Anadarko Petroleum 10-K 2008
Documents found in this filing:
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Year Ended December 31, 2007
Commission File No. 1-8968
ANADARKO PETROLEUM CORPORATION
1201 Lake Robbins Drive, The Woodlands, Texas 77380-1046
Securities registered pursuant to Section 12(b) of the Act:
Common Stock, par value $0.10 per share
Preferred Stock Purchase Rights
The above Securities are listed on the New York Stock Exchange.
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes x No ¨.
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No x.
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨.
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨.
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. Large accelerated filer x Accelerated filer ¨ Non-accelerated filer ¨ Smaller reporting company ¨.
Indicate by check mark whether the registrant is a shell company. Yes ¨ No x.
The aggregate market value of the Companys common stock held by non-affiliates of the registrant on June 29, 2007 was $24.1 billion based on the closing price as reported on the New York Stock Exchange.
The number of shares outstanding of the Companys common stock as of January 31, 2008 is shown below:
TABLE OF CONTENTS
Anadarko Petroleum Corporation is among the largest independent oil and gas exploration and production companies in the world, with 2.43 billion barrels of oil equivalent (BOE) of proved reserves as of December 31, 2007. The Companys major areas of operation are located onshore in the United States, the deepwater of the Gulf of Mexico and Algeria. Anadarko also has production in China and a development project in Brazil and is executing strategic exploration programs in several other countries. The Company actively markets natural gas, oil and natural gas liquids (NGLs) and owns and operates gas gathering and processing systems. In addition, the Company has hard minerals properties that contribute operating income through non-operated joint ventures and royalty arrangements in several coal, trona (natural soda ash) and industrial mineral mines located on lands within and adjacent to its Land Grant holdings. The Land Grant is an 8 million acre strip running through portions of Colorado, Wyoming and Utah where the Company owns most of its fee mineral rights. Anadarko is committed to minimizing the environmental impact of exploration and production activities in its worldwide operations through programs such as carbon dioxide (CO2) sequestration and the reduction of surface area used for production facilities. Unless the context otherwise requires, the terms Anadarko or Company refer to Anadarko Petroleum Corporation and its consolidated subsidiaries. The Companys corporate headquarters are located at 1201 Lake Robbins Drive, The Woodlands, Texas 77380, where the telephone number is (832) 636-1000.
On August 10, 2006, Anadarko completed the acquisition of Kerr-McGee Corporation (Kerr-McGee) in an all-cash transaction totaling $16.5 billion plus the assumption of approximately $2.6 billion in debt. On August 23, 2006, Anadarko completed the acquisition of Western Gas Resources, Inc. (Western) in an all-cash transaction totaling $4.8 billion plus the assumption of $625 million in debt. Anadarko financed $22.5 billion for the acquisitions under a 364-day committed acquisition facility. As part of an asset realignment associated with the acquisitions, the Company sold its wholly-owned Canadian oil and gas subsidiary, Anadarko Canada Corporation, in November 2006 for approximately $4 billion. Anadarko also divested, in 2007 and 2006, certain properties onshore in the United States, in the Gulf of Mexico and Qatar for total proceeds of approximately $13 billion before income taxes. The proceeds from all of these transactions were used to reduce indebtedness. Through December 31, 2007, the Company had reduced the initial amount financed under the acquisition facility from $22.5 billion to approximately $1 billion, using divestiture proceeds, long-term refinancing and cash flow from operations. For additional information, see Acquisitions and Divestitures and Outlook under Item 7 of this Form 10-K.
During 2007, Anadarko changed its method of accounting for its oil and gas exploration and development activities from full cost to the successful efforts method. In accordance with Statement of Financial Accounting Standards (SFAS) No. 154, Accounting Changes and Error Corrections, financial information for prior periods has been revised to reflect retrospective application of the successful efforts method, as prescribed by SFAS No. 19, Financial Accounting and Reporting by Oil and Gas Producing Companies. Additionally, unless noted otherwise, the following information relates to Anadarkos continuing operations and excludes the discontinued Canadian operations. For additional information, see Note 1Summary of Significant Accounting Policies of the Notes to Consolidated Financial Statements under Item 8 of this Form 10-K.
Available Information The Company files Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, registration statements and other items with the Securities and Exchange Commission (SEC). Anadarko provides access free of charge to all of these SEC filings, as soon as reasonably practicable after filing or furnishing, on its internet site located at www.anadarko.com. The Company will also make available to any stockholder, without charge, copies of its Annual Report on Form 10-K as filed with the SEC. For copies of this, or any other filing, please contact: Anadarko Petroleum Corporation, Investor Relations Department, P.O. Box 1330, Houston, Texas 77251-1330 or call (832) 636-1216.
In addition, the public may read and copy any materials Anadarko files with the SEC at the SECs Public Reference Room at 100 F Street, N.E., Room 1580, Washington, DC 20549. The public may obtain information
on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an internet site (www.sec.gov) that contains reports, proxy and information statements and other information regarding issuers, like Anadarko, that file electronically with the SEC.
As of December 31, 2007, Anadarko had proved reserves of 8.5 trillion cubic feet (Tcf) of natural gas and 1.0 billion barrels of crude oil, condensate and NGLs. Combined, these proved reserves are equivalent to 2.43 billion barrels of oil or 14.6 Tcf of gas. During 2007, sales of proved reserves in place associated with the Companys asset realignment program totaled 620 million barrels of oil equivalent (MMBOE). Excluding the effect of divestitures, the Company added approximately 252 MMBOE of proved reserves in 2007. Reserve adds were primarily driven by successful drilling in coalbed methane (CBM) and conventional plays and positive revisions associated with successful infill drilling onshore in the United States, as well as the initial recognition of proved reserves for the Peregrino development offshore in Brazil. As of December 31, 2007, Anadarko had proved developed reserves of 6.3 Tcf of natural gas and 574 million barrels (MMBbls) of crude oil, condensate and NGLs. Proved developed reserves comprise 67% of total proved reserves.
Anadarkos estimates of proved reserves and associated future net cash flows as of December 31, 2007 were made solely by the Companys engineers and are the responsibility of management. The methods and procedures used in preparing the Companys estimates of proved reserves, as of December 31, 2007, were reviewed by Netherland, Sewell & Associates, Inc. (NSAI). It should be understood that NSAIs review of the Companys procedures and methods relating to Anadarkos estimates of proved reserves does not constitute a complete review, study or audit of the estimated proved reserves. Through participation in the procedures and methods review of Anadarko properties, NSAI was able to: (1) observe, in some detail, the methods and procedures, and the degree to which the Companys engineers adhere to the definitions and guidelines of the SEC in developing the reserve estimates; (2) provide opinions to Anadarkos reserves group and reserves estimators regarding questions and issues raised during the meetings; (3) provide Anadarkos reserves group and reserves estimators with industry information related to reserves estimating issues and practices. Anadarko incorporated NSAIs suggestions for changes in methods and procedures into its reserve estimation process where the Company deemed appropriate. NSAIs opinions resulting from their participation in the review meetings should not be construed as NSAI expressing a view on the overall reasonableness of the Companys reserve estimates or procedures and methods. Managements intent in retaining NSAI to review its methods and procedures is to provide for objective third-party input on these methods and procedures and gather industry information applicable to its reserve estimation and reporting process.
The Companys estimates of proved reserves, proved developed reserves and proved undeveloped reserves at December 31, 2007, 2006 and 2005 and changes in proved reserves during the last three years are contained in the Supplemental Information on Oil and Gas Exploration and Production ActivitiesUnaudited (Supplemental Information) in the Consolidated Financial Statements under Item 8 of this Form 10-K. Additional information with respect to the Companys methods and procedures employed in the reserve estimation process, are also found in the Supplemental Information. The Company files annual estimates of certain proved oil and gas reserves with the U.S. Department of Energy (DOE), which are within 5% of the amounts included in the above estimates.
Also contained in the Supplemental Information in the Consolidated Financial Statements are the Companys estimates of future net cash flows and discounted future net cash flows from proved reserves. See Operating Results and Critical Accounting Policies and Estimates under Item 7 of this Form 10-K for additional information on the Companys proved reserves.
Sales Volumes and Prices
The following table shows the Companys annual sales volumes from continuing operations. Sales volumes for 2007 include approximately 15 MMBOE associated with properties that were divested during 2007. Volumes for natural gas are in billion cubic feet (Bcf) at a pressure base of 14.73 pounds per square inch. For the computation of MMBOE, six thousand cubic feet (Mcf) of gas is the energy equivalent of one barrel of oil, condensate or NGLs.
The following table shows the Companys annual average sales prices and average production costs from continuing operations. The impact on average sales prices from derivative instruments the Company utilizes to manage price risk related to the Companys sales volumes is shown separately in the table. Natural gas sales and oil and condensate sales include net unrealized gains (losses) related to these derivatives of $(395) million and $(653) million for 2007 and $579 million and $258 million for 2006, respectively. Unrealized gains (losses) related to derivatives were not material in 2005. Production costs are costs incurred to operate and maintain the Companys wells and related equipment and include cost of labor, well service and repair, location maintenance, power and fuel, transportation, cost of product, property taxes, production and severance taxes and production related general and administrative costs. Certain amounts for prior years have been reclassified to conform to the current presentation. Additional information on volumes, prices, production costs and markets is contained in Financial Results and Marketing Strategies under Item 7 of this Form 10-K. Additional detail of production costs is contained in the Supplemental Information under Item 8 of this Form 10-K. Information on major customers is contained in Note 16Major Customers of the Notes to Consolidated Financial Statements under Item 8 of this Form 10-K.
Sales Prices and Production Costs
Properties and ActivitiesUnited States
Overview Anadarkos active areas in the United States include the Lower 48 states, Alaska and the deepwater Gulf of Mexico. Reserves in the United States comprised 85% of Anadarkos total proved reserves at year-end 2007. During 2007, the Companys drilling efforts in the United States resulted in 1,760 gas wells, 16 oil wells and 18 dry holes. The accompanying maps illustrate the locations of Anadarkos domestic onshore and offshore oil and gas operations.
The following table presents selected 2007 United States operating data by area.
Powder River Basin
Pinedale & Jonah
Greater Natural Buttes
Fee Mineral (Net) 8,686,001 7,978
GAS FIELD (CONTAINS OPERATED WELLS)
OIL FIELD (CONTAINS OPERATED WELLS)
Colville River Unit
Note: Alaska not to scale
ACREAGE LOWER 48 ALASKA
UNDEVELOPED LEASEHOLD (Net) 3,849,760 1,346,152
DEVELOPED LEASEHOLD (Net) 2,025,430 7,693
FEE MINERAL (Net) 8,686,001 7,978
N SCALE 0 100MI. 200MI.
OnshoreLower 48 States At the end of 2007, about 71% of the Companys proved reserves were located onshore in the Lower 48 states. The Company has allocated approximately 50% of the 2008 capital budget to the Lower 48 states. Of this amount, approximately 60% is allocated to the Rockies and approximately 40% is allocated to the Southern Region.
Rockies During 2007, part of Anadarkos focus was on the integration of the properties it acquired in 2006 through the acquisitions of Kerr-McGee and Western. The acquired properties, which increased Anadarkos tight gas and CBM holdings in the Rockies, included tight gas plays in the Greater Natural Buttes, Wattenberg and the Pinedale and Jonah fields. Prior to the acquisitions, the Companys activity in the region was primarily associated with developing tight gas in the Wamsutter area, conventional reservoirs, CBM and enhanced oil recovery (EOR) projects.
In the Greater Natural Buttes area of northeast Utah, the Company continues to be primarily focused on development of the Wasatch and Mesa Verde formations through infill drilling operations and the deepening of existing producing wells. Anadarko operates approximately 1,300 wells in the Greater Natural Buttes field area and has an interest in over 675 non-operated wells. In 2008, Anadarko plans to drill approximately 195 wells, continue its down spacing pilot program and target deeper pool formations.
The Wattenberg natural gas field is located in the Denver Julesburg basin in northeast Colorado. The acquisition of Kerr-McGee added an operated component to the Companys already significant royalty position in this basin. Development activities in this area focus primarily on improved recovery through infill drilling, re-completions and re-fracture stimulations of older wells. In 2008, Anadarko expects to engage in development drilling, re-completion and re-fracturing stimulations of over 600 wells.
Anadarko also was active in the Wamsutter and Moxa Arch fields in 2007. Both fields are located on the Land Grant in southern Wyoming. The Land Grant provides the Company with the added economic benefit of royalty revenues on operated wells. It also allows Anadarko to benefit from the success of outside operators as they drill on Anadarkos net revenue fee acreage. In addition, the Land Grant provides the Company with a large captured area on which to explore. In 2008, Anadarko intends to participate in over 150 wells in this area.
