Anadarko Petroleum: Offshore Will Strengthen The Production Base

| About: Anadarko Petroleum (APC)
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Morgan Stanley reiterated the positive outlook of the company and set the price target at $110, reflecting an upside potential of 34%.

The capital budget of 2014 is strategically allocated to increase the production mix allocation to higher-yielding hydrocarbons, such as focusing more on liquids.

The continued success of the Wattenberg program has led the company to drill more than 360 wells by operating 13 rigs in 2014.

The Lucius development project and the Heidelberg project in the Gulf of Mexico are also expected to contribute to the total production by the end of 2014 and 2015, respectively.

Anadarko is set to deliver production growth, but the Tronox case will remain a headwind to the stock price till the final verdict.

Anadarko Petroleum (NYSE:APC) recently announced its capital spending program for 2014. The company said that it will increase its 2014 capital spending budget to $8.1-$8.5 billion, reflecting an increase of $0.8 billion from $7.7 billion in 2013. The company has allocated more than 80% of the total budget towards oil and liquid-rich opportunities aimed at increasing 50000 barrels per day in liquid volume. The breakup of the capital budget can be seen in the figure below.

Source: Company's Press Release

The capital budget is set to achieve sales volume growth of 6%-7% by achieving a production growth of 40,000 barrels per day from 2013 same-store sales. The chart below shows the horizontal growth in the sales volume of the company.

Source: Investor Presentation

Wattenberg Program to Lead the Company's Future Growth

The Wattenberg Horizontal program in Colorado is the largest growth driver of Anadarko. The play is generating returns in excess of 100%, and is the highest in the company's onshore portfolio. Going forward, the company is determined to accelerate and maintain these returns. During October 2013, Anadarko and Noble Energy (NYSE:NBL) exchanged 50000 net acres in different parts of the area, giving Anadarko a more consolidated acreage position. The consolidated acreage position will allow the company to operate with lower costs and improve its operating efficiency.

During 2013, the company's Wattenberg production increased to 56000 boe per day, up by almost 34000 from 2012. The increase was primarily driven by the improved takeaway capacity provided by the Plain Rail terminal in November. However, the takeaway capacity will further increase this year. The company continues to grow its cryogenic processing capacity by adding Lancaster Train 1 that is expected to be online in the first quarter of 2014. Similarly, Train 2 is scheduled to be online in 2015. Both of these trains will each have a processing capacity of 300 million cubic feet per day (MMcf/d). In 2014, the company expects to operate approximately 13 rigs by drilling more than 360 wells in the Wattenberg field.

Offshore will Strengthen the Production Base

In addition to the onshore business, the company is also considering offshore sources, such as the Gulf of Mexico, to strengthen the production base. It plans to achieve 80000 boe from the Lucius development within the second half of 2014. Similarly, the Heidelberg development has been on the right track and is expected to deliver the oil production in 2016.

Investment Thesis

Given the prime location of its assets, the production target of a CAGR of 5%-7% until 2020 seems to be achievable. It is of worth mentioning here that the company is focusing on changing the production mix to become more favorable, such as increasing the liquid composition from 44% in 2013 to more than 60% by the end of 2020.

Source: Investor Presentation

From an investment perspective, the increasing production alone does not make a very compelling case for the company, and it should be viewed in relation to the reserve replacement. Over the last five years, the company has shown an increase of 21.2% in its proved reserves, and this is a favorable signal. As of 2013, the company had approximately 2.79 billion barrels equivalent of proved reserves, making it one of the largest independent E&P companies. Going forward, the company expects to achieve the reserve replacement target of 150% in the long term.

But the long-term scenario is not as simple, as it seems to be as the company is facing the Tronox case that includes the unfavorable verdict of which can be very unhealthy and will adversely affect the stock valuation.

Stock Price Catalyst

The proceedings of the Tronox case remain a headwind to the company's stock valuation. Before the company bought Kerr McGee, it spun off from Tronox and kept the legal liabilities from its business. Now, Tronox filed for bankruptcy, and as a consequence, Anadarko might have to pay for the damages. The final settlement is expected to be somewhere between $5 billion to $14.5 billion.

Anadarko has already booked $850 million for Tronox-related losses in its fourth quarter, but it may not be enough. Currently, it is highly unlikely that Anadarko will have to pay the $14.5 billion. However, if the amount is greater than what the company has already set aside, we can expect the company to deal with years of court battles.

Concluding Remarks

Anadarko is moving ahead with a number of low-risk projects at Wattenberg, Wolfcamp and the international and deep-water projects in the Gulf of Mexico. These projects are expected to create a 6%-7% sales volume growth in 2014. However, uncertainty regarding the Tronox case continues to put pressure on the stock valuation. The worst-case will be a long court battle; however, as far as the operations are concerned, the company's fundamentals remain intact. Therefore, I recommend buying the stock.

Disclosure: I 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.