Apache (APA) reported a weak second quarter thanks to disruptions in its production and lower natural gas and oil price realizations for the production it brought to market. Apache hopes to make up for lost ground in the third quarter, but for now investors are eyeing Apache as a potentially weak stock, which is leading to trades at a discount to its real value.
There were several positive indicators in Apache's second quarter despite its lower earnings. One major achievement from the company is the continuing reduction in fracking costs, driven by its commitment to explore new techniques and technologies such as what it calls "at the bit technology" that allows it to access real time data from within the hole. These innovations lead to fewer tool changes and can even result in fewer wells drilled to reach ultimate recovery from a reservoir.
Increasing Production, but NGLs Not Promising
Apache has 62 rigs drilling in the U.S., and as Chairman and CEO G. Steven Farris pointed out in its second quarter earnings call, not a single one of these wells is targeting natural gas. However, several of its previous drilling initiatives are just beginning to reach normal production, and of these many plays are producing more natural gas than oil. For example, Apache's Permian Basin assets in Oklahoma and the Texas Panhandle are contributing 55,200 boe per day to Apache's production numbers, but of this, just 30% is in liquids.
Apache is also choosing a poor time to pivot towards natural gas liquids. When dry natural gas prices started to weaken, many natural gas producers turned towards natural gas liquids as a cheaper alternative to bolster production than oil. Now, it appears that the sudden influx of liquid natural gas into the marketplace may lead to a similar crash in prices of this commodity; already analyst firm Tudor, Pickering, Holt & Co. is calling the price situation an "NGL bloodbath." Ethane propane NGL mix prices are down 58% from prices for the same mix in January. Nevertheless, Apache is in the beginning stages of a joint venture to send natural gas liquids to the Gulf Coast by rail that includes a commitment to build a new natural gas processing plant, which may prove an expensive decision in the short term if prices continue to fall.
Competitor Devon Energy (DVN) is already feeling the pinch, as its realized prices for natural gas liquids fell 26% in the second quarter from the same quarter a year ago, to $31.42 a barrel. This is prompting Devon to move more quickly on its transition to oil, as now neither its traditional natural gas nor liquid natural gas production will produce the revenues it needs to continue growing.
Chesapeake Energy (CHK) is also being battered by the price environment, but typically for Chesapeake, it is forging ahead without making the dramatic changes it needs. Chesapeake is forecasting that its natural gas production will only fall by 0.2 bcf per day in 2013 compared to this year, though it plans to raise its oil production by 80%, which should help make up for the losses its risking by continuing to produce natural gas at essentially previous volumes. Chesapeake also plans to raise its natural gas liquids production by 30%, again forging ahead into a market that is already showing signs of weakness.
Devon and Chesapeake, as well as Apache, could take a page from EOG Resources (EOG), which began producing the greater portion of its revenues from liquids than natural gas as far back as 2010. While it did not share in the leaps in growth that its peers did in 2009 and 2010 due to the resources it committed to this change, EOG saw its revenues jump 85% between 2010 and 2011 as these changes took effect, solidifying its position as pack leader on unconventional oil plays. EOG is continuing to focus on oil while casting its attention towards wholly owned and joint venture operated unconventional infrastructure facilities to support its drive towards lower costs. While it is producing natural gas liquids it is not doing so at the expense of its oil production, which continues to be its major focus.
Similarly, Occidental Petroleum (OXY) CEO Stephen Chazen indicated at the close of the first quarter that the company was prepared to reduce liquids- and gas-rich well drilling "if the current low NGL prices continue," which was before the summer slide brought prices even lower. Its worldwide natural gas liquids realizations in the second quarter averaged $42.06 per barrel, a 20% decrease from the first quarter of this year. However, while it is shifting away from natural gas liquids, Oxy is not yet releasing its plan for diverting those resources.
Apache is currently trading around $89, with a price to book of 1.2 and a forward price to earnings of 7.6. By comparison, Devon is currently trading around $59, with a price to book of 1.1 and a forward price to earnings of 8.7. Chesapeake is trading around $19 with a price to book of 0.9 and a forward price to earnings of 10.1. Oxy is trading around $89 with a price to book of 1.1 and a forward price to earnings of 10.1. EOG, the segment leader since its second quarter earnings release, is continuing to surge ahead, now trading around $111 with a price to book of 2.3 and a forward price to earnings of 17.2.
Although Apache's second quarter earnings were weak almost across the board, its underlying production and assets remain strong. With a debt to equity ratio of 0.3, Apache is inherently able to maneuver if prices remain weak and it needs to seek a capital infusion for a greater push towards oil. Its multinational natural gas projects will also help it recover, since although U.S. natural gas prices are flirting below the cost of production in some areas, internationally prices are stable, especially in the Asia Pacific. These concerns are leading Apache to trade at a discount, which makes it an excellent buy side opportunity.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.