The Companys Pinedale and Jonah fields, located in the Green River basin of southwest Wyoming, were acquired as part of the Western acquisition. The gas produced at Pinedale and Jonah is transported through Company-owned gathering systems that deliver gas to an Anadarko processing facility, located on the Land Grant. In 2008, Anadarko plans to participate in over 200 wells in this area.
During 2007, the Companys phased development projects at its EOR operations at Salt Creek, Monell and Sussex, located in Wyoming, continued to demonstrate year-over-year increases in production due to CO2 injection. In 2008, Anadarko plans to continue to develop and monitor these activities.
Other areas in the Rockies include CBM and conventional type plays in various areas that have a high number of shallow low-cost wells. The Companys CBM operations are located in Wyomings Powder River basin and Atlantic Rim field, as well as the Helper and Clawson fields in Utah. The Companys acreage position in the Powder River basin was increased with the acquisition of Western in 2006.
Southern Region Anadarkos properties in the Southern Region are located primarily in Texas with a focus on natural gas plays.
Production and development activities at the Companys properties in the east Texas area concentrated in the Bossier and Carthage areas. In 2008, Anadarko plans to continue its Cotton Valley infill and pilot horizontal drilling programs in the Carthage area. Anadarkos east Texas Austin Chalk activity continues to focus on horizontal drilling in Tyler and Jasper counties. Much of the 2007 activity and 2008 plans involve extending the field boundaries and drilling infill development wells to optimize well spacing.
Operations in west Texas are concentrated on increasing production and reserves in the tight gas play of the Haley field. During 2007, the Company entered into a joint venture on a portion of the Haley field to reduce risk and increase acreage in the basin. In 2008, the joint venture expects to drill 44 wells in the Haley field. The Company also continues its development activities in the Ozona field where it anticipates drilling approximately 50 wells in 2008.
Other areas in the Southern Region include properties in South Texas and the Hugoton field. In South Texas, the Company had an active drilling program in Starr and Hidalgo counties during 2007. Drilling and completion activities are expected to continue in 2008. The Hugoton field in southern Kansas continues to be a long-life, slow-decline asset for Anadarko with over 1,200 producing gas wells.
Alaska Anadarkos activity in Alaska is concentrated primarily on the North Slope. Approximately 2% of the Companys proved reserves at year-end 2007 were in Alaska. In 2008, the Company expects to participate in four exploration wells in Alaska.
During 2007, development activity at the Colville River Unit (22% WI) focused on continued drilling in the Alpine, Nanuq and Fiord fields. Development of the Qannik field was sanctioned in 2007 with first production expected in late 2008. Of the four exploration wells, the Company anticipates drilling two natural gas prospects in the Foothills area in 2008.
Gulf of Mexico At year-end 2007, about 12% of the Companys proved reserves were located offshore in the deepwater Gulf of Mexico where Anadarko owns an average 63% working interest in 561 blocks and has access to an additional 22 blocks through participation agreements. Anadarko has allocated approximately 25% of the capital budget to the deepwater Gulf of Mexico for 2008.
Anadarko significantly increased its holdings in the deepwater Gulf of Mexico through the acquisition of Kerr-McGee. Notable properties acquired in this area include interests in the Nansen, Boomvang, Gunnison, Red Hawk and Constitution/Ticonderoga fields as well as several additional discoveries in the eastern Gulf of Mexico. The Company had one exploration discovery well in 2007 in the deepwater Gulf of Mexico, holds interests in 25 producing fields and is in the process of developing 4 additional fields.
Independence Hub The Independence Hub, located in approximately 8,000 feet of water, began production in July 2007. Anadarko operates the facility, which is owned by third parties. The facility, capable of processing 1 Bcf of gas per day, serves several ultra-deepwater natural gas fields, including eight field discoveries operated by Anadarko. Anadarkos working interests in these fields range from 20% to 100%. Initial production is from 15 wells, of which Anadarko has an interest in 14. In 2008, the Company plans to drill one development well in the area.
Marco Polo/K2 complex Anadarko operates, and a third party owns, the platform and production facilities for the Marco Polo deepwater development project. Six K2 subsea wells (42% WI) are tied back to the Marco Polo platform, where four Marco Polo field wells (100% WI) are also producing. In early 2007, Anadarko reduced its working interest in K2 through the sale of a 23% WI. During 2008, the Company plans to drill three wells at K2 and bring on three new Marco Polo completions.
Nansen field (50% WI) The Nansen field began production in 2002 and was developed with the worlds first truss spar in 3,700 feet of water. During 2006, the Company completed a multi-well satellite drilling program in the northwest Nansen field area with four discoveries, and development of a tie-back to the Nansen spar commenced. The Company expects to begin production from this area by early 2008. Also in 2008, the Company expects to drill two new wells and re-complete two additional wells in the Nansen area.
Boomvang field, East Breaks Blocks 641, 642, 643, 686 and 688 (30% WI), Block 598 (100% WI), and Block 599 (33% WI) The Boomvang field began production in 2002 and was developed with a truss spar in 3,450 feet of water. During 2007, the Company initiated production from three successful exploration satellites that were tied back to the Boomvang spar. In 2008, the Company plans to drill one well and re-complete three additional wells.
Gunnison field (50% WI) The Gunnison field has been producing since 2003 and incorporates a truss spar in 3,100 feet of water. During 2006, the Dawson Deep discovery began production as a subsea tie-back to the Gunnison spar. The Company plans to drill a development well in 2008.
GULF OF MEXICO FIELDS
K2 & K2N
N 0 60 MILES
UNDEVELOPED (Net) 1,994,661
DEVELOPED (Net) 132,351
PRODUCING BLOCKS 53
EXPLORATORY BLOCKS 508
Red Hawk field (50% WI) The Red Hawk field, located in approximately 5,300 feet of water, began production in 2004 utilizing the worlds first cell spar designed for developing smaller reservoirs in deepwater basins. During 2007, the Company completed installation of compression equipment at the spar which is expected to extend the life of the field. During 2008, the Company expects to re-complete one well.
Constitution/Ticonderoga fields The Constitution field (100% WI) began production in 2006 utilizing a truss spar located in approximately 5,000 feet of water. The Ticonderoga field (50% WI) also began production in 2006 as a subsea tie-back to the Constitution spar. During 2007, the initial phase of development was completed for the Constitution field bringing the producing well count to six. Additional drilling and completion at the Ticonderoga field is expected to result in three producing wells in 2008. The Company is evaluating the Constitution spar as a potential hub for the accelerated development of several nearby discoveries.
Other During 2008, the Company is expecting first production from the Blind Faith field (25% WI). Anadarko also has participation agreements to explore deepwater blocks in the central and western Gulf of Mexico.
Exploration Anadarkos exploration program in the Gulf of Mexico is currently focused on the extensive middle-to-lower Miocene play within the central Gulf of Mexico and the developing lower Tertiary play near the 2006 Kaskida discovery in the western Gulf of Mexico. During 2007, the Company announced one exploration discovery, West Tonga at Green Canyon Block 726 (37.5% WI). Anadarko also participated in one well still drilling at year-end and three unsuccessful wells. The Company expects to participate in approximately six to eight exploration wells and three delineation wells in the area in 2008.
Properties and ActivitiesAlgeria
Overview Anadarko is engaged in exploration, development and production activities in Algerias Sahara Desert. At the end of 2007, about 11% of the Companys proved reserves were located in Algeria where a total of eight fields discovered by the Company were on production. In 2007, net sales volumes from the Companys properties in Algeria represented 11% of the Companys total sales volumes. During 2007, Anadarko participated in six development wells with a 100% success rate. During 2008, the Company expects to drill about 22 development wells and one exploration well in Algeria.
Production and Development On Block 404, production from the HBNS field averaged 125 MBbls/d of oil (gross) and production from five of the satellite fields averaged 35 MBbls/d of oil (gross) in 2007. Production from the HBN field, which extends from Block 404 into Block 403 and is unitized with other companies, averaged 72 MBbls/d of oil (gross) in 2007. Anadarko is also actively involved in the unitized Ourhoud field, which is located in the southern portion of Block 404 and extends into Block 406a and Block 405. Production from the Ourhoud field averaged 238 MBbls/d of oil (gross) in 2007. Anadarko has an interest in several fields farther south on Block 208. Development of the Block 208 fields, including contract tendering for the new production facility, is progressing. Initial production from Block 208 is targeted for late 2011.
Exploration During 2007, Anadarko had a satellite discovery at the ZENN-1 and one unsuccessful exploration well. One well was drilled to further appraise the BBKS discovery. During 2008, the Company expects to delineate the ZENN-1 discovery and participate in drilling one exploration well.
Contracts and Partners Anadarkos interest in the Production Sharing Agreement (PSC) for Blocks 404 and 208 is 50% before participation at the exploitation stage by Sonatrach, the national oil and gas company of Algeria. The Company has two partners, each with a 25% interest, also prior to participation by Sonatrach. Under the terms of the PSC, oil reserves that are discovered, developed and produced are shared by Sonatrach, Anadarko and its two partners. Sonatrach is responsible for 51% of the development and production costs. Anadarko and its partners also have an exploration program under way on Blocks 404 and 208 and have an exploration license, under a separate PSC, for Block 403c/e (67% interest). Anadarko and its joint-venture partners fund Sonatrachs share of exploration costs and are entitled to recover these exploration costs from production in the development phase.
Anadarkos operations in Algeria have been governed by the PSC since October 1989. In March 2006, Anadarko received from Sonatrach a letter purporting to give notice under the PSC that enactment of a law in 2005 (2005 Law) relating to hydrocarbons triggered Sonatrachs right under the PSC to renegotiate the PSC in order to re-establish the equilibrium of Anadarkos and Sonatrachs interests. Anadarko and Sonatrach reached an impasse over whether Sonatrach has a right to renegotiate the PSC based on the 2005 Law and entered into a formal non-binding conciliation process under the terms of the PSC in an attempt to resolve this dispute. The conciliation on the 2005 Law dispute was concluded in 2007, without a definitive resolution. There have been no further developments on the 2005 Law dispute. At this time, Anadarko is unable to reasonably estimate what the economic impact under the PSC might be if Sonatrach were to succeed in modifying the PSC.
Exceptional Profits Tax In July 2006, the Algerian parliament approved legislation establishing an exceptional profits tax on foreign companies Algerian oil production. In December 2006, implementing regulations regarding this legislation were issued. These regulations provide for an exceptional profits tax imposed on gross production at rates of taxation ranging from 5% to 50% based on average daily production volumes for each calendar month in which the price of Brent crude averages over $30 per barrel, retroactively effective to August 2006 production. Uncertainty existed at the time as to whether the exceptional profits tax would apply to the full value of production or only to the value of production in excess of $30 per barrel.
In January 2007, Sonatrach advised Anadarko that it would begin collecting the exceptional profits tax from Anadarkos share of production commencing with March 2007 liftings, including for the prior months since the new tax went into effect. In April 2007, ALNAFT, the new agency in the Algerian Ministry of Energy and Mines responsible for overseeing the Algerian hydrocarbons industry, issued the Application Procedure further defining the procedure and conditions under which the exceptional profits tax is applied and the methodology for its calculation. The Application Procedure and other information supplied by Sonatrach revealed that the exceptional profits tax was being applied to the full value of production rather than to the amount in excess of $30 per barrel. This was evidenced by changes in the Companys crude oil lifting schedule, which was conveyed to Anadarko by Sonatrach. As a result, Anadarko changed the measurement basis for the exceptional profits tax liability for the first quarter of 2007 to reflect the application of the tax to the full value of production. For additional information, see Note 18Other Taxes of the Notes to Consolidated Financial Statements under Item 8 of this Form 10-K.
At December 31, 2007, Anadarko had 106 MMBbls of proved undeveloped reserves in Algeria, the economics of which are sensitive to the exceptional profits tax. Anadarko is continuing to evaluate the impact of the exceptional profits tax on the economic viability of its future projects in Algeria, as well as its legal remedies with regard to the exceptional profits tax.
In response to the Algerian governments imposition of the exceptional profits tax, the Company has notified Sonatrach of its disagreement with the collection of the exceptional profits tax. The Company believes that the PSC provides fiscal stability through several of its provisions that require Sonatrach to pay all taxes and royalties. To facilitate discussions between the parties in an effort to resolve the dispute, on October 31, 2007, the Company initiated a conciliation proceeding on the exceptional profits tax as provided in the PSC. The conciliation proceeding is non-binding on the parties. At this time, the Company cannot determine the ultimate outcome of the conciliation proceeding, any intervening negotiations or any subsequent recourse to arbitration by either side.
