(Source: Anadarko Petroleum, February 2016)
Important Note: This article is not an investment recommendation and should not be relied upon when making investment decisions - investors should conduct their own comprehensive research. Please read the disclaimer at the end of this article.
The relatively low price received by Anadarko Petroleum (NYSE:APC) in its divestiture of the Marcellus Shale assets puts the spotlight on the challenging margin environment in the Marcellus North and may indicate the company's and strategic buyers' pessimistic view with regard to regional differentials in the Northeast, the Marcellus North in particular.
In the December 21 press release, Anadarko announced it has agreed to sell its "operated and non-operated upstream assets and operated midstream assets" in the Marcellus Shale for ~$1.24 billion. The midstream assets owned by Western Gas Partners (NYSE:WES), APC's sponsored master limited partnership, which represent the larger part of Anadarko-controlled midstream assets in the Marcellus, are not part of the sale.
The divestiture includes ~195,000 net acres and associated dry gas production of approximately 470 million cubic feet per day, as of the end of the third quarter of 2016. Given the significant, moderate-decline existing production, Anadarko appears to be receiving little value for the remaining development potential that the properties offer.
As one can see from a slide from Anadarko's older (November 2014) presentation, the company's most prolific acreage in Bradford and Sullivan Counties, Pennsylvania, is mostly non-operated. Still, the core portion of the acreage is meaningful in size and appears to offer significant development backlog in the event regional differentials in the Marcellus North area improve meaningfully.
(Source: Anadarko Petroleum, November 2014)
The buyer in the transaction is private equity-backed Alta Resources Development, LLC, an operating entity with a strong track record of shale property acquisitions and subsequent exits via sales.
What Is Driving The Unexpectedly Low Sale Price?
The non-operated nature of a large portion of the acreage is an important consideration in understanding the outcome of this transaction. It likely explains why the winning bid comes from a private equity-backed entity and not from another Marcellus operator.
It is worth noting that a large portion of the non-operated acreage - which also happens to be the most prolific portion of the package - falls within areas dominated by Chesapeake Energy (NYSE:CHK). Arguably, Chesapeake would be the most logical acquirer for the assets. However, the company's financial constraints and significant existing exposure to the Marcellus North likely handicapped its ability (and, possibly willingness) to participate. The map of Chesapeake's acreage is shown below:
(Source: Chesapeake Energy, October 2016)
Another major factor impacting the valuation is the outlook for Marcellus North price differentials. The slide from Anadarko's presentation at the top of this note suggests that a realized price in the $2.50/Mcf range would be required for new drilling to generate competitive returns on investment. Using current futures pricing, the average Henry Hub price for the five-year period beginning January 2018 is $2.91/Mcf. Even if one were to assume that basis differentials for volumes sold locally in the Marcellus North would contract to $0.50 per Mcf for the same period, only select, mostly non-operated areas within Anadarko's acreage would likely be able to compete for capital.
Finally, CHK's high-price midstream contracts, if they also apply to Anadarko's volumes operated by Chesapeake, could be a significant factor impacting the valuation. High midstream fees under long-term dedications could depress cash flows from both existing and future production.
Implications For Anadarko
The sale of the Marcellus assets by Anadarko is not unexpected. The Marcellus has received very little capital allocation in the company's budget over the last two years. In 2015, the company drilled just one operated well and participated in 18 non-operated wells in the Marcellus. No operated drilling activity occurred in 2016.
Anadarko has been tightening its U.S. onshore portfolio to concentrate resources on the core Delaware Basin and D-J Basin operations. The Marcellus was one of several assets that were expected to go on the auction block. In my expectation, additional asset sales are likely to follow in 2017, of which the likely sale of the company's massive Eagle Ford position is the most notable.
The divestiture of the Marcellus is a logical strategic step, given the mostly non-operated nature of the core portion of the acreage. However, I view the sale price as a disappointment.
While the proceeds from the Marcellus divestiture will help Anadarko to fund its drilling program acceleration in the U.S. onshore planned for 2017, the $1.24 billion in sale proceeds are unlikely to make a big difference in the context of the company's overall financial scale. On the other hand, the long-term optionality associated with this significant asset and large existing production stream is now gone, with no adequate compensation received, in my opinion. Raising equity might have been a more attractive alternative from a value preservation perspective.
That said, investors are likely to view the divestiture as a neutral development, as the resulting tightening of the company's operational focus will likely offset the effect of the uninspiring sale valuation.
The announcement is a negative data point with regard to asset valuations in the Marcellus North, particularly for acreage outside the "core of the core" area located mostly in Susquehanna and Bradford Counties. The most direct "read-across" is to Chesapeake's Marcellus North assets that in significant part overlap with Anadarko's assets being sold.
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