Apache (APA) reported second quarter earnings of $0.86 per share, far below its 2011 second quarter earnings of $3.17 per share. The drastically lowered earnings reflected a harsh natural gas price environment as well as falling oil prices, despite record production of 774,000 boe per day. The drop in realized oil prices was steep for Apache. Its second quarter 2012 average was $97.66 per barrel, compared to $106.31 per barrel in the same period last year.
Apache's lower earnings were also the result of a write down of Apache's Canadian assets due to the price environment, similar to the write down that competitor Anadarko Petroleum (APC) was forced to take over its coal bed methane properties in Wyoming. However, Apache showed confidence that its lower earnings were temporary, pointing to its 67,000 location inventory in onshore U.S. plays alone.
Without these special items, Apache's second quarter earnings were $2.07 per share, which is still below analyst estimates of $2.53 per share. Unanticipated downtime in Canada and the Gulf of Mexico, as well as in other areas, caused Apache to lose 16,000 boe per day during the quarter, which contributed to the slide once one time items are removed.
Still On Track for Growth
Apache should meet most of its 2012 growth targets, which include a Permian Basin growth target of 13% for the year. Quarter over quarter, Apache increased production by 5% in the Permian. The Permian continues to be the source of most of Apache's U.S. oil production, contributing 58,391 barrels per day in the second quarter, compared to 41,773 barrels per day from the Gulf of Mexico and 11,985 barrels per day from its central U.S. operations, which include the Anadarko Basin, where Apache is drilling heavily.
Apache raised its number of rigs in the Anadarko Basin from seven at the beginning of the year to 24 at the end of the second quarter, still behind the 36 rigs it is running in the Permian but a play for strong growth all the same. By comparison, competitor Newfield (NFX), a major player on the Cana Woodford since 2010, is running five operated rigs and seeing seven day IP rates between 430 boe per day and 1,550 boe per day on this play.
Though it is remiss in not mentioning the Anadarko Basin in its last few operational updates, Apache competitor ConocoPhillips (COP), now the largest independent producer in North America after its spin off, is also making a consistent play on the Anadarko, which it counts as a key asset. It closed 2011 averaging 12 mboe per day from its Anadarko operations, 59 mmcfd of which was in natural gas and 3 mbd of which was in oil. Given the gas weight of the properties it is not a surprise that ConocoPhillips is quietly pulling back from the properties.
Marathon Oil (MRO), which experienced a decline in second quarter earnings year over year similar to Apache's, is taking a similar approach to ConocoPhillips'. It plans to reduce its rig count on the Anadarko Woodford due to the low price environment, down to two from six. Analysts are calling moves like this the beginning of a trend as 2013 promises to see reduced activity and capital expenditures, so this might be an example of foresight on Marathon's part. It could also give Apache an opportunity to drive Anadarko revenues higher based on lower lease prices with less competition.
Apache is looking toward its international holdings to help blunt the impact of oil and gas prices in the U.S., indicating that drilling will begin on Block L8 of the Mbawa prospect off the shores of Kenya in the very near future. Its partners in the venture, Tullow Oil and Pancontinental Oil and Gas, seem to disagree on the potential of the Mbawa prospect. Tullow estimates the well has a 15% chance of success, and Pancontinental is already estimating that the first well could hit 4.9 billion barrels of oil.
The cost of failure here is steep, as Woodside Petroleum found out in 2007. Woodside spent $100 million on its Kenya project only to find a dry hole, and decided to buy out its contract with the Kenyan government rather than continue drilling at a loss. The costs of the joint venture led by Apache are likely to be equally high, considering that Apache hired security from the Kenyan Navy to protect its operations from the risk of piracy, a severe problem in this area of the Indian Ocean.
Apache expects that fertilizer plants in Australia will be shut down for three weeks in the middle of the third quarter, which will have a negative impact on this third quarter natural gas sales volumes. This is particularly unfortunate given that Australia is among the areas where Apache realizes the highest prices for its natural gas production. Its average price per mcf in Australia is $4.41, higher than anywhere else save the North Sea, where its average price per mcf is $9.42.
Apache is currently trading around $88, with a price to book of 1.2 and a forward price to earnings of 7.2, very close to the value ratios of Newfield, which is trading around $32 with a price to book of 1.0 and a forward price to earnings of 7.9. Anadarko is trading around $69, with a price to book of 1.7 and a forward price to earnings of 15.1. Marathon is trading around $28 with a price to book of 1.1 and a forward price to earnings of 7.5, while ConocoPhillips is trading around $57 with a price to book of 1.5 and a forward price to earnings of 7.8.
While any of these four stocks represent a consistent value, Apache may be the best positioned to take on the challenges in the next year. Though oil and gas prices are showing small signs of improvement, it is unlikely that normal levels will return to the U.S. until 2014. With its strong international presence, particularly in the crucial Asia Pacific and North Sea regions, Apache can divert expenditures to development where revenues are still strong, generating further shareholder returns.