Properties and ActivitiesOther International
Overview The Companys other international oil and gas production and/or development operations are located primarily in China and Brazil. The Company has exploration acreage in China, Brazil, Ghana, Indonesia and other selected areas. About 4% of the Companys total proved reserves were located in these other international locations at year-end 2007. During 2007, net sales volumes from the Companys other international properties accounted for 3% of the Companys total volumes. In 2008, the Company expects to drill about 16 development and 16 exploration wells at various other international locations.
China Anadarkos development and production project in China straddles Blocks 04/36 and 05/36 in Bohai Bay in approximately 75 feet of water. Development drilling has been ongoing through 2007 and is anticipated to continue in 2008. Further investment is planned in 2008 to install additional processing equipment and add further drilling slots to the existing platforms. At the end of 2007, net production from China was approximately 17 MBbls/d of oil. During 2007, Anadarko participated in two exploration wells that were both plugged and abandoned.
The Company also has an exploration project (100% WI in exploration phase) under way at South China Sea Block 43/11. During 2008, the Company plans to drill one deepwater exploration well in the South China Sea.
Brazil Anadarko holds a 50% interest and is the operator of the Peregrino field located in the Campos basin in approximately 350 feet of water. During 2007, development of the field was sanctioned, and a successful appraisal well was drilled. First production is expected in 2010.
Anadarko also holds exploration interests in several blocks located offshore in the Campos and Espírito Santo basins. During 2007, Anadarko participated in one exploration well in the Espírito Santo basin that was still drilling at year end. In 2008, Anadarko expects to participate in four deepwater exploration wells.
Ghana The Company announced two offshore discoveries in Ghana in 2007; one in West Cape Three Points block (30.9% interest) and one in Deep Tano block (18% interest). Additional seismic data was acquired to help with delineation. In 2008, the Company expects to drill three to six appraisal wells and two to three additional exploration wells in the two blocks, subject to rig availability.
Indonesia Anadarko has a participating interest in approximately 2.4 million exploration acres in Indonesia through a combination of several operated and non-operated Production Sharing Contracts. Anadarko also has entered into an outside-operated agreement, under which the Company has access to an additional 7.4 million acres. Anadarko participated in one successful exploration well in Indonesia in 2007. During 2008, Anadarko plans to participate in two exploration wells.
Other Anadarko also has active exploration projects in Mozambique, Qatar, Trinidad, Tunisia and several countries in West Africa, as well as activities in other potential new venture areas overseas. In October 2007, the Company divested certain interests in Qatar for approximately $350 million, however, Anadarko still continues an exploration program in Qatar.
The Companys 2007 drilling program focused on known oil and gas areas in the United States (Lower 48 states, Alaska and Gulf of Mexico), Algeria and other countries where it holds acreage. Exploration activity consisted of 55 wells, including 32 wells in the Lower 48 states, 2 wells in Alaska, 10 wells offshore in the Gulf of Mexico, 3 wells in Algeria and 8 wells in other international locations. Development activity consisted of 1,768 wells, which included 1,733 wells in the Lower 48 states, 7 wells in Alaska, 10 wells offshore in the Gulf of Mexico, 6 wells in Algeria and 12 wells in other international locations.
The following table shows the number of oil and gas wells completed in each of the last three years:
The following table shows the number of wells in the process of drilling or in active completion stages and the number of wells suspended or waiting on completion as of December 31, 2007:
As of December 31, 2007, the Company had an ownership interest in productive wells as follows:
Properties and Leases
The following schedule shows the number of developed lease, undeveloped lease and fee mineral acres in which Anadarko held interests at December 31, 2007:
Midstream Properties and Activities
Anadarko invests in midstream (gathering and processing) facilities to complement its oil and gas operations in regions where the Company has natural gas production. The Company is better able to manage both the value received for, and cost of, gathering, treating and processing natural gas through its ownership and operation of these facilities. In addition, Anadarkos midstream business provides gathering, treating and processing services for third-party customers, including major and independent producers. Anadarko generates revenues in its gathering and processing activities through various fee structures that include fixed-rate, percent of proceeds, or keep-whole agreements. The Company also processes a portion of its gas at various third-party plants.
In 2006, Anadarko significantly increased the size and scope of its midstream business through the acquisitions of Western and Kerr-McGee. With these acquisitions, Anadarko has systems in eight states (Wyoming, Colorado, Utah, New Mexico, Kansas, Oklahoma, Texas and Louisiana) located in major onshore producing basins. During 2007, the Company divested control of its interests in two natural gas gathering systems and associated processing plants, in areas where Anadarko has limited or no oil and gas production, for $1.85 billion. During 2008, approximately 10% of the Companys capital budget is allocated to midstream operations. The following table provides key statistics for Company-owned gathering and processing facilities.
The Companys marketing department actively manages the sales of Anadarkos natural gas, crude oil and NGLs. In marketing its production, the Company attempts to maximize realized prices while managing credit risk exposure. The Company also purchases natural gas, crude oil, condensate and NGLs volumes for resale primarily from partners and producers near Anadarkos production. These purchases allow Anadarko to aggregate larger volumes and attract larger, creditworthy customers, which helps enable the Company to maximize prices received for the Companys production and minimize balancing issues with customers and pipelines during operational disruptions.
The Company sells natural gas under a variety of contracts. The Company has the marketing capability to move large volumes of gas into and out of the daily gas market to take advantage of any price volatility. The Company may also engage in trading activities for the purpose of generating profits from exposure to changes in market prices of natural gas, crude oil, condensate and NGLs. The Companys marketing strategy includes the use of leased natural gas storage facilities and various derivative instruments. However, the Company does not engage in market-making practices nor does it trade in any non-energy-related commodities. The Companys marketing function does not participate in any energy marketing-related partnerships.
In 2007, the Company also engaged in sales of greenhouse gas emission reduction credits (ERCs) derived from CO2 injection operations in Wyoming. The Company expects additional sales of ERCs in the future.
Segment and Geographic Information
Information on operations by segment and geographic location is contained in Note 17Segment and Geographic Information of the Notes to Consolidated Financial Statements under Item 8 of this Form 10-K.
As of December 31, 2007, the Company had approximately 4,000 employees. Anadarko considers its relations with its employees to be satisfactory. The Company has had no significant work stoppages or strikes associated with its employees.
Regulatory Matters, Environmental and Additional Factors Affecting Business
See Risk Factors under Item 1a and Environmental under Item 7 of this Form 10-K.
Title to Properties
As is customary in the oil and gas industry, only a preliminary title review is conducted at the time properties believed to be suitable for drilling operations are acquired by the Company. Prior to the commencement of drilling operations, a thorough title examination of the drill site tract is conducted and curative work is performed with respect to significant defects, if any, before proceeding with operations. Anadarko believes the title to its leasehold properties is good and defensible in accordance with standards generally acceptable in the oil and gas industry subject to such exceptions that, in the opinion of legal counsel for the Company, are not so material as to detract substantially from the use of such properties.
The leasehold properties owned by the Company are subject to royalty, overriding royalty and other outstanding interests customary in the industry. The properties may be subject to burdens such as liens incident to operating agreements and current taxes, development obligations under oil and gas leases and other encumbrances, easements and restrictions. Anadarko does not believe any of these burdens will materially interfere with its use of these properties.
See Capital Resources and Liquidity under Item 7 of this Form 10-K.
Ratios of Earnings to Fixed Charges and Earnings to Combined Fixed Charges and Preferred Stock Dividends
These ratios were computed by dividing earnings by either fixed charges or combined fixed charges and preferred stock dividends. For this purpose, earnings include income from continuing operations before income taxes and fixed charges and excludes undistributed earnings of equity investees. Fixed charges include interest and amortization of debt expenses and the estimated interest component of rentals. Preferred stock dividends are adjusted to reflect the amount of pretax earnings required for payment. The 2006 and 2005 ratios have been revised to reflect retrospective application of the successful efforts method of accounting.
Forward-Looking Statements The Company has made in this report, and may from time to time otherwise make in other public filings, press releases and discussions with Company management, forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 concerning the Companys operations, economic performance and financial condition. These forward-looking statements include information concerning future production and reserves, schedules, plans, timing of development, contributions from oil and gas properties, and those statements preceded by, followed by or that otherwise include the words believes, expects, anticipates, intends, estimates, projects, target, goal, plans, objective, should or similar expressions or variations on such expressions. For such statements, the Company claims the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995. Although the Company believes that the expectations reflected in such forward-looking statements are reasonable, it can give no assurance that such expectations will prove to have been correct. Important factors that could cause actual results to differ materially from the Companys expectations include, but are not limited to, the Companys assumptions about energy markets, production levels, reserve levels, operating results, competitive conditions, technology, the availability of capital resources, capital expenditures and other contractual obligations, the supply and demand for and the price of oil, natural gas, NGLs and other products or services, the weather, inflation, the availability of goods and services, drilling risks, future processing volumes and pipeline throughput, general economic conditions, either internationally or nationally or in the jurisdictions in which the Company or its subsidiaries are doing business, legislative or regulatory changes, including changes in environmental regulation, environmental risks and liability under federal, state and foreign environmental laws and regulations, potential environmental obligations arising from Kerr-McGees former chemical business, the securities or capital markets, our ability to repay debt, the outcome of any proceedings related to the Algerian exceptional profits tax, the Companys ability to successfully market and complete its proposed midstream Master Limited Partnership initial public offering, and other factors discussed below and elsewhere in this Form 10-K and in the Companys other public filings, press releases and discussions with Company management. Anadarko undertakes no obligation to publicly update or revise any forward-looking statements.
Our debt and other financial commitments may limit our financial and operating flexibility.
As of December 31, 2007, our total debt was about $14.7 billion, which included a $2.2 billion note payable from a midstream subsidiary to a related party. We also have various commitments for operating leases, drilling contracts and transportation and purchase obligations for services and products. Our financial commitments could have important consequences to you. For example, they could:
A downgrade in our credit rating could negatively impact our cost of capital.
Standard and Poors (S&P) and Moodys Investors Service (Moodys) rate our debt at BBB- with a stable outlook and Baa3 with a negative outlook, respectively. Although we are not aware of any current plans of S&P or Moodys to lower their respective ratings on our debt, we cannot be assured that such credit ratings will not be downgraded. A downgrade in our credit ratings could negatively impact our cost of capital or our ability to effectively execute aspects of our strategy. The only outstanding debt that contains rating downgrade triggers that
would accelerate the maturity dates of outstanding debt is a $2.2 billion midstream note held by one of Anadarkos subsidiaries, the maturity of which could accelerate if Anadarkos senior unsecured credit rating were to be rated below BB- by S&P or Ba3 by Moodys. The $2.2 billion midstream note is not guaranteed by the Anadarko parent company but is unconditionally guaranteed, jointly and severally, by certain midstream subsidiaries.
We may incur substantial costs to comply with environmental requirements, including costs arising from Kerr-McGees former chemical business.
Prior to the merger, Kerr-McGee spun off its chemical manufacturing business to a newly created and separate company, Tronox Incorporated (Tronox). Under the terms of a Master Separation Agreement (MSA), Kerr-McGee agreed to reimburse Tronox for certain qualifying environmental remediation costs, subject to certain limitations and conditions and up to a maximum aggregate reimbursement of $100 million. However, Kerr-McGee could be subject to joint and several liability for certain costs of cleaning up hazardous substance contamination attributable to the facilities and operations conveyed to Tronox if Tronox becomes insolvent or otherwise unable to pay for certain remediation costs. As a result of the merger, we will be responsible to provide reimbursements to Tronox pursuant to the MSA, and we may be subject to potential joint and several liability, as the successor to Kerr-McGee, if Tronox is unable to perform certain remediation obligations.
Commodity pricing and demand may limit our production and profitability.
Crude oil prices continue to be affected by political developments worldwide, pricing decisions and production quotas of OPEC and volatile trading patterns in the commodity futures markets. In addition, in OPEC countries in which we have production, such as Algeria, when the world oil market is weak we may be subject to periods of decreased production due to government-mandated cutbacks. Natural gas prices also continue to be highly volatile. In periods of sharply lower commodity prices, we may curtail production and capital spending projects, as well as delay or defer drilling wells in certain areas because of lower cash flows. Changes in crude oil and natural gas prices can impact our determination of proved reserves and our calculation of the standardized measure of discounted future net cash flows relating to oil and gas reserves. In addition, demand for oil and gas in the United States and worldwide may affect our level of production.
