Why Apache Remains A Buy

| About: Apache Corporation (APA)

Summary

Apache has remained focused on improving its operating efficiency by using advanced completion techniques to keep production high and costs low, which will help it deliver strong earnings growth.

Apache will produce around 273,000 bpd from its North American onshore assets in 2016 with cash operating costs of around $10/barrel.

This means that Apache could generate around $4 billion in cash operating margins next year if the oil price forecast of $52/barrel holds true.

A recent report by Wood Mackenzie points out that shale oil drillers in the U.S. have managed to bring down their costs low enough to generate earnings even in a low oil pricing scenario. In fact, the report points out that the shale oil producers have brought down their costs by as much as 40% over the past couple of years, which is why they can attain break-even levels at oil prices ranging from as low as $35 a barrel.

Apache (NYSE:APA) is no different. The company's assets in North America and across the globe have tremendously low cash operating costs, which should allow it to continue performing strongly going forward as the oil pricing environment improves. Let's see how.

Focus on optimization and returns will drive Apache higher

Apache's consistent focus on optimizing its assets and generating higher returns even in a weak oil price environment will prove to be tailwinds for the company in the long run. For instance, Apache experienced sequential production growth of 2% in the Permian Basin during the first quarter of 2016 despite a significant decrease in the number of wells placed on production.

This improved production was a result of Apache's focus on improving the completion process by deploying longer laterals and artificial lift installations. As a result of such optimization moves, Apache had improved its production with 32 gross operated wells last quarter as compared to 57 drilled and completed wells in the fourth quarter of 2015.

As mentioned above, Apache's use of longer laterals was key to the company's reduced production costs and higher recoveries. This is not surprising as the use of longer lateral lengths helps oil drillers to increase production at a lower per feet cost. This is because the deployment of a longer lateral length enables the well driller to pump fracking liquids and water in a higher number of stages as against a shorter lateral.

As a result of an increase in the number of stages, the reservoir contact increases, the reserves are isolated more efficiently, and this leads to a higher release of oil and gas reserves. Thus, production increases while costs remain low as similar pumping equipment is used in both long and short fracs.

As a result, it is not surprising to see why Apache's best well drilled in the Delaware to date, namely the Seagull 103 HR, delivered an impressive average 30-day initial production rate of 2,799 Boe/d as a lateral of 4,600 feet was used. The company has now placed five gross operated wells on production in this area, primarily targeting the Bone Spring formations in the Pecos Bend area in the Delaware Basin. This is a good move as these wells carry higher production rate that too with a well cost of $3.5 million, down approximately 60% from 2014 levels.

How Apache's focus on production efficiency will drive margins

In my opinion, Apache's focus on enhancing its production efficiency will lead to margin growth in the long run. I'm saying this because Apache has managed to bring down its cash operating costs impressively by focusing on production efficiency. For instance, in the Permian basin, Apache has managed to bring down its cash operating costs to just $9 per barrel of oil equivalent.

In the preceding quarter, this was higher at $11 per barrel of oil equivalent. This means that on a sequential quarter basis, Apache's operating costs in the Permian have come down by more than 18% as the company has gone on to deploy longer laterals and enhance production at lower costs.

This means that as oil prices rise, Apache's returns from the Permian basin will grow impressively since the company has single-digit operating costs in this area. Moreover, for its other North American assets as well, Apache has managed to bring down its cash operating cost to just $10 per barrel. Now, this year, Apache believes that it will produce around 273,000 barrels per day from its North American onshore assets.

Assuming that the company manages to keep its costs constant at current levels of around $10 a barrel in North America, and oil prices rise to $52 per barrel WTI next year as forecasted by the EIA, Apache will be on track to deliver solid cash margins. If such cost and price assumptions turn out to be true, Apache's cash margin for each barrel will come in at $42, which when multiplied by the average production of 273,000 barrels per day for 2016 means that its margin per day will be around $11.4 million.

Thus, over the course of the full year of 2017, Apache's cash operating margins will be around $4 billion from just its North American assets.

Conclusion

Therefore, it is quite evident that Apache is now well-prepared to do well even in a weak oil pricing environment. However, as the price of oil is expected to improve going forward on the back of an increase in demand and lower supply, the company's earnings performance could improve further. So, in my opinion, it will be a smart idea to remain invested in Apache even though the stock has gained close to 20% this year in light of the points discussed above.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.