Apache's (APA) Kitimat project, in which it is partnering with EOG Resources (EOG) and Encana (ECA), seems to be hitting the skids as increased competition lowers estimates of demand and potential profits from the venture.
Royal Dutch Shell (RDS.A), backed by some of the largest consumers of LNG in Asia such as Korean Gas and PetroChina, is competing directly with Apache in Kitimat. Further south, Cheniere Energy (LNG) is fast tracking plans for LNG export from the Gulf Coast. Meanwhile, Pieridae Energy Canada recently announced plans for an LNG liquefaction and export center to be located in Goldboro, on the eastern coast of Canada, for export to Europe and India. Interestingly enough, Pieridae Energy Canada is led by Alfred Sorensen, who previously headed the firm Galveston LNG, the shares of which EOG purchased to acquire its stake in the Kitimat project, making it a partner with Apache.
All of these plans add up to big question marks for Apache's final investment decision on Kitimat. As recently as this summer, Apache indicated that the major sticking point for moving forward was signing enough long term supply contracts based on oil prices to support the project, but not only is the increased competition for contracts making this more difficult, but other project leaders' apparent willingness to work with shorter term contracts not indexed to oil is making Apache a less desirable partner. Moreover, other majors like Exxon Mobil (XOM) are indicating the possibility of entering the LNG export market from the North American continent, leading to hesitation on behalf of would-be LNG purchasers when better deals could be just over the horizon.
Apache blames Cheniere in particular for creating "unrealistic expectations" for LNG export, but I think Apache was attempting to force unrealistic expectations on the marketplace. If Apache managed to be the sole North American LNG exporter it could possibly expect to dictate its price, but with the LNG market worldwide heating up, there is no reason Apache should think that way.
Ahead of third quarter earnings, analysts are estimating Apache will turn in earnings per share of $2.25 on revenue of $4.1 billion, a drop from its third quarter 2011 earnings per share of $2.95 on revenue of $4.3 billion. Apache missed estimates for both of the last two quarters, so if this quarter brings another miss, few investors will be surprised, but neither will Apache's stock be rewarded. These lowered expectations are largely the result of the natural gas price environment, and that analysts even expect Apache to end this year flat from last year shows just how hard Apache is fighting to keep its ground.
Indeed, Apache warned earlier this month that shut ins from planned turnarounds and unplanned maintenance in the North Sea will hurt third quarter output, as will weather related disruptions in the Gulf of Mexico, putting Apache on track for production flat with the second quarter. This compares unfavorably with close peer Anadarko Petroleum (APC), which released third quarter earnings showing increased production in the third quarter and increased its higher margin liquids sales by 41,000 barrels per day during the period.
Looking to the Positive
With energy prices sliding, Apache hopes to make up for lost ground in the fourth quarter with record production. It hopes to meet this mark with its international operations, given that 31% of its second quarter production was domestic natural gas, which accounted for just 8% of its total revenue, compared to international liquids, which accounted for 27% of second quarter production but fully 49% of second quarter revenue.
Egypt's Western Desert, heavy with stacked pay opportunities, is a drilling focus for Apache outside of North America; Apache drilled 68 wells using 22 rigs in the second quarter, which led to 13 discoveries. With just 18% of its gross acreage in Egypt developed, Apache has room for growth here. However, Apache will lose its concession to sell up to 100 mmcf/d gross to the Egyptian General Petroleum Corporation without an oil price cap at the end of this year. Starting in 2013, all of Apache's Egyptian natural gas production will be sold on an industry pricing formula that limits it to maximum realizations of $2.65 per mmbtu.
Apache has stronger promise in its domestic mid-Continent plays. Its Central Region operations, into which it lumps the Anadarko and Whittenberg basins, are contributing to Apache's growth, with 23 rigs running for a 42% production increase between the second quarter of 2011 and the second quarter of 2012, though most of this production is weighted to natural gas. Moving forward, Apache expects to counter this with increased production from the liquids rich Granite Wash in particular.
Apache is trading around $83 per share, with a price to book of 1.1 and a forward price to earnings of 7.9. This built in discount reflects concerns over the firm's production and revenues, as well as its plans to overcome these deficits. Meanwhile, Shell is trading around $69 per share, with a price to book of 1.2 and a forward price to earnings of 11.0. Cheniere is trading around $16 per share, with a price to book of 10.9 and a negative forward price to earnings. Encana is trading around $23 per share, with a price to book of 3.0 and a forward price to earnings of 29.8. EOG is trading around $116 per share, with a more palatable price to book of 2.4 and a forward price to earnings of 18.5.
I think Apache's discount will most likely deepen by the end of this year, as investors are currently flocking towards newsmakers like EOG and Anadarko, largely avoiding steady movers like Apache. Even if its short term outlook doesn't look promising for growth, looking across the next few years, I believe Apache will catch up to the growth curve and provide returns for the long term.