Our results of operations could be adversely affected by asset impairments.
If we expect significant sustained decreases in oil and natural gas prices in the future, we may be required to write down the value of our oil and gas properties if the future cash flows from these properties fall below their net book value. Future non-cash asset impairments could negatively affect our results of operations.
As a result of mergers and acquisitions, at December 31, 2007 we had approximately $5.0 billion of goodwill on our balance sheet. Goodwill is not amortized, but instead must be tested at least annually for impairment by applying a fair-value-based test. Goodwill is deemed impaired to the extent that its carrying amount exceeds its implied fair value. Although our latest tests indicate that no goodwill impairment is currently required, various factors such as future deterioration in market conditions could lead to goodwill impairments that could have a substantial negative effect on our profitability.
We are subject to complex laws and regulations relating to environmental protection that can adversely affect the cost, manner and feasibility of doing business.
Our operations and properties are subject to numerous federal, state and local laws and regulations relating to environmental protection from the time projects commence until abandonment. These laws and regulations govern, among other things:
In addition, these laws and regulations may impose substantial liabilities for our failure to comply with them or for any contamination resulting from our operations. For a description of certain environmental proceedings in which we are involved, see Legal Proceedings under Item 3 of this Form 10-K.
We may not be insured against all of the operating risks to which our business is exposed.
Our business is subject to all of the operating risks normally associated with the exploration for and production, gathering, processing and transportation of oil and gas, including blowouts, cratering and fire, any of which could result in damage to, or destruction of, oil and gas wells or formations or production facilities and other property and injury to persons. As protection against financial loss resulting from these operating hazards, we maintain insurance coverage, including certain physical damage, employers liability, comprehensive general liability and workers compensation insurance. However, we are not fully insured against all risks in all aspects of our business, such as political risk, business interruption risk and risk of major terrorist attacks. The occurrence of a significant event against which we are not fully insured could have a material adverse effect on our financial position.
Material differences between the estimated and actual timing of critical events may affect the completion of and commencement of production from development projects.
We are involved in several large development projects. Key factors that may affect the timing and outcome of such projects include:
Delays and differences between estimated and actual timing of critical events may affect the forward looking statements related to large development projects.
Our domestic operations are subject to governmental risks that may impact our operations.
Our domestic operations have been, and at times in the future may be, affected by political developments and by federal, state and local laws and regulations such as restrictions on production, changes in taxes, royalties and other amounts payable to governments or governmental agencies, price or gathering rate controls and environmental protection regulations.
We operate in other countries and are subject to political, economic and other uncertainties.
Our operations in areas outside the United States are subject to various risks inherent in foreign operations. These risks may include, among other things:
Our international operations may also be adversely affected by laws and policies of the United States affecting foreign trade and taxation.
Realization of any of these factors could materially and adversely affect our financial position, results of operations and cash flows.
The oil and gas exploration and production industry is very competitive, and some of our exploration and production competitors have greater financial and other resources than we do.
The oil and gas business is highly competitive in the search for and acquisition of reserves and in the gathering and marketing of oil and gas production. Our competitors include national oil companies, major oil and gas companies, independent oil and gas companies, individual producers, gas marketers and major pipeline companies, as well as participants in other industries supplying energy and fuel to industrial, commercial and individual consumers. Some of our competitors may have greater and more diverse resources upon which to draw than we do. If we are not successful in our competition for oil and gas reserves or in our marketing of production, our financial condition and results of operations may be adversely affected.
The unavailability or high cost of drilling rigs, equipment, supplies, personnel and other oil field services could adversely affect our ability to execute our exploration and development plans on a timely basis and within our budget.
Our industry is cyclical and, from time to time, there is a shortage of drilling rigs, equipment, supplies or qualified personnel. During these periods, the costs of rigs, equipment, supplies and personnel are substantially greater and their availability may be limited. As a result of increasing levels of exploration and production in response to strong demand for crude oil and natural gas, the demand for oilfield services has risen and the costs of these services are increasing, while the quality of these services may suffer. Additionally, these services may not be available on commercially reasonable terms.
Our drilling activities may not be productive.
Drilling for oil and gas involves numerous risks, including the risk that we will not encounter commercially productive oil or gas reservoirs. The costs of drilling, completing and operating wells are often uncertain, and drilling operations may be curtailed, delayed or canceled as a result of a variety of factors, including:
Certain of our future drilling activities may not be successful and, if unsuccessful, this failure could have an adverse effect on our future results of operations and financial condition. While all drilling, whether developmental or exploratory, involves these risks, exploratory drilling involves greater risks of dry holes or failure to find commercial quantities of hydrocarbons. Because of the percentage of our capital budget devoted to higher-risk exploratory projects, it is likely that we will continue to experience significant exploration and dry hole expenses.
We are vulnerable to risks associated with operating in the Gulf of Mexico that could negatively impact our operations and financial results.
Our operations and financial results could be significantly impacted by conditions in the Gulf of Mexico because we explore and produce extensively in that area. As a result of this activity, we are vulnerable to the risks associated with operating in the Gulf of Mexico, including those relating to:
In addition, we are currently conducting some of our exploration in the deep waters (greater than 1,000 feet) of the Gulf of Mexico, where operations are more difficult and costly than in shallower waters. The deep waters in the Gulf of Mexico lack the physical and oilfield service infrastructure present in its shallower waters. As a result, deepwater operations may require a significant amount of time between a discovery and the time that we can market our production, thereby increasing the risk involved with these operations.
Further, production of reserves from reservoirs in the Gulf of Mexico generally declines more rapidly than from reservoirs in many other producing regions of the world. This results in recovery of a relatively higher percentage of reserves from properties in the Gulf of Mexico during the initial few years of production and, as a result, our reserve replacement needs from new prospects may be greater there than for our operations elsewhere. Also, our revenues and return on capital will depend significantly on prices prevailing during these relatively short production periods.
Our proved reserves are estimates. Any material inaccuracies in our reserve estimates or assumptions underlying our reserve estimates could cause the quantities and net present value of our reserves to be overstated or understated.
There are numerous uncertainties inherent in estimating quantities of proved reserves, including many factors beyond our control that could cause the quantities and net present value of our reserves to be overstated. The reserve information included or incorporated by reference in this report represents estimates prepared by our internal engineers. The procedures and methods for estimating the reserves by our internal engineers were reviewed by independent petroleum consultants. Estimation of reserves is not an exact science. Estimates of economically recoverable oil and natural gas reserves and of future net cash flows necessarily depend upon a number of variable factors and assumptions, any of which may cause these estimates to vary considerably from actual results, such as:
Estimates of reserves based on risk of recovery and estimates of expected future net cash flows prepared or audited by different engineers, or by the same engineers at different times, may vary substantially. Actual production, revenues and expenditures with respect to our reserves will likely vary from estimates, and the variance may be material. The net present values referred to in this report should not be construed as the current market value of the estimated oil and natural gas reserves attributable to our properties. In accordance with SEC requirements, the estimated discounted net cash flows from proved reserves are generally based on prices and costs as of the date of the estimate, whereas actual future prices and costs may be materially higher or lower.
Failure to replace reserves may negatively affect our business.
Our future success depends upon our ability to find, develop or acquire additional oil and natural gas reserves that are economically recoverable. Our proved reserves generally decline when reserves are produced, unless we conduct successful exploration or development activities or acquire properties containing proved reserves, or both. We may not be able to find, develop or acquire additional reserves on an economic basis. Furthermore, if oil and natural gas prices increase, our costs for additional reserves could also increase.
We have limited control over the activities on properties we do not operate.
Other companies operate some of the properties in which we have an interest. We have limited ability to influence or control the operation or future development of these non-operated properties or the amount of capital expenditures that we are required to fund with respect to them. Our dependence on the operator and other working interest owners for these projects and our limited ability to influence or control the operation and future development of these properties could materially adversely affect the realization of our targeted returns on capital and lead to unexpected future costs.
Our ability to sell our natural gas and crude oil production could be materially harmed if we fail to obtain adequate services such as transportation.
The marketability of our production depends in part upon the availability, proximity and capacity of pipeline facilities and tanker transportation. If any of the pipelines or tankers become unavailable, we would be required to find a suitable alternative to transport the gas and oil, which could increase our costs and/or reduce the revenues we might obtain from the sale of the gas and oil.
Our commodity price risk management and trading activities may prevent us from benefiting fully from price increases and may expose us to other risks.
To the extent that we engage in price risk management activities to protect ourselves from commodity price declines, we may be prevented from realizing the full benefits of price increases above the levels of the derivative instruments used to manage price risk. In addition, we engage in speculative trading in hydrocarbon commodities, which subjects us to additional risk.
We may reduce or cease to pay dividends on our common stock.
We can provide no assurance that we will continue to pay dividends at the current rate or at all. The amount of cash dividends, if any, to be paid in the future will depend upon their declaration by our Board of Directors and upon our financial condition, results of operations, cash flow, the levels of our capital and exploration expenditures, our future business prospects and other related matters that our Board of Directors deems relevant.
Repercussions from terrorist activities or armed conflict could harm our business.
Terrorist activities, anti-terrorist efforts or other armed conflict involving the United States or its interests abroad may adversely affect the United States and global economies and could prevent us from meeting our
financial and other obligations. If events of this nature occur and persist, the attendant political instability and societal disruption could reduce overall demand for oil and natural gas, potentially putting downward pressure on prevailing oil and natural gas prices and causing a reduction in our revenues. Oil and natural gas production facilities, transportation systems and storage facilities could be direct targets of terrorist attacks, and our operations could be adversely impacted if infrastructure integral to our operations is destroyed or damaged by such an attack. Costs for insurance and other security may increase as a result of these threats, and some insurance coverage may become more difficult to obtain, if available at all.
Provisions in our corporate documents and Delaware law could delay or prevent a change of control of Anadarko, even if that change would be beneficial to our stockholders.
Our certificate of incorporation and bylaws contain provisions that may make a change of control of Anadarko difficult, even if it may be beneficial to our stockholders, including provisions governing the classification, nomination and removal of directors, prohibiting stockholder action by written consent and regulating the ability of our stockholders to bring matters for action before annual stockholder meetings, and the authorization given to our Board of Directors to issue and set the terms of preferred stock.
In addition, we have adopted a stockholder rights plan, which would cause extreme dilution to any person or group that attempts to acquire a significant interest in Anadarko without advance approval of our Board of Directors, while Section 203 of the Delaware General Corporation Law imposes restrictions on mergers and other business combinations between us and any holder of 15% or more of our outstanding common stock.
The loss of key members of our management team, or difficulty attracting and retaining experienced technical personnel, could reduce our competitiveness and prospects for future success.
The successful implementation of our strategies and handling of other issues integral to our future success will depend, in part, on our experienced management team. The loss of key members of our management team, including James T. Hackett, our Chairman, President and Chief Executive Officer, could have an adverse effect on our business. We entered into an employment agreement with Mr. Hackett to secure his employment with us. We do not carry key man insurance. Our exploratory drilling success and the success of other activities integral to our operations will depend, in part, on our ability to attract and retain experienced explorationists, engineers and other professionals. Competition for such professionals is extremely intense. If we cannot retain our technical personnel or attract additional experienced technical personnel, our ability to compete could be harmed.
The Company has no outstanding or unresolved SEC staff comments.
Information on Properties is contained in Item 1 of this Form 10-K and in Note 21Commitments of the Notes to Consolidated Financial Statements under Item 8 of this Form 10-K.
General The Company is a defendant in a number of lawsuits and is involved in governmental proceedings arising in the ordinary course of business, including, but not limited to, royalty claims, contract claims and environmental claims. The Company has also been named as a defendant in various personal injury claims, including claims by employees of third-party contractors alleging exposure to asbestos, silica and benzene while working at refineries (previously owned by predecessors of acquired companies) located in Texas, California and Oklahoma. While the ultimate outcome and impact on the Company cannot be predicted with certainty, management believes that the resolution of these proceedings will not have a material adverse effect on the consolidated financial position, results of operations or cash flow of the Company.
