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Apache deals drive production growth

Acquisitions of Mariner Energy and Devon Energy's US Gulf of Mexico upstream assets significantly enhance Apache's production-growth prospects, writes NJ Watson

APACHE returned to profit in the first quarter, although the upstream independent's earnings still fell short of market expectations. However, two sizeable recent acquisitions should help prevent further disappointments.

In late April, Apache reported a first-quarter net profit of $0.705bn, or $2.08 a share, a turnaround from a loss of $1.76bn, or $5.25 a share, in the year-earlier period. The improvement was the result of near doubling in crude-oil prices and a record 300,557 barrels a day (b/d) of liquids production, an 8% rise over first-quarter 2009.

Higher oil and gas output – gas production rose by 5% to 1.7bn cubic feet a day, pushing total production 7% higher to 0.586m barrels of oil equivalent a day (boe/d) – raised revenues to $2.7bn, up by 68% from first-quarter 2009. During the first three months of the year, several important projects were in the ramp-up phase or reaching peak production. The Van Gogh and Pyrenees oil developments in Australia both achieved peak production ahead of last year's forecasts, while in North America, Apache increased drilling and production activity at the Horn River and Granite Wash gasfields.

Even so, Apache's adjusted earnings were $0.713bn, or $2.10 a share, which was 6% below Wall Street forecast of $2.24 a share, mainly because of higher-than-expected depletion rates, and depreciation, amortisation and operating costs.

Undeterred, chairman and chief executive Steven Farris claims: "Apache is off to a fast start in 2010, with strong operational and financial results and two strategic steps that will add to the company's growth."

Strategic steps

Those two strategic steps are the acquisitions of Mariner Energy and the offshore Gulf of Mexico (GOM) assets of Devon Energy, costing together about $5bn. Farris says they will provide near-term US Gulf production growth and an "extensive inventory" of opportunities in the deep-water GOM.

Fadel Gheit, an analyst at Oppenheimer, a brokerage, says the deals will "significantly enhance" Apache's growth outlook. He expects the company's shares to outperform the S&P 500 over the next 12-18 months.

In early May, US antitrust regulators approved the $2.7bn purchase of Mariner, which was announced almost three weeks previously in a rather haphazard way – an Apache employee accidentally sent an email to analysts and some media outlets informing them of the deal, before unsuccessfully trying to recall it.

The cash-and-stock deal converts Apache into a sizeable player in the deep-water GOM, where big oil and gas discoveries have been made over the past few years by BP, Chevron and others. Mariner has estimated proved reserves of 181m boe as well as unbooked resource potential of 2bn boe. "We really wanted to find an exploration-growth engine on the oil side in the US," Farris told the Houston Chronicle. "And the best place to find that is in the deep-water GOM."

The Mariner deal adds to Apache's already large positions in the shallow-water Gulf and the onshore Permian basin of West Texas and southeast New Mexico. Its position in those areas was also boosted by a slightly earlier deal to acquire all of Devon Energy's GOM-shelf assets – estimated proved and probable reserves of 83m boe across 158 blocks. "These assets fit well with the firm's existing infrastructure and offshore operating expertise in exploiting multiple layers of deposits," says Eric Chenoweth, an analyst at Morningstar, an equity research firm.

Devon's assets cost a pricey $1.05bn, which was about $250m more than some analysts had expected. But Apache's financial flexibility remains strong. About $2bn of the $5bn total outlay will come from issuing equity, while Apache will use a portion of its $2.1bn of cash reserves to help fund the deals. As such, year-end net debt/capital ratio should still be below 25% – one of the lowest in the industry.

Apache's production should ultimately be boosted by 63,000 boe/d from the Mariner deal and by 19,000 boe/d by the Devon transaction – a total of 82,000 boe/d, representing 14% of Apache's total first-quarter production. Assuming both deals close later this year, they should provide 25,000 boe/d towards Apache's previously announced 5-10% production-growth forecast for 2010.

And there is further good news for shareholders, who have suffered from a volatile stock price over the past six months, with the shares bouncing around between $93 and $110: while adding 14% to production volumes, the acquisitions have increased the share count by only 5%, which should boost per-share earnings, cash flow, production and reserves in the first full year, says Oppenheimer's Gheit. Even so, the shares suffered some collateral damage last month, as worries grew about the knock-on effect on other GOM operations of the disastrous BP oil spill (see p4).

LNG adventure

While these acquisitions and its plan to drill more than 60 wells in the Granite Wash play in the Texas Panhandle and in the Horn River basin of British Columbia (BC) will strengthen Apache's North America-centred production base, a third acquisition made in January, a controlling stake in the proposed liquefied natural gas (LNG) export terminal in Kitimat, BC, points to Apache's international ambitions (see p34).

Says Farris: "LNG is a big step forward for Apache; we can monetise very large gas resources at LNG prices, which are linked to crude oil prices, to complement our portfolio."

That portfolio is remarkably balanced: in the first quarter, the production mix was 51% liquids and 49% gas; and 53% non-North America and 47% North America. Financial flexibility, capital discipline and a strong focus on cost control are also competitive advantages.

Production from international operations averaged 310,000 boe/d in the first quarter, a 2% increase over the fourth quarter of 2009. The company said the higher volumes were the result of drilling successes in Egypt and the successful commissioning of Australian oil developments, such as Van Gogh.

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