Apache: Even Assigning Minimal Value To Suriname, The Stock Is Worth A Look
- Apache has a significant tilt towards international development, perhaps more so than many realize.
- Buyers today have to weigh declines in legacy areas (Egypt, North Sea) against the potential upside from Suriname.
- Apache is a mixed bag, but at current oil prices, nearly every producer looks solid.
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Apache Corporation (NASDAQ:APA), while at first glance it might seem to have a similar setup to other North American production companies, really has a rather unique outlook. The current international portfolio plus a large exploratory budget has production declining at a rate greater than that of nearly all peers. That all changes if / when Suriname begins to produce; a play not expected to throw off first oil until 2025. While results there have been exciting, it's tough to see a market that continues to underappreciate strong proved reserve depth getting overly optimistic on future Suriname cash flows. With so many wonderful opportunities in either North American or international markets, I struggle to have the bullishness I have here compared to other oil plays.
Apache Outlook, Domestic versus International
Apache has exploration and production ("E&P") operations in three key geographies: the United States, the North Sea, and Egypt. Additionally, it is actively exploring offshore areas in Suriname, where it has announced four positive discoveries thus far with its partner, Total (TOT). The international portfolio, while it only makes up a little more than one third of total production forecasts, actually generates closer to half of corporate revenue because of greater oil mix and better realized international pricing. I've found investors tend to think of Apache as a play on Permian shale with a little sprinkling of international; that view undersells the importance of international locales.
*Source: Apache Corporation, Q4 2020 Results Presentation, Slide 11
That international bias has also been a source of some problems, most prominently Egypt. Egypt has long been the cornerstone of Apache results. It has operated in the Western Desert there for nearly three decades and is one of the largest acreage holders in the region. Yet despite ample acreage concessions (5.2mm gross acreage) and a strong minority partner in Sinopec, its Egyptian operations have seen steady production declines that began in earnest late in 2018. This was supposed to be a short term issue, and management has alluded to returning Egypt to growth for many years now. Admittedly the coronavirus was a great reason to back off of that rebound but forecast, but even 2021 guidance with a five rig drilling program is only guided to "moderate" the rate of decline. Driving that are aggressive well decline rates that are not abnormal in the region. Stated estimates have been around 25% according to executives, however production rates fell nearly 10% from Q3 to Q4.
This is unlikely to reverse, as Apache came into 2020 running ten rigs and still saw recovery tail off quickly. While the 15% production decline in Egypt this past year gives a lower base to maintain production at, pretty clear that the firm likely needs seven to eight operating rigs to hold even Q4 2020 exit rates, requiring a $500mm annual capital spend budget versus the $350mm allocated to Egypt at present. Even then, the question is whether Apache will allocate that amount of dollars to Egypt. While it is not impacting the situation currently, it is important to remember that Egyptian operations are run under production sharing contracts ("PSCs"). Under those terms, Apache bears all the risks and costs of exploration and in return is entitled to receive a variable volume of oil and gas. This allocation is supposed to represent recovery of costs incurred and a share of production after cost recovery; the government pockets the rest. It is a unique approach, and this structure tends to do is protect the driller during the bottom of commodity bust cycles, something that Apache was highlighting as a benefit early in 2020:
*Source: Apache Corporation, April 2020 Marketing, Slide 13
Reality is, of course quite different now. At the time of Q1 2020 presentation above, Brent crude was in the $25.00 per barrel range. Today, Brent has moved past $70.00 per barrel. While the actual structure of these PSCs is non-public, suffice to say that it is getting to the point where Apache is going to see diminished returns from higher oil prices on Egyptian drilling. That reality is going to incentivize Apache to put its money to work in other places first, namely the Permian Basin. Quick well turnaround times and lighter upfront capital needs make unconventional shale a great lever to take advantage of immediate pricing.
Nonetheless, management made it clear to me and to other analysts in inquiries that even at current strip pricing, there is no appetite for them to move from two to three rigs operating in the Permian. Recall that Apache is already one of the few companies to actually move up capital expenditure guidance into 2021. Back in November of 2020, management was pegging the spend figure at less than $1,000mm, but alongside Q4 results that was upped to $1,100mm. Not a major move, but that bump in outlook is largely due to adding another rig in the Permian, primarily in the Austin Chalk in Eastern Texas. The market gave this a bit of a pass, but I think CEO John Christmann knows he is on a tight leash. Two rigs ought to be enough to sustain current North American production and that is a level that they are happy with. Instead, the focus continues to be to offtake an excess amount of free cash flow to pay down debt before thinking about returning to growth spending.