Environmental Matters In June 2005 and November 2005, Kerr-McGee Oil and Gas Onshore LP received Notices of Violation from the Colorado Department of Public Health and Environment alleging that allowable air emissions under the Clean Air Act were exceeded with respect to certain production operations in Colorado. Kerr-McGee Oil and Gas Onshore LP also received a letter from the Department of Justice in November 2005 alleging violations of certain air quality and permitting regulations at the Cottonwood and Ouray compressor stations in Uintah County, Utah, which were operated by Westport Oil and Gas Company, L.P. prior to Westports merger with Kerr-McGee in 2004. The Department of Justice later alleged that certain air quality regulations were also violated at the Bridge compressor station in Uintah County. The Company has negotiated a Consent Decree with the state and federal agencies to resolve all of the air issues by agreeing to pay a monetary penalty of $200,000 and by performing Supplemental Environmental Projects, at an estimated cost of $250,000. The settlement will also require the Company to perform certain air emission control measures requiring capital expenditures of approximately $18 million over a period of several years. The Consent Decree has been filed with the United States District Court for the District of Colorado in a matter styled United States of America v. Kerr-McGee Corporation. On August 17, 2007, the Rocky Mountain Clean Air Committee and the Natural Resources Defense Council filed a motion to intervene in the litigation, asserting that the monetary penalty was insufficient, and on September 28, 2007, the Court approved an order allowing the parties to intervene. The parties are currently briefing the Court on the level of intervention the intervening parties should be allowed in the matter. The Consent Decree must be approved by the Court before it becomes final.
On December 28, 2005, a subsidiary of the Company, Kerr-McGee Oil & Gas Onshore LP (formerly known as Westport Oil and Gas Company, L.P.) (KMOG Onshore), received a letter from the Environmental Protection Agency (EPA) alleging that KMOG Onshore constructed well pads and associated roads and pipelines in a wetland adjacent to the Hams Fork River in Lincoln County, Wyoming without obtaining necessary permits required by the Clean Water Act. The letter also directed KMOG Onshore to cease and desist the unauthorized discharge (which Kerr-McGee had already stopped) and undertake removal and restoration activities. A restoration plan has been approved by the EPA. The estimated five year cost for restoration is $900,000. This amount will be used to purchase five acres of land dedicated to wetlands preservation, relocation of facility equipment, re-vegetation and monitoring. The EPA did not require KMOG Onshore to shut in the wells. In addition to implementation of the restoration plan, on September 17, 2007, the EPA and the Company entered into a consent agreement whereby the Company agreed to pay an administrative penalty of $157,000 to resolve the alleged violation, which the Company paid in October 2007.
Other Matters The Company is subject to other legal proceedings, claims and liabilities which arise in the ordinary course of its business. In the opinion of Anadarko, the liability with respect to these actions will not have a material effect on the consolidated financial position, results of operations or cash flow of the Company.
There were no matters submitted to a vote of security holders during the fourth quarter of 2007.
Executive Officers of the Registrant
Mr. Hackett was named President and Chief Executive Officer in December 2003 and assumed the additional role of Chairman of the Board in January 2006. Prior to joining Anadarko, he served as President and Chief Operating Officer of Devon Energy Corporation following its merger with Ocean Energy, Inc. in April 2003. Mr. Hackett served as President and Chief Executive Officer of Ocean Energy, Inc. from March 1999 to April 2003 and as Chairman of the Board from January 2000 to April 2003. He currently serves as a director of Fluor Corporation and Temple-Inland, Inc. and serves as Chairman of the Board of the Federal Reserve Bank of Dallas.
Mr. Kurz was named Chief Operating Officer in December 2006. Prior to this position, he served as Senior Vice President, Marketing and General Manager, U.S. Onshore since 2005, Vice President, Marketing since 2003 and Manager, Energy Marketing since 2001. He previously worked in Anadarkos marketing department since 2000.
Mr. Daniels was named Senior Vice President, Worldwide Exploration in December 2006, Senior Vice President, Exploration and Production in 2004 and named Vice President, Canada in 2001. Prior to this position, he served in various managerial roles in the Exploration Department for Anadarko Algeria Company, LLC. He has worked for the Company since 1985.
Mr. Meloy was named Senior Vice President, Worldwide Operations in December 2006 and had served as Senior Vice President, Gulf of Mexico and International Operations since the acquisition of Kerr-McGee in August 2006. Prior to joining Anadarko, he served Kerr-McGee as Vice President of Exploration and Production since 2005, Vice President of Gulf of Mexico Exploration, Production and Development since 2004, Vice President and Managing Director of Kerr-McGee North Sea (U.K.) Limited since 2002 and Vice President of Gulf of Mexico Deep Water since 2000.
Mr. Reeves was named Senior Vice President, General Counsel and Chief Administrative Officer in February 2007. He had previously served as Senior Vice President, Corporate Affairs & Law and Chief Governance Officer since 2004. Prior to joining Anadarko, he served as Executive Vice President, Administration and General Counsel of North Sea New Ventures from 2003 to 2004, and as Executive Vice President, General Counsel and Secretary of Ocean Energy, Inc. and its predecessor companies from 1997 to 2003. He has also served as a director of Key Energy Services, Inc., a publicly traded oil field services company, since October 2007.
Mr. Walker was named Senior Vice President, Finance and Chief Financial Officer in September 2005. Prior to joining Anadarko, he served as Managing Director for the Global Energy Group of UBS Investment Bank since 2003 and was President and Chief Financial Officer of 3TEC Energy Corporation from 2000 to 2003. From 1987 to 2000, he worked for Prudential Financial in a variety of merchant banking positions.
Mr. Busmire was named Vice President and Chief Accounting Officer in 2006. Prior to joining Anadarko, he served as Senior Vice President, Chief Financial Officer, Treasurer and Controller of Noble Corporation since 2005 and was a Managing Director of Pickering Energy Partners, Inc. since 2004. Prior to this position, he served as Vice President of Investor Relations at Ocean Energy, Inc. since 2000. Prior to this position, Mr. Busmire served as Controller of Altura Energy since 1997.
Officers of Anadarko are elected at an organizational meeting of the Board of Directors following the annual meeting of stockholders, which is expected to occur on May 20, 2008, and hold office until their successors are duly elected and shall have qualified. There are no family relationships between any directors or executive officers of Anadarko.
Information on the market price and cash dividends declared per share of common stock is included in Corporate Information in the Anadarko Petroleum Corporation 2007 Annual Report (Annual Report) which is incorporated herein by reference.
As of January 31, 2008, there were approximately 17,600 record holders of Anadarko common stock. The following table sets forth the amount of dividends declared and paid on Anadarko common stock during the two years ended December 31, 2007:
The amount of future common stock dividends will depend on earnings, financial condition, capital requirements and other factors, and will be determined by the Directors on a quarterly basis. For additional information, see Dividends under Item 7 and Note 6Stock-Based Compensation and Note 14Common Stock under Item 8 of this Form 10-K.
Common Stock Repurchase Table The following table sets forth information with respect to repurchases by the Company of its shares of common stock during the fourth quarter of 2007.
The following performance graph and related information shall not be deemed soliciting material or to be filed with the Securities and Exchange Commission, nor shall such information be incorporated by reference into any future filing under the Securities Act of 1933 or Securities Exchange Act of 1934, each as amended, except to the extent that the Company specifically incorporates it by reference into such filing.
The following graph compares the cumulative 5-year total return to shareholders on Anadarkos common stock relative to the cumulative total returns of the S & P 500 index and two customized peer groups, the 2007 Peer Group consisting of eleven companies and the 2006 Peer Group comprised of twelve companies. The companies included in the customized 2007 peer group are: Apache Corp., ConocoPhillips, Devon Energy Corp., EnCana Corp., EOG Resources Inc, Hess Corp., Marathon Oil Corp., Noble Energy Inc, Occidental Petroleum Corp., Pioneer Natural Resources Company and Talisman Energy Inc. The companies included in the customized 2006 peer group are: Apache Corp., Chesapeake Energy Corp., Chevron Corp., ConocoPhillips, Devon Energy Corp., EnCana Corp., EOG Resources Inc, Hess Corp., Marathon Oil Corp., Noble Energy Inc, Occidental Petroleum Corp. and Pioneer Natural Resources Company. The Company has chosen to change the performance index from that used in the Companys 2006 Form 10-K, the 2006 Peer Group, to the 2007 Peer Group because it believes that the 2007 Peer Group represents a better comparator group for the Company following the 2006 mergers with Kerr-McGee and Western. Ten of the twelve companies in the 2006 Peer Group are also included in the 2007 Peer Group. An investment of $100 (with reinvestment of all dividends) is assumed to have been made in the Companys common stock, in the index and in the peer groups on December 31, 2002 and its relative performance is tracked through December 31, 2007.
COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN AMONG
ANADARKO PETROLEUM CORPORATION, THE S & P 500 INDEX,
THE 2007 PEER GROUP AND THE 2006 PEER GROUP
General Anadarko Petroleum Corporations primary line of business is the exploration, development, production, gathering, processing and marketing of natural gas, crude oil, condensate and NGLs. The Companys major areas of operations are located in the United States and Algeria. The Company also has activity in China, Brazil and several other countries. The Companys focus is on adding high-margin oil and natural gas reserves at competitive costs and continuing to develop more efficient and effective ways of exploring for and producing oil and gas. The primary factors that affect the Companys results of operations include, among other things, commodity prices for natural gas, crude oil and NGLs, production volumes, the Companys ability to find additional oil and gas reserves, as well as the cost of finding reserves and changes in the levels of costs and expenses required for continuing operations. Unless the context otherwise requires, the terms Anadarko or Company refer to Anadarko Petroleum Corporation and its consolidated subsidiaries.
On August 10, 2006, Anadarko completed the acquisition of Kerr-McGee in an all-cash transaction totaling $16.5 billion plus the assumption of $2.6 billion of debt. On August 23, 2006, Anadarko completed the acquisition of Western in an all-cash transaction totaling $4.8 billion plus the assumption of $625 million of debt. Anadarko initially financed $22.5 billion for the acquisitions under a 364-day committed acquisition facility. In conjunction with the 2006 acquisitions, Anadarko implemented an asset realignment program. The goal of the Kerr-McGee and Western acquisitions was to provide a more economically efficient platform with higher and more consistent growth potential, with the intent of divesting properties that were no longer deemed to be core to Anadarkos operations. During 2007, the Company successfully completed the majority of the divestitures associated with the realignment program. Divestitures under the realignment program in 2007 and 2006 contributed proceeds of approximately $17 billion before income taxes. As expected, Anadarkos proved reserves after completing the divestitures were about equal to levels before the acquisitions. For additional information about the benefits the Company believes are provided by the realigned portfolio, see Outlook. Through December 31, 2007, the Company had paid down its borrowings under the acquisition facility to $1.0 billion with proceeds from asset divestitures, long-term refinancing and free cash flow from operations. Unless noted otherwise, the following information relates to continuing operations and excludes discontinued Canadian operations. See Acquisitions and Divestitures, Outlook and Discontinued Operations for additional information.
The following discussion pertains to Anadarkos financial condition, results of operations and changes in financial condition. Following is an index by major category of discussion including a brief description of contents:
Results of Continuing Operations
During 2007, Anadarko changed its method of accounting for its oil and gas exploration and development activities from full cost to the successful efforts method. In accordance with Statement of Financial Accounting Standards (SFAS) No. 154, Accounting Changes and Error Corrections, financial information for prior periods has been revised to reflect retrospective application of the successful efforts method, as prescribed by SFAS No. 19, Financial Accounting and Reporting by Oil and Gas Producing Companies. Although the full cost method of accounting for oil and gas exploration and development continues to be an accepted alternative, the successful efforts method of accounting is the preferred method. The Company believes the successful efforts method provides a more transparent representation of its results of operations and the ability to assess the Companys investments in oil and gas properties for impairment based on their estimated fair values rather than being required to base the valuation on prices and costs as of the balance sheet date.
The effect of the accounting change on income from continuing operations for the full year ended December 31, 2007 was an increase of approximately $2.0 billion or $4.32 per diluted share. The effect of the accounting change on income from continuing operations for the year ended December 31, 2006 was a decrease of $322 million or $0.69 per diluted share. The effect of the accounting change on income from continuing operations for the year ended December 31, 2005 was a decrease of $98 million or $0.21 per diluted share. There was no effect on cash and cash equivalents. For additional information on the impact of the change to the successful efforts method of accounting see Note 1Summary of Significant Accounting PoliciesProperties and Equipment, Note 2Change in Accounting Principle and Note 8Properties and Equipment of the Notes to Consolidated Financial Statements under Item 8 of this Form 10-K.
Anadarkos financial and operating results for 2006 include the operating results of Kerr-McGee and Western since the dates of their acquisitions.
