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Avinash Gandhi

APC AT A GLANCE

P/E ► 73.4 VERY HIGH EV/EBITDA ► 10.3 AVG ROA ► 2.3% AVG ROE ► 2.3% AVG Debt to Equity ► 1.50 AVG Current Ratio ► 2.10 HIGH Interest Coverage Ratio ► 2.00 AVG

 

 

 

 

 

 

Anadarko Petroleum is an oil and gas company that produces primarily in the U.S. and Algeria. Its product is a commodity good, meaning that it is only differentiated from competitors by price. Anadarko's success is determined by the demand for oil and natural gas, a demand that is highly unpredictable due to the combination of a rising demand for energy, the efficiency of fossil fuels, increasing oil and gas prices, and growing environmental concerns. While Anadarko is a competitive producer among similarly sized peers, due to its focus on new gas reserves from recent acquisitions, it does not have the earning potential of larger companies like Chevron.

Company Background

Anadarko produces crude oil and gas, including liquified natural gas (NGL). Its domestic focus is on natural gas, with its primary reserves in the Rocky Mountains and the Gulf of Mexico; internationally, Anadarko produces oil at its main extraction sites in the OPEC member, Algeria.

Oil and gas are used as energy sources. Oil fuels nearly every modern mode of transportation, and is used as an input to every industry, from agriculture to metallurgy. Natural gas is mostly used as a method of electricity generation; it is very efficient, and burns far more cleanly than its alternative, coal (both, however, contribute to the greenhouse effect). Natural gas is also used as a fertilizer, and liquified natural gas, a processed form of natural gas, is used in natural gas vehicles. The diverse uses of its products makes Anadarko a potential beneficiary from the success of nearly every industry.

Anadarko's spectacular end-of-year results, compared with its low 1st quarter results, can be attributed to complicated tax proceedings that allow the company to defer taxes until they must be paid during the 1st quarter.

Restructuring

In 2004, Anadarko sold 11% of its reserves in order to cut costs, free up capital, and boost production in its current sites. While the company previously had an exploration-based strategy, the current focus on existing production has helped improve the company's revenues. The 2006 acquisitions of Kerr-McGee and Western Gas Resources allowed Anadarko to expand operations without exploring for new reserves, though a company goal has now become the reduction of the debt incurred by the transaction. Anadarko's great hope from Kerr-McGee and Western Gas is to find and exploit their possible reserves; the company is hoping to combine expanded production from the two acquisitions with rising gas prices to raise profit margins and bring in more revenues. This goal could be pushed forward by Anadarko having a number of its rigs tied up on contract until 2012, allowing the company to focus on expanding elsewhere. Because of this, the firm's focus is shifting now to natural gas, a cleaner (albeit carbon-emitting) alternative to oil and coal.

Trends and Forces

Anadarko is heavily affected by the dynamics of the fossil fuel industry, especially environmental trends and the artificial oligopolies created by OPEC. Political turbulence and natural disasters also have the potential to greatly increase costs and decrease profit margins in the industry.

The Fossil Fuel Industry

Fossil fuels are hydrocarbons; they are called "fossil" fuels because they form from decaying plants and animals that are buried in the earth for millions of years. They are highly efficient sources of energy when burned, and have been the primary source of power, worldwide, since the Industrial Revolution. Forms of fossil fuel include oil, coal, and natural gas; Anadarko is in the business of extracting oil and coal, and so their overall success is determined by the amount of these fuels that are needed to power the human population. Fossil fuels are also commodity goods, meaning that their pricing is often downwardly pressured through competition, and is often cyclical. Because of this, profits may be volatile; though demand for energy is rising, a number of factors are contributing to the unpredictable demand for fossil fuels.

OPEC

The Organization of the Petroleum Exporting Countries (OPEC) plays a key role in promoting profits for Anadarko (and most of the oil industry). The countries limit firms' production, artificially creating shortages and raising prices. Anadarko produces extracts oil primarily in Algeria, a member of OPEC, and so benefits from OPEC's policies. Artificially high oil prices are key to Anadarko's profitability because oil by itself is a commodity good, and so its markets would be subject to volatile price cycles and harsh price competition. With artifically low production, prices remain volatile but also high, thus creating larger profit margins for all oil companies.