Production Declines Pre-Suriname
Consensus view is going to align with management commentary on where the business is headed, and what is clear from that is at least when it comes to its existing asset base, Apache is going to continue to spend less than it would take to sustain current output. Management is taking a very safe route here, electing to self-fund capital for Suriname (more on that below) and pay down debt at the same time. Higher oil prices are not going to be a large allure, and that means that analysts are expecting total production to fall to 345k boe/d by 2024, a decline of nearly 100k boe/d from 2019 levels. The rate of change is going to be strongest this year, but this represents nearly 7% average annual production declines through 2024 - one of the largest of any major public E&P.
Beyond 2024 is where things potentially get interesting. Apache has been exploring Suriname via Block 58, a leasehold that comprises 1.4mm gross acres with varying water depths. Suriname might not be a common country that crops up when discussing oil production, even for those that have followed the industry for some time. In fact, it is a region that has historically not been a big winner when it comes to oil discoveries. Fortunes have changed lately, and its neighbor Guyana had already been a major exploration area for international oil producers in recent years after significant discoveries; Apache is not alone in exploring the area, as Exxon Mobil (XOM), Royal Dutch Shell (RDS.A), and Total (TOT) all have nearby operations.
Looking for the next big thing, it makes logical sense that producers looked toward Guyana's neighbor for other potential opportunities. Part of the allure has been lower royalty expenses, as more established regions like Brazil or even Middle Eastern plays like Egypt demand higher kickbacks. After decades of poor results, better technology has made exploration activity here palatable.
*Source: Apache Corporation, April 2020 Marketing, Slide 21
Funding a new large scale development like this is difficult for non-majors, and it also embeds a lot of risks. Late in 2019, Apache entered into a joint venture with Total to explore and develop Block 58. It's a complex agreement, with variable profit share dependent on who funds initial development and appraisal. With Total set to fund 87.5% of the initial first $10,000mm in development spend as well as a $75mm earn-out to Apache on first oil, no surprise that initially Total is going to be reaping most of the benefit. What economic benefit Apache sees in 2025 is unclear, but it will likely see something. The joint venture has drilled four exploratory wells (Maka Central-1, Sapakara West-1, Kwaskwasi-1, Keskesi Eas-1), all of which confirmed oil. It will be moving to the northern side of the block (Bonboni) to drill an exploratory well there, but thus far there seem to be ample resources in the region. The target is to reach a final investment decision ("FID") with new partner Total by year end of this year, reaching first oil by 2025. There will soon be a second rig deployed into Suriname for exploration and appraisal work, but no guidance has been given yet or where that is heading.
Free Cash Flow, Takeaways
It is incredibly difficult to peg a value on Suriname, but what we can do is assign value based on what is currently in place. There, the setup remains solid for free cash flow. The 2021 capital program of $1,100mm is easily funded organically at current strip prices. Breakeven is $45.00 per barrel West Texas Intermediate / $3.00 per mmbtu of NYMEX natural gas, so if you use current strip prices, there is north of $1,000mm in free cash flow on the way. Priority on those cash flows will be debt reduction, with Apache working hard to bring its balance sheet back into line with peers. If this truly is the beginning of a commodity super cycle, funding will be easy enough, and expect investors to push for more clarity on restoration of a meaningful dividend or other such returns of cash to shareholders.
Downsides are present. There is still years of Suriname capital to fund even with Total as a joint venture partner, and it needs to be in a better position. Egypt PSC contracts limit the gearing the company has to higher oil prices despite limited hedges, a potential downside given how strip prices have run. But, if oil prices cooperate and remain at these levels, that remains a moot point.
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This article was written by
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I have a decade of experience in both the investment advisory and investment banking spaces, with stints in portfolio management, residential mortgage-backed securities, derivatives, and internal audit at various firms. Today, I am a full-time investor and "independent analyst for hire" here on Seeking Alpha.
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