Net Income Anadarkos income from continuing operations for 2007 totaled $3.8 billion, or $8.05 per share (diluted), compared to income from continuing operations for 2006 of $2.5 billion, or $5.33 per share (diluted). Anadarko had income from continuing operations in 2005 of $2.0 billion, or $4.15 per share (diluted). The increase in income from continuing operations for 2007 compared to 2006 was primarily due to gains on divestitures and higher sales volumes, partially offset by the impact of lower natural gas and oil and condensate prices, higher costs and expenses, including other taxes related to an Algerian exceptional profits tax, and higher interest expense. The increase in 2006 net income compared to 2005 was primarily due to higher sales volumes and prices, partially offset by higher operating costs and expenses and higher interest expense. In 2007 and 2006, the higher sales volumes, costs and expenses and interest expense were due primarily to the impact of operations acquired and debt incurred with the third quarter 2006 acquisitions. Results for 2006 were also impacted by charges associated with impairments of certain international properties. The Companys sales revenues for 2007 and 2006 include $(1,048) million and $837 million, respectively, related to the recognition of net unrealized gains (losses) on derivatives used to manage price risk on natural gas, crude oil, condensate and NGLs sales. The significant fluctuations in unrealized gains (losses) are due primarily to an increase in Anadarkos derivative portfolio as a result of the 2006 acquisition of Kerr-McGee, as well as the discontinuance of hedge accounting effective January 1, 2007. The majority of the unrealized gains recorded in 2006 related to derivatives assumed with the Kerr-McGee acquisition. Unrealized gains (losses) related to derivatives were not material in 2005.
Revenues and Other
Anadarkos total revenues and other for 2007 increased 55% compared to 2006 due to gains on divestitures and higher sales volumes, partially offset by significantly lower natural gas and oil and condensate prices. The decrease in prices for 2007 was largely attributed to the significant impact unrealized gains and losses on derivatives had on prices during 2007 and 2006. The increase in 2006 compared to 2005 was primarily due to higher sales volumes and the significant impact unrealized gains and losses on derivatives had on prices.
Gains on divestitures in 2007 related primarily to the Companys asset realignment program. During 2007, net gains of $4.1 billion were related to divestitures of oil and gas properties and net gains of $0.6 billion were related to the divestiture of certain gathering and processing interests that generally were not affiliated with the Companys operating areas. For additional information see, Acquisitions and Divestitures.
The Company utilizes derivative instruments to manage the risk of a decrease in the market prices for its anticipated sales of natural gas, crude oil, condensate and NGLs. This activity is referred to as price risk management. The impact of price risk management (including realized and unrealized gains and losses) decreased total revenues $472 million during 2007 compared to an increase of $1,131 million in 2006. The impact of price risk management decreased total revenues $294 million during 2005. See Energy Price Risk under Item 7a and Note 10Financial Instruments under Item 8 of this Form 10-K.
Analysis of Oil and Gas Operations Sales Volumes
Anadarkos daily sales volumes increased 18% in 2007 compared to 2006 primarily due to higher sales volumes of 138 MBOE/d associated with the full-period impact of the 2006 acquisitions and higher sales volumes in the Gulf of Mexico of 18 MBOE/d associated with production start up at Independence Hub in the second half of 2007, partially offset by a decrease in sales volumes of 64 MBOE/d associated with the impact of 2007 divestitures in the onshore United States, the Gulf of Mexico and Qatar. During 2006, Anadarkos daily sales volumes increased 29% compared to 2005 primarily due to higher sales volumes associated with the third quarter 2006 acquisitions of 114 MBOE/d and higher sales volumes from the Gulf of Mexico, partially offset by lower legacy gas volumes in east Texas and Louisiana, and lower oil sales volumes in Venezuela.
Sales volumes represent actual production volumes adjusted for changes in commodity inventories. Anadarko employs marketing strategies to help manage volumes and mitigate the effect of price volatility, which is likely to continue in the future.
Natural Gas Sales Volumes, Average Prices and Revenues
The Companys daily natural gas sales volumes increased 25% in 2007 compared to 2006 primarily due to higher sales volumes associated with the 2006 acquisitions of 491 MMcf/d and higher sales volumes of 106 MMcf/d in the Gulf of Mexico related to the start up of the Independence Hub, partially offset by decreases in sales volumes of 224 MMcf/d associated with 2007 divestitures in the onshore United States and Gulf of Mexico. Anadarkos daily natural gas sales volumes in 2006 increased 35% compared to 2005. The increases were primarily due to higher sales volumes of 423 MMcf/d associated with the third quarter 2006 acquisitions and higher volumes in the Haley field of West Texas, partially offset by natural declines in east Texas and north Louisiana. Production of natural gas is generally not directly affected by seasonal swings in demand.
Excluding the impact of gains and losses on derivatives, Anadarkos average natural gas price for 2007 decreased 7% compared to 2006. The relative difference in 2007 and 2006 prices is primarily attributed to a higher than average North America natural gas storage level, the full year effect in 2007 of the return of Gulf of Mexico gas production capacity in 2006 that was damaged during the 2005 hurricane season and a significant increase in liquefied natural gas supply into the United States. Excluding the impact of both realized and unrealized gains and losses on derivatives, Anadarkos average natural gas price for 2006 decreased 17% compared to 2005. As of December 31, 2007, the Company has implemented price risk management on about two-thirds of its anticipated natural gas wellhead sales volumes for 2008.
Crude Oil and Condensate Sales Volumes, Average Prices and Revenues
Anadarkos daily crude oil and condensate sales volumes were up 11% in 2007 compared to 2006 primarily due to an increase in sales volumes of 48 MBbls/d associated with the 2006 acquisitions, partially offset by a decrease in sales volumes of 20 MBbls/d associated with 2007 divestitures in the onshore United States, the Gulf of Mexico and Qatar and a decrease in Venezuela sales volumes due to contract changes in late 2006. Anadarkos daily crude oil and condensate sales volumes for 2006 were up 25% compared to the same period of 2005. The increases in 2006 compared to 2005 were primarily due to higher sales volumes associated with the third quarter 2006 acquisitions of 37 MBbls/d and additional wells being tied in and put into production at the Companys legacy properties in the Gulf of Mexico, partially offset by a decrease in sales volumes from Venezuela. Production of oil usually is not affected by seasonal swings in demand.
Excluding the impact of gains and losses on derivatives, Anadarkos average crude oil price for 2007 increased 14% compared to 2006. The higher crude oil prices were attributed primarily to additional global demand, limited excess production capacity and heightened geopolitical tension. Excluding the impact of both realized and unrealized gains and losses on derivatives, Anadarkos average crude oil price for 2006 increased 18% compared to 2005. The higher crude oil prices were attributed to continuing political unrest in oil exporting countries, increased worldwide demand and the impact of hurricanes in the Gulf of Mexico on oil production and infrastructure. As of December 31, 2007, the Company has utilized price risk management on about half of its anticipated oil and condensate sales volumes for 2008.
Natural Gas Liquids Sales Volumes, Average Prices and Revenues
Anadarkos daily NGLs sales volumes were up 2% in 2007 compared to 2006 primarily due to higher sales volumes of 8 MBbls/d associated with the 2006 acquisitions, partially offset by a decrease in sales volumes of 6 MBbls/d related to the 2007 divestitures. Anadarkos daily NGLs sales volumes in 2006 were up 17% compared to 2005, primarily due to higher sales volumes associated with the third quarter 2006 acquisitions of 6 MBbls/d.
For 2007, the average NGLs price increased 16% compared to 2006. During 2006, average NGLs prices increased 15% compared to 2005. NGLs production is dependent on natural gas and NGLs prices as well as the economics of processing the natural gas to extract NGLs. NGLs sales represent revenues derived from the processing of Anadarkos natural gas production.
Gathering, Processing and Marketing Revenues
During 2007, gathering and processing sales increased $721 million compared to 2006 primarily due to gathering and processing operations acquired with the 2006 acquisitions, partially offset by a decrease associated with divestitures in 2007. During 2006, gathering and processing sales increased $512 million compared to 2005 also due to the 2006 acquisitions. Gathering and processing revenues represent revenues derived from gathering and processing natural gas from sources other than the Companys production. Marketing sales primarily represent the revenues earned on sales of third-party gas, oil and NGLs, net of the related purchases.
Costs and Expenses
During 2007, Anadarkos costs and expenses increased 46% compared to 2006 due to the following factors:
During 2006, Anadarkos costs and expenses increased 101% compared to 2005 due to the following factors:
Interest Expense and Other (Income) Expense
Interest Expense Anadarkos gross interest expense for 2007 increased 66% compared to 2006. The increase was primarily due to higher average borrowings associated with the 2006 acquisitions and higher interest rates compared to 2006. Anadarkos gross interest expense increased 174% during 2006 compared to 2005. The increase was primarily due to an increase in debt associated with the 2006 acquisitions. For additional information see Acquisitions and Divestitures and Debt below and Interest Rate Risk under Item 7a of this Form 10-K.
In 2007, capitalized interest increased by 53% compared to 2006. In 2006, capitalized interest increased by 78% compared to 2005. These increases were primarily due to higher capitalized costs that qualify for interest capitalization.
Other (Income) Expense For 2007, the Company had other income of $74 million compared to $6 million for 2006. The increase of $68 million was primarily due to higher interest income of $37 million, a $22 million loss on an impaired equity investment in 2006 and a $10 million loss related to environmental reserve adjustments in 2006.
For 2006, the Company had other income of $6 million compared to $76 million for 2005. The decrease of $70 million was primarily due to a $60 million decrease in gains related to the effect of market values for firm transportation subject to a keep-whole agreement, a $22 million loss on an impaired equity investment and an $18 million loss related to environmental and legal reserve adjustments, partially offset by a $30 million increase in interest income. The keep-whole agreement was terminated April 1, 2006.
Income Tax Expense
For 2007, income tax expense related to continuing operations increased 103% compared to 2006 primarily due to an increase in income before income taxes and variances from the statutory rate. For 2006, income taxes decreased 1% compared to 2005 primarily due to a decrease in state income taxes resulting from enacted Texas legislation, excess U.S. foreign tax credits and a decrease in net foreign income taxes.
The variance from the 35% statutory rate in 2007 is primarily caused by the Algerian exceptional profits tax which is non-deductible for Algerian income tax purposes, other foreign taxes in excess of federal statutory rates, state income taxes and other items. For 2006 and 2005, variances from the 35% statutory rate are caused by foreign taxes in excess of federal statutory rates, state income taxes, excess U.S. foreign tax credits and other items.
Texas House Bill 3, signed into law in May 2006, eliminates the taxable capital and earned surplus components of the existing franchise tax and replaces these components with a taxable margin tax calculated on a combined basis. The new tax is effective for reports due on or after January 1, 2008 (based on business activity during 2007). Anadarko is required to include the impact of the law change on its deferred state income taxes in income for the period which includes the date of enactment. The adjustment, a reduction in Anadarkos deferred state income taxes in the amount of approximately $14 million and $69 million, net of federal benefit, was included in the 2007 and 2006 tax provision, respectively.
Segment AnalysisAdjusted EBITDAX To assess the operating results of Anadarkos segments, management uses income from continuing operations before income taxes, interest expense, exploration expense, DD&A expense and impairments (Adjusted EBITDAX). The Companys definition of Adjusted EBITDAX, which is a non-GAAP measure, excludes exploration expense, as exploration expense is not an indicator of operating efficiency for a given reporting period, but is monitored by management as part of costs incurred in exploration and development activities. Similarly, DD&A expense and impairments are excluded from Adjusted EBITDAX
as a measure of segment operating performance, as capital expenditures are evaluated at the time capital costs are incurred. Anadarkos definition of Adjusted EBITDAX also excludes interest expense to allow for assessment of segment operating results without regard to the Companys financing methods or capital structure. Management believes that the presentation of Adjusted EBITDAX provides information useful in assessing the Companys financial condition and results of operations and that Adjusted EBITDAX is a widely accepted financial indicator of a companys ability to incur and service debt, fund capital expenditures and make distributions to shareholders.
Adjusted EBITDAX, as defined by Anadarko, may not be comparable to similarly titled measures used by other companies, and therefore, the Companys consolidated Adjusted EBITDAX should be considered in conjunction with income from continuing operations and other performance measures prepared in accordance with GAAP, such as operating income or cash flow from operating activities. Adjusted EBITDAX has important limitations as an analytical tool because it excludes certain items that affect income from continuing operations and net cash provided by operating activities. Adjusted EBITDAX should not be considered in isolation or as a substitute for analysis of Anadarkos results as reported under GAAP. Below is a reconciliation of consolidated Adjusted EBITDAX to income from continuing operations before income taxes.