Economic Growth

Increasing worldwide economic growth has led to a rising worldwide demand for energy. While the most cost-efficient form of energy is coal, increasing environmental degradation from coal's use has led to the search for a new form of electricity generation. Natural gas has been touted as a cleaner alternative to coal, and though there are currently clean coal technologies in development, increasing demand for clean energy could benefit Anadarko greatly, especially because of its new gas focus. Furthermore, increasing economic growth is leading to a growing need for transportation. In the short run, the primary source of energy to fuel worldwide transportation is oil, making Anadarko's oil business a potential beneficiary. This could change in the long run, however, as factors like political instability and environmental concerns drive a shift away from fossil fuels.

Environmental Concerns

Fossil fuels, though highly cost-efficient forms of energy, are heavy polluters when burned. Increasing environmental concern over environmental degradation and global climate change is fueling a consumer-driven push away from dirty forms of energy toward cleaner forms like wind energy and solar power. These concerns are also causing political movements, which are leading to increased regulation in the fossil fuels market. Government regulations like emissions caps, renewable energy subsidies, and carbon trading schemes all facilitate transitions away from dirty, nonrenewable fuels. Natural gas is being touted by a number of sources (few of them environmental advocates) as "the" alternative to oil and coal. While natural gas does burn more cleanly than either oil or coal, and releases fewer greenhouse gases than either, natural gas is still a carbon-emitter. The current international focus on slowing carbon emissions is very likely to slow the market for both oil and natural gas, hurting Anadarko's business immensely.

Rising Oil and Gas Prices

Oil and gas prices have fluctuated heavily over the past few years, though the most recent trend is a rise in prices - over $100 a barrel after the 2008 New Year. Because both are nonrenewable forms of energy (they will eventually run out), slowing discoveries of new sources combined with increasing pricing has led to speculation that production is approaching peak oil quantities. This implies that prices will continue to rise, as will production costs, making oil less accessible to consumers and less profitable for producers. With the increasing cost of these traditionally cheap forms of energy, there is rising demand for cheaper, more cost-efficient, renewable energy. While Anadarko currently benefits from high prices keeping profit margins up, the limited nature of these commodities could mean that long-run profitability would be crimped by slowing revenue streams, as demand for energy shifts from fossil fuels to renewable sources.

Political Strife

Most of Anadarko's production occurs in the U.S., making it one of the most stable oil and gas companies in terms of production. Many of the OPEC countries have huge problems with political strife and terrorism, and because oil is the primary revenue source for these countries, oil companies often get mixed up in the frays; terrorist attacks on extraction sites and employees as well as the nationalization of oil sites have the potential to greatly raise oil companies' costs. Anadarko does produce oil and natural gas in Algeria, an OPEC country and heated political zone, but because this production amount is small in comparison with the company's production in the U.S., Anadarko does not risk as much as some of its competitors.

Natural Disaster

Because of the geological position of many of Anadarko's sites, the company risks production failures and rising costs from natural disasters. Hurricanes in the Gulf of Mexico and harsh weather conditions in the Rockies can damage equipment, hurt employees, and make transportation of the product very difficult. This would lead to higher costs and lower profits all around.

Competition

Anadarko's primary competition stems from energy companies that produce both oil and natural gas. Among these are Chevron, Cabot Oil & Gas, EnCana, Apache, Comstock Resources and Devon Energy.

Anadarko does most of its production in the U.S., which makes it far less vulnerable than a company like Chevron to political strife and terrorist attacks. There is also far less governmental pressure, and the threat of nationalization of Anadarko's properties is very low.

Oil and gas are commodity goods that are in high demand. Both are also costly to find and extract, but can be made cheaper through economies of scale, making high production key to increasing profits. In terms of natural gas production, Anadarko is second among similarly sized competitors. This makes it profitable, but in an industry with huge players like Chevron and ExxonMobil, Anadarko comparitively less competitive.

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