because they just announced the sale of all their Argentina assets to YPF for $852mm on March 12, 2014, we can tell pretty conclusively how they did here.   Apache entered the region in 2006, buying Pioneer’s producing properties for $675mm, and Pan American’s 7 concessions for $396mm.  Including those purchases they spent about $936mm more than they earned in Argentina in 2005 through 2013, before recouping most of that in the final sale in 2014.  So including the sale they lost about $84mm but they also had about $1b in capital tied up earning nothing through that period.

Australia- poor returns so far

Apache has huge gas fields in Australia, but some of them are in stranded locations waiting on the completion of LNG projects to export the gas.  They also have a stake in the huge and badly overbudget Wheatstone LNG project (13%).  Its hard to get a sense of this region because the delays from Wheatstone LNG have really hurt.  Not only do they not get the cash from their stake in Wheatstone, they don’t have anywhere to sell a lot of their gas.  So although this region has not been good, it is difficult to write the book on this one just yet.  Wheatstone is due to start in 2016, and “first phase” was originally going to cost $30B, though it will probably go way over budget.  

Canada- Similar to Australia, waiting for LNG projects on the Canadian west coast

Canada looked OK as an investment until they purchased billions of dollars of BP assets in the fire sale that followed the horizon disaster.  These assets were in Western Canada, and are mostly gas.  When the LNG plants are built there, they will be in prime position to export, but as it stands now, they’ve spent a huge chunk of cash and are not seeing good returns.  Kitmat construction is just starting up, and first production may be a ways off yet.

Egypt: Apache’s cash flow gusher

When Egypt is mentioned in the same breath as Apache, it is usually to discuss the risk of having asset in a very unstable country like Egypt.  I certainly think this is a huge risk.  Its is not at all hard to imagine Egypt devolving into civil war, and the government massacring Islamism rebels Assad style, or otherwise doing something to get put on the US sanctions list.  This is probably a big reason why they elected to sell 1/3 of their Egypt business to Sinopec last year for $2.95 B.  Management may also be hesitant to talk about it because if they go around crowing about what a great deal they’ve got there, it might be lead to a public backlash in Egypt.

Lets look at two charts side by side:

Now this is gross, much of which goes to the Government.  But the point is that they’ve been able to grow and grow production there.

Now look at free cash flow.  They’ve been able to generate almost $12b in free cash flow here (including the $2.95 from the Chinese included in the 2013 number) while simultaneously growing production consistently.  This is a remarkable investment.  It is a home run.  It is only a slight exaggeration to say that Apache, as a company, basically is in the business of taking free cash flow generated in Egypt and spending it on various and marginally unprofitable enterprises around the world.  And Egypt is only about 13% of pro-forma production (after netting out production taxes).

And finally the USA- a big money pit, but with reasons for optimism

Since 2010 Apache has shifted focus back onto the continental US.  They have focused their attention on the midcontinent region in the Texas panhandle and Oklahoma and in the Permian Basin in West Texas.  More recently they have also been active in the Eagleford.

They had also been acquiring Gulf of Mexico (GOM below) assets, but most recently have sold nearly everything but some shallow-water properties.

To get a sense of how  unfocused Apache's strategy has been in the US, look at the churn in assets below.  Apache had bought up Gulf of Mexico assets from BP, Devon, and Mariner, only to sell it all four to eight years later.  Because operating income is not broke out by region within the USA it is hard for met to tell how good of an investment these were, but based on their overall numbers for the US, I suspect they weren't great investments.

March 2014- Apache agrees to sell Lucious and Heidelberg  Deepwater GOM stake to FCX for $1.4b

5/8/13-  Fieildwood  Energy buys Apache GOM shelf asssets for  3.75b

5/1/12- Apache  announces the acquisition of Cordillera Energy, anadarko basin  PE backed company for $2.85b

11/10/2010- Apache completes Mariner acquisition.  Deepwater and shelf GOM assets plus permian basin assets.  $2.7b not including assumption of $1.7b debt.

7/26/2010- Apache buys BP permian basin assets for $2.5b

6/9/2010- Apache buys Shelf GOM assets from Devon for $1.05b

1/18/2007- Apache buys $1.0b of permian assets from Anadarko.

June 2006- Apache buys  GOM outer continental shelf properties from BP for $845mm.

1/5/2006- Apache buys Amarada Hess's Permian acreage for $239mm.   Seems like a good deal for  27mmboe of liquids and  27BCF  P1 reserves.

So although production has certainly been going up in the US, they have basically been buying that growth.  Cumulatively they have spent about $10b or so more in the USA then they have generated.   Neither the midcon/Anadarko Basin, nor the Permian have proved to be especially economic for the industry, generally speaking.  So what are the reasons for optimism?  I believe that E&Ps that have had the best and most consistent financial returns are those with a significant position in a major play.  They have an informational advantage over the small guys, have better access to services and take-away capacity.   Apache most certainly has this status in those two regions.  Secondly, well performance and drilling efficiency have been consistently improving for years now across all major plays, including in the Permian recently.  Finally, Apache had a disadvantage vis-à-vis certain other E&Ps in that they were not adept at the land game.  There is no doubt that the best financial performance was achieved by the companies that went in and bought land directly rather than buying packages or acquiring other companies.  Whiting or EOG leased land in the Bakken from land owners.  Apache bought their way into the Permian and midcontinent through huge, and relatively expensive acquisitions.  But going forward I think that Apache can now focus on operational improvements, rather than having to do more big acquisitions.  Even if their financial performance in the USA is just less of a drag than it had been that should be very positive for the company.

Summary:

Apache’s recent capital efficiency has been generally bad or mediocre in all regions except Egypt.  But modest improvements in their massive US operations seem imminent, and both Australia and Canada should eventually start to generate cash in 2016-2017 as LNG projects start to come online.  Argentina is sold, and won’t be a drag going forward.  The North Sea could go either way.  Overall this is an OK company with OK management, but with some possible tailwinds and a terrifically low valuation at about 4x EBITDA, +/- a bit depending on which number you are using.   And this is why I have a small position in them.  The main positive development that I’m watching for is if the drilling economics in the Permian Basin were to start to show significant improvement.  If this were to happen I would load up on Apache stock, because they could go on a big run.  The major negative risks are Egyptian sanctions/civil war/expropriations, further LNG delays in Australia/Canada, and (of course, as always) declines in the price of oil.