Oil and Gas Exploration and Production The increase in Adjusted EBITDAX for 2007 compared to 2006 was primarily due to an increase in gains on divestitures of $4.1 billion and higher sales volumes, partially offset by the impact of lower natural gas and oil and condensate prices and higher costs and expenses, including the Algerian exceptional profits tax. The increase in 2006 Adjusted EBITDAX compared to 2005 was primarily due to higher sales volumes and prices, partially offset by higher operating costs and expenses. In 2007 and 2006, the higher sales volumes and costs and expenses were due primarily to the impact of operations acquired with the third quarter 2006 acquisitions. The Companys sales revenues include the impact of price risk management (including realized and unrealized gains and losses) which decreased total revenues $472 million during 2007, compared to an increase of $1,131 million in 2006 and a decrease of $294 million during 2005. Of these amounts for 2007 and 2006, $(1,048) million and $837 million, respectively, were related to the recognition of net unrealized gains (losses) on derivatives used to manage price risk on natural gas, crude oil, condensate and NGLs sales. Unrealized gains and (losses) on derivatives were not material in 2005.
Midstream The increase in Adjusted EBITDAX for 2007 compared to 2006 resulted primarily from an increase in gains on divestitures of $532 million related to midstream assets and an increased scope of midstream operations resulting from the 2006 acquisitions, partially offset by a decrease in earnings associated with the 2007 divestitures. During July 2007, the Company divested its interests in two natural gas gathering systems and associated processing plants that did not operate in areas where Anadarko has significant oil and gas production. These divested facilities accounted for $75 million, or 21%, of Anadarkos midstream segments adjusted EBITDAX excluding gains on divestitures during 2007. The increase in 2006 Adjusted EBITDAX compared to 2005 was also primarily due to the 2006 acquisitions.
Marketing Marketing earnings primarily represents the revenues earned on sales of third-party gas, oil and NGLs, net of the related purchases. The increase in Adjusted EBITDAX for 2007 compared to 2006, as well as 2006 compared to 2005, resulted primarily from the effects of higher volumes transported as a result of the 2006 acquisitions.
Other and Intersegment Eliminations All other and intersegment eliminations consists primarily of the elimination of revenues and expenses between segments, corporate costs that are not allocated to the operating segments and income from hard minerals investments and royalties. The decrease in Adjusted EBITDAX for 2007 compared to 2006 was primarily due to increased interest expense from the 2006 acquisitions, increases in compensation expense from the increased average number of employees associated with the 2006 acquisitions and an increase in eliminations of intersegment transactions. The decrease in 2006 Adjusted EBITDAX compared to 2005 was primarily due to higher interest, compensation, legal and other general expenses attributed to the 2006 acquisitions as well as an increase in eliminations of intersegment transactions.
Acquisitions and Divestitures In August 2006, Anadarko acquired Kerr-McGee and Western in separate all-cash transactions. Anadarko initially financed $22.5 billion for the acquisitions through a 364-day committed acquisition facility with plans to repay it with proceeds from asset divestitures, free cash flow from operations and the issuance of equity, debt and bank financing during the term of the facility. Through December 31, 2007, the Company had reduced the initial amount owed under the acquisition facility from $22.5 billion to approximately $1.0 billion, using divestiture proceeds, long-term debt financing and cash flow from operations.
Kerr-McGee Transaction On August 10, 2006, Anadarko completed the acquisition of Kerr-McGee for $16.5 billion, or $70.50 per share, plus the assumption of $2.6 billion of debt. Kerr-McGees year-end 2005 proved reserves, excluding Gulf of Mexico shelf divestitures, totaled 898 MMBOE, of which approximately 62% was natural gas. Proved undeveloped reserves represented 30% of the total.
Kerr-McGees legacy core properties are located in the deepwater Gulf of Mexico and onshore in Colorado and Utah. They include deepwater Gulf of Mexico blocks which are supported by Kerr-McGees hub-and-spoke infrastructure. In Colorado, Kerr-McGee holds acreage in the Wattenberg natural gas play, located largely on Anadarkos Land Grant holdings, where Anadarko owns the royalty interest. In Utah, Kerr-McGee holds acreage in the Uinta basins prolific Greater Natural Buttes gas play. In addition to its U.S. portfolio, Kerr-McGee produces oil and is continuing to develop and explore offshore China, has made discoveries and is pursuing the development of fields offshore Brazil, and is exploring West Africa and the islands of Trinidad and Tobago.
Western Transaction On August 23, 2006, Anadarko completed the acquisition of Western for $4.8 billion, or $61.00 per share, plus the assumption of $625 million of debt. Westerns year-end 2005 proved reserves totaled 153 MMBOE, with proved undeveloped reserves representing 57% of the total. Essentially all of the reserves are natural gas.
Westerns coalbed methane properties within the Powder River basin are directly adjacent to Anadarkos assets in this developing play. Anadarko believes that combining its properties with Westerns will accelerate the development of these natural gas resources and produce volume growth through the end of the decade, and possibly longer, with more than 12,000 identified drilling locations in inventory. The acquisition of Western also significantly increased the Companys holdings in gathering and processing systems.
Divestitures As a result of a portfolio refocusing effort stemming from the acquisitions of Kerr-McGee and Western, Anadarko divested certain properties during 2007 and 2006 for approximately $17 billion before income taxes. Net proceeds from these divestitures were used to retire debt. While the Company has identified some additional assets for possible monetization, the vast majority of producing property divestitures were closed by year-end 2007.
During 2006, Anadarko sold its wholly-owned subsidiary, Anadarko Canada Corporation, for approximately $4 billion before taxes. See Discontinued Operations. On the acquisition date, Kerr-McGees other assets included approximately $1 billion of assets held for sale. The sale of these assets closed in August 2006 and the proceeds were also used to pay down debt incurred to fund the acquisitions.
During 2007, the Company closed several unrelated divestiture transactions representing approximately $11 billion before income taxes. The most significant of these transactions are discussed below.
In January 2007, the Company sold its interests in the Knotty Head and Big Foot oil discoveries, as well as the Big Foot North prospect in the Gulf of Mexico, for $0.9 billion. During February 2007, Anadarko also closed the sale of its Genghis Khan discovery in the deepwater Gulf of Mexico for $1.3 billion. In March 2007, Anadarko divested control of its interests in 28 Permian basin oil and gas fields in West Texas for $1.0 billion (see Off-Balance Sheet Arrangements), sold its Vernon and Ansley fields located in Jackson Parish, Louisiana, for $1.5 billion and sold its interests in the Elk basin and Gooseberry area of the Northern Rockies for $0.4 billion.
In April 2007, Anadarko sold its interests in the Williston basin area of the Northern Rockies for $0.4 billion. In May 2007, Anadarko sold its interests in certain natural gas properties in Oklahoma and Texas for $0.9 billion and also sold a 23% working interest in the K2 Unit in the Gulf of Mexico for $1.2 billion. Anadarko remains the K2 Unit operator with a 42% working interest. In June 2007, Anadarko sold certain of its interests in the Austin Chalk play in central and east Texas for $0.8 billion.
In July 2007, the Company divested control of its interests in the Chaney Dell and Midkiff/Benedum natural gas gathering systems and associated processing plants for $1.9 billion (see Off-Balance Sheet Arrangements).
In October 2007, the Company divested certain interests in Qatar for approximately $350 million. Anadarko used the net proceeds from this transaction to further reduce debt. For additional information, see Note 5Discontinued Operations, Assets Held for Sale and Other Divestitures under Item 8 of this Form 10-K.
Proved Reserves Anadarko focuses on growth and profitability. Reserve replacement is a key to growth. Future profitability depends upon the cost of finding and developing oil and gas reserves, among other factors. Reserve growth can be achieved through successful exploration and development drilling, improved recovery or acquisition of producing properties.
In conjunction with the August 2006 acquisition of Kerr-McGee and Western, Anadarko implemented an asset realignment program. The goal of the Kerr-McGee and Western acquisitions was to provide a more economically efficient platform with higher and more consistent growth potential, with the intent of divesting properties that were no longer deemed to be core to Anadarkos operations. During 2007, the Company successfully completed the majority of the divestiture stage of the realignment program. As expected, Anadarkos proved reserves were about equal to levels before the acquisitions. For additional information about the benefits the Company believes are provided by the realigned portfolio, see Outlook.
The following discussion of proved reserves, reserve additions and revisions and future net cash flows from proved reserves includes both continuing and discontinued operations. A breakdown of reserve information by continuing and discontinued operations is contained in the Supplemental Information under Item 8 of this Form 10-K.
The Companys proved natural gas reserves at year-end 2007 were 8.5 Tcf compared to 10.5 Tcf at year-end 2006 and 7.9 Tcf at year-end 2005. Anadarkos proved crude oil, condensate and NGLs reserves at year-end 2007 were 1.0 billion barrels compared to 1.3 billion barrels at year-end 2006 and 1.1 billion barrels at year-end 2005. Crude oil, condensate and NGLs comprised about 42%, 42% and 46% of the Companys proved reserves at year-end 2007, 2006 and 2005, respectively.
The Companys estimates of proved reserves are made using available geological and reservoir data as well as production performance data. These estimates, made by the Companys engineers, are reviewed annually and revised, either upward or downward, as warranted by additional data. The available data reviewed include, among other things, seismic data, structure and isopach maps, well logs, production tests, material balance calculations, reservoir simulation models, reservoir pressures, individual well and field performance data, individual well and field projections, offset performance data, operating expenses, capital costs and product prices. Revisions are necessary due to changes in, among other things, reservoir performance, prices, economic conditions and governmental restrictions, as well as changes in the expected recovery rates associated with infill drilling. Sustained decreases in prices, for example, may cause a reduction in some proved reserves due to reaching economic limits sooner.
Reserve Additions and Revisions During 2007, the Company added 252 MMBOE of proved reserves as a result of additions (purchases in place, discoveries, improved recovery and extensions) and revisions. The Company expects the majority of future reserve adds to come from positive revisions associated with infill drilling and extensions of current fields and new discoveries onshore in North America and the deepwaters of the Gulf of Mexico, as well as through improved recovery operations, purchases of proved properties in strategic areas and successful exploration in international growth areas. The success of these operations will directly impact reserve additions or revisions in the future.
Additions During 2007, Anadarko added 131 MMBOE of proved reserves. The Company added 130 MMBOE of proved reserves primarily as a result of successful drilling in coalbed methane and conventional plays of the Rockies and the initial recognition of proved reserves at the Peregrino field in Brazil. During 2006, Anadarko added 1,118 MMBOE of proved reserves. Of this amount, 1,030 MMBOE were related to purchases in place primarily associated with the acquisitions of Kerr-McGee and Western in August 2006. In addition, the Company added 88 MMBOE of proved reserves primarily as a result of successful drilling in core areas onshore in the United States. During 2005, Anadarko added 212 MMBOE of proved reserves. Of this amount, 207 MMBOE were added as a result of successful drilling in the deepwater Gulf of Mexico and fields in the north Louisiana Vernon, east Texas Bossier, west Texas Haley and Canadian Wild River areas and successful improved recovery operations in Wyoming.
Revisions Total revisions in 2007 were 121 MMBOE or 4.0% of the beginning of year reserve base. The revisions were related primarily to the large onshore natural gas plays such as Greater Natural Buttes, Wattenberg, and Pinedale and Jonah fields, where the reserve bookings for the infill wells are treated as a positive revision, and the increase in oil and natural gas prices. Total revisions for 2006 and 2005 were (75) MMBOE and 79 MMBOE, respectively. Revisions in 2006 related primarily to performance revisions of (136) MMBOE mainly due to downward revisions of the Companys reserves at the K2 complex in the Gulf of Mexico and adjustments in Algeria, and price revisions of (99) MMBOE primarily due to a significant decrease in natural gas prices since the end of 2005, partially offset by additional infill drilling reserve bookings of 160 MMBOE. Revisions in 2005 related primarily to additional infill drilling reserve bookings of 102 MMBOE, partially offset by the impact of government imposed limits on production in Venezuela, as well as a reduction of NGLs reserves in Algeria resulting from a change in project scope.
Sales in Place In 2007, the Company sold properties located in the United States and Qatar representing 609 MMBOE and 11 MMBOE of proved reserves, respectively. In 2006, the Company sold properties located in Canada representing 248 MMBOE of proved reserves. In addition, sales in place included 39 MMBOE of proved reserves related to government imposed contract changes which resulted in the Companys Venezuelan properties being exchanged for an equity interest in a new Venezuela operating entity. In 2005, Anadarko sold properties located in the United States, Oman and Canada representing 25 MMBOE, 25 MMBOE and 1 MMBOE of proved reserves, respectively.
Future Net Cash Flows At December 31, 2007, the present value (discounted at 10%) of future net cash flows from Anadarkos proved reserves was $28.9 billion (stated in accordance with the regulations of the Securities
and Exchange Commission (SEC) and the Financial Accounting Standards Board (FASB)). This present value was calculated based on prices at year-end held flat for the life of the reserves, adjusted for any contractual provisions. The increase of $3.3 billion or 13% in 2007 compared to 2006 is primarily due to higher natural gas and oil prices at year-end 2007 and successful exploration and development, partially offset by the divestiture program. See Supplemental Information under Item 8 of this Form 10-K.
The present value of future net cash flows does not purport to be an estimate of the fair market value of Anadarkos proved reserves. An estimate of fair value would also take into account, among other things, anticipated changes in future prices and costs, the expected recovery of reserves in excess of proved reserves and a discount factor more representative of the time value of money and the risks inherent in producing oil and gas.
Anadarko invests in midstream (gathering and processing) facilities to complement its oil and gas operations in regions where the Company has natural gas production. The Company is better able to control the timing of development of its oil and gas properties and manage both the value received for, and cost of, gathering, treating and processing natural gas through its ownership and operation of these facilities. In addition, Anadarkos midstream business provides gathering, treating and processing services for third-party customers, including major and independent producers. Anadarko generates revenues in its gathering and processing activities through various fee structures that include fixed-rate, percent of proceeds, or keep-whole agreements. The Company also processes a portion of its gas at various third-party plants.
In 2006, Anadarko significantly increased the size and scope of its midstream business through the acquisitions of Western and Kerr-McGee. Anadarko currently has systems in eight states (Wyoming, Colorado, Utah, New Mexico, Kansas, Oklahoma, Texas and Louisiana) located in major producing basins of the onshore United States.
On October 15, 2007, Western Gas Partners, LP (the Partnership), a newly formed 100% owned subsidiary of the Company, filed a registration statement on Form S-1 with the SEC relating to a proposed underwritten initial public offering of 18.75 million common units, representing limited partnership interests in the Partnership, plus an option for the underwriters to purchase up to an additional 2.81 million common units. The Partnership was initially formed by Anadarko, the indirect owner of the general partner of the Partnership, to own and develop midstream assets. Upon completion of this transaction, Anadarko expects to hold approximately 59% of the interests in the Partnership. Anadarko will retain indirect ownership of the general partnership interest in the Partnership and will continue to operate the Partnerships assets pursuant to an omnibus agreement, a services and secondment agreement and a tax sharing agreement. Since gathering and processing assets support Anadarkos oil and gas producing activities, Anadarko plans to maintain operational control of the assets and expects to continue to consolidate the results of that business in its financial statements. The Company expects to use proceeds it receives from this transaction to repay a portion of the midstream note payable to a related party discussed below.
In December 2007, a midstream subsidiary issued a $2.2 billion note payable to a related party. See Note 9Debt and Interest Expense of the Notes to Consolidated Financial Statements under Item 8 and Debt below for additional information.
The Companys marketing department manages sales of its natural gas, crude oil and NGLs. In marketing its production, the Company attempts to maximize realized prices while managing credit exposure. The Companys sales of natural gas, crude oil, condensate and NGLs are generally made at the market prices of those products at the time of sale. In 2007, the Company also engaged in sales of greenhouse gas emission reduction credits (ERCs) derived from CO2 injection operations in Wyoming. The Company expects additional sales of ERCs in the future.
The Company also purchases natural gas, crude oil, condensate and NGLs volumes for resale primarily from partners and producers near Anadarkos production. These purchases allow Anadarko to aggregate larger volumes, fully utilize transportation capacity, attract larger, creditworthy customers and facilitate its efforts to
maximize prices received for the Companys production and minimize balancing issues with customers and pipelines during operational disruptions.
The Company may also engage in trading activities for the purpose of generating profits from exposure to changes in market prices of natural gas, crude oil, condensate and NGLs. The Company does not engage in market-making practices and limits its trading activities to natural gas, crude oil and NGLs commodity contracts. The Companys trading risk position, typically, is a net short position that is offset by the Companys natural long position as a producer. See Energy Price Risk under Item 7a of this Form 10-K.
In an effort to protect the Company from commodity price risk stemming from the 2006 acquisitions, the Company entered into derivatives covering 72% and 55% of the acquired companies then expected production volumes for 2007 and 2008, respectively. This price risk management program employed collars and other derivatives, intended to help ensure a return on investment while maintaining upside potential that could result from higher commodity prices.
In recent years, all segments of the energy market have experienced increased scrutiny of their financial condition, liquidity and credit. This has been reflected in credit rating downgrades of many merchant energy trading companies. Anadarko has not experienced any material financial losses associated with credit deterioration of third parties; however, in certain situations the Company has declined to transact with some counterparties and changed its sales terms to require some counterparties to pay in advance or post letters of credit for purchases.
Natural Gas Natural gas continues to fulfill a significant portion of North Americas energy needs and the Company believes the importance of natural gas in meeting this energy need will continue. Natural gas prices have varied over the last year, with an overall decline in prices during 2007. Price volatility persists due to a relatively tight supply and demand balance. Anadarko markets its natural gas production to maximize the commodity value and reduce the inherent risks of the physical commodity markets. Anadarko Energy Services Company (AESC), a wholly-owned subsidiary of Anadarko, is a marketing company offering supply assurance, competitive pricing, risk management and other services tailored to its customers needs. The Company sells natural gas under a variety of contracts and may also receive a service fee related to the level of reliability and service required by the customer. The Company has the marketing capability to move large volumes of gas into and out of the daily gas market to take advantage of any price volatility.
The Company owns a significant amount of natural gas firm transportation capacity that is used to help ensure access to downstream markets and provides the opportunity to capture incremental value when pricing differentials between physical locations occur. The Company also stores some of its purchased natural gas in contracted storage facilities with the intent of selling the gas at a higher price in the future. Normally, the Company will have forward contracts in place (physical delivery or financial derivative instruments) to sell the stored gas at a fixed price.
Western and Kerr-McGee both have gas marketing organizations that are being incorporated into AESC. Kerr-McGee had a long-term gas sales contract with Cinergy (since acquired by Fortis). In 2006, approximately 50% of gas volumes and revenues associated with the Kerr-McGee acquisition were sold under this legacy contract. This contract was terminated in March 2007, and the associated volumes were integrated into the Companys marketing operations.
Crude Oil, Condensate and NGLs Anadarkos crude oil, condensate and NGLs revenues are derived from production in the U.S., Algeria and other international areas. Most of the Companys U.S. crude oil and NGLs production is sold under contracts with prices based on market indices, adjusted for location, quality and transportation. Oil from Algeria is sold by tanker as Saharan Blend to customers primarily in the Mediterranean area. Saharan Blend is a high quality crude that provides refiners large quantities of premium products such as jet and diesel fuel. Oil from China is sold by tanker as Cao Fei Dian (CFD Blend) to customers primarily in the Far East markets. CFD Blend is a heavy sour crude oil which is sold into both the prime fuels refining market and the heavy fuel oil blend stock market. The Company also purchases and sells third-party produced crude oil, condensate and NGLs in the Companys domestic and international market areas. Included in this strategy is the use of contracted NGLs storage facilities and various derivative instruments.
Capital Resources and Liquidity
Overview Anadarkos primary sources of cash during 2007 were divestiture transactions, cash flow from operating activities and proceeds from the midstream subsidiary note to a related party. The Company used cash primarily to retire debt, to fund Anadarkos capital spending program and to pay income taxes and dividends. Anadarkos primary sources of cash during 2006 were the issuance of debt, cash flow from operating activities and divestitures. During 2006, the Company used cash primarily to fund the acquisitions of Kerr-McGee and Western, to fund its capital spending program, repurchase Anadarko common stock, pay dividends and retire debt as well as preferred stock. Anadarkos primary source of cash during 2005 was cash flow from operating activities. The Company used 2005 cash flow primarily to fund its capital spending program, repurchase Anadarko common stock and pay dividends. In addition, the Company used $170 million of cash from the 2004 divestitures to retire debt in 2005.
Following is a discussion of significant sources and uses of cash flows during the period. Forward-looking information related to the Companys capital resources and liquidity are discussed in Outlook that follows.
Divestitures During 2007, Anadarko derived significant sources of cash from its divestiture program. See Acquisitions and Divestitures. Proceeds from these divestitures were used to reduce debt and pay income taxes on taxable gains associated with the divestitures.
Cash Flow from Operating Activities Anadarkos cash flow from continuing operating activities in 2007 was $2.8 billion compared to $4.7 billion in 2006 and $3.2 billion in 2005. The decrease in 2007 cash flow was attributed to the impact of income taxes on divestitures and higher costs and expenses, partially offset by the impact of higher sales volumes associated with the acquisitions. The Company had tax payments of $2.3 billion in 2007 that significantly impacted cash flow from operating activities as a result of the taxable gains on the divestitures. This decrease was effectively offset by an increase in cash flow from investing activities where proceeds from divestitures are presented before income taxes. The increase in 2006 cash flow compared to 2005 was attributed to the impact of the acquisitions and higher commodity prices, partially offset by higher costs and expenses and slightly lower legacy sales volumes.
Excluding the impact of acquisitions and divestitures, fluctuations in commodity prices have been the primary reason for the Companys short-term changes in cash flow from operating activities. Anadarko holds derivative instruments to help manage commodity price risk. Sales volume changes can also impact cash flow in the short-term, but have not been as volatile as commodity prices in prior years. Anadarkos long-term cash flow from operating activities is dependent on commodity prices, reserve replacement, the level of costs and expenses required for continued operations and the level of acquisition and divestiture activity.
Debt At year-end 2007, Anadarkos total debt was $14.7 billion compared to total debt of $23.0 billion at year-end 2006 and $3.6 billion at year-end 2005. During 2007, the Company repaid $10.5 billion in debt that was classified as current at December 31, 2006, primarily with proceeds from divestitures and the issuance of a long-term $2.2 billion midstream note payable discussed below. The increase in debt in 2006 was attributed primarily to borrowings associated with the 2006 acquisitions.
In January 2008, Anadarko entered into forward-looking 18-month interest rate swaps effective March 2008 with an aggregate notional value of $1.0 billion whereby the Company will pay a weighted-average fixed interest rate of 2.74% and receive a floating interest rate indexed to the three-month LIBOR rate. Anadarko discontinued hedge accounting on January 1, 2007, therefore all gains and losses associated with these swaps will be recorded to interest expense.
For additional information on the Companys debt instruments, such as transactions during the period, years of maturity and interest rates, see Note 9Debt and Interest Expense of the Notes to Consolidated Financial Statements under Item 8 of this Form 10-K.
Midstream Subsidiary Note Payable to a Related Party In late December 2007, Anadarko and an entity formed by a group of unrelated third-party investors (the Investor) formed Trinity Associates LLC (Trinity). As discussed in Note 11Unconsolidated Affiliates of the Notes to Consolidated Financial Statements under Item 8 of this Form 10-K, Trinitys initial capitalization consisted of Anadarkos $100 million cash contribution in
exchange for a common interest in Trinity and the Investors $2.2 billion cash contribution in exchange for a preferred interest. Trinity, a related party, extended a $2.2 billion loan to a wholly-owned subsidiary of Anadarko, referred to herein as Midstream Holding, which holds and operates midstream assets directly and through its subsidiaries. The Company used all of the loan proceeds received by Midstream Holding to repay a portion of the Companys acquisition facility indebtedness. The principal balance owed by Midstream Holding to Trinity is reflected in the consolidated balance sheet as Midstream Subsidiary Note Payable to a Related Party. Midstream Holdings obligations under the loan agreement are not guaranteed by Anadarko Petroleum Corporation but are unconditionally guaranteed, jointly and severally, by all of Midstream Holdings subsidiaries.
Capital Expenditures The following table shows the Companys capital expenditures relating to continuing operations by category.
Anadarkos capital expenditures decreased 5% in 2007 compared to 2006. The Companys capital spending increased 59% in 2006 compared to 2005. The 2007 decrease was primarily due to a decrease in development drilling and construction expenditures and a decrease in exploration lease acquisition activity, partially offset by an increase in capital expenditures on gathering and processing facilities. The increase in 2006 resulted primarily from an increase in exploration lease acquisitions, offshore drilling completions, development of the CBM infrastructure and capital expenditures of the acquired companies. Additionally, all of the periods were impacted by rising service and material costs. The variances in the mix of oil and gas spending reflect the Companys available opportunities based on the near-term ranking of projects by net asset value potential.
Proved property acquisitions and unproved property acