Anadarko: Deeply Undervalued, Ready To Shoot Higher

| About: Anadarko Petroleum (APC)

In late May, Anadarko Petroleum (NYSE:APC) announced that rather than go to trial, it settled its suit with contractor and sometime partner Noble (NYSE:NBL). Noble brought the suit seeking $102 million in damages against Anadarko after Anadarko cancelled an offshore oil rig lease with Noble, due to the U.S. Gulf of Mexico drilling moratorium in the wake of BP's (NYSE:BP) Deepwater Horizon incident. Anadarko was prepared to argue that the moratorium was an act of God, which would release it from its obligations. The terms of the settlement are not yet public.

Anadarko's Alaskan operations may also be facing a minor hurdle after a fatal accident involving its subcontractor QC Logistics, which transported water and sand to Anadarko's drilling operations. Anadarko is suspending its contract with the company until inspections on all of QC Logistics' vehicles are completed. It also appears that the driver of the vehicle disregarded an Anadarko policy prohibiting trucks from travelling in the area where the driver was hauling at the time of the crash.

Anadarko Riding on Deepwater Success

Anadarko's involvement in the Deepwater Horizon incident is not preventing it from exploring deepwater prospects across the globe. Like competitor Apache (NYSE:APA), Anadarko is targeting a division of resources that places equal weight on oil and natural gas. Currently, dry natural gas accounts for just over half of Apache's annual sales volumes, compared to 61% just three years ago. Its deepwater activities fit this picture, with oil targets in the Gulf of Mexico and North Sea and natural gas targets off the eastern and western coasts of Africa.

Anadarko's success with its Windjammer natural gas discovery off the shores of East Africa is inviting a raft of competitors to the play, with Eni (NYSE:E), Statoil (NYSE:STO), and WHL Energy Limited, among others, participating in exploration efforts there. The pile-in is contributing to a severe rig shortage in the area, which drives up costs and lengthens time to production. This could mean a switch for Anadarko and others towards rig ownership, rather than production through contract, as more players compete for deepwater rigs worldwide.

Anadarko's next jump in deepwater production is expected to be from the Lucius field in 2014, accompanied by further exploration to identify "Lucius look alikes" in the area. Anadarko is operator of the Lucius unit with a 35% working interest. Other participants include Exxon Mobil (NYSE:XOM), Apache Deepwater LLC, an Apache subsidiary, and Eni. The field was discovered in 2009, and its reserves are estimated at more than 300 mboe. Strong production from this field would be a confirmation that Anadarko is on its way to the supermajors.

So far, the project is on track for production in 2014. The partners in the project made an excellent deal with the operators of the nearby Hadrian South field, Exxon Mobil, Petrobras Brasileiro (NYSE:PBR) and Eni. Through the deal, the Hadrian South operators will be able to use the Lucius partners' natural gas processing facility in exchange for a handling fee and the cost of facility upgrades necessary to handle the Hadrian South field's processing. This type of cost sharing arrangement is extremely beneficial for Anadarko given the costs of deepwater exploration and production.

Anadarko has yet to produce any similar targets to the Lucius in the Gulf. Its most recent exploration, in the Spartacus prospect, came up dry. However, Anadarko still plans to drill between six and eight exploration and appraisal wells in furtherance of its goal of finding other prospects like the Lucius, and given the size and quality of the numerous fields in the Gulf of Mexico I think there is a very good chance Anadarko will be among the next to make a world-class discovery here.

Looking to the Wattenburg for Onshore Liquids Production

Anadarko is depending on resources like its unconventional play on the Wattenburg to continue transitioning to a solid oil producer. The Wattenburg is producing 60% oil, 10% liquid natural gas, and 30% dry gas for Anadarko, for a total of 80 mboe per day net. With an 88% net revenue interest, Anadarko receives nearly the full benefit of its holdings.

Onshore production, even through unconventional drilling methods, remains significantly less expensive than deepwater activities. I think Anadarko will be looking at more U.S. onshore, liquids-rich plays in the near future, especially since in its presentation at the UBS Global Oil and Gas Conference earlier this month, Anadarko placed its holdings on the Marcellus Shale at the lowest end of development costs. At the high end it placed its offshore holdings in Brazil, noting that this asset could be held out for potential monetization. Since Brazil is one of the world's hotspots for oil activity, Anadarko would not have a problem divesting this asset, and would probably be able to command a premium.


Anadarko is targeting 3 bboe of reserves by year end 2014, which would be up from 2.5 bboe today. This looks like a low goal at first glance, but considering the number of acquisitions Anadarko made in the recent past it makes sense for the company to pull back from further acquisitions (aside from exceptional opportunities) and focus on development and production.

Though it is more exposed to natural gas than most supermajors, Anadarko has a well-diversified global resource base that holds promise in multiple plays. I also like Anadarko's ability to exploit deepwater, unconventional, and conventional drilling methods simultaneously as part of a cohesive growth plan. I believe the stock is significantly undervalued as it currently trades around $58. The stock is down 18% for the month, reflecting general investor pessimism over energy stocks as a class in the last few weeks, but represents an opportunity for the value-minded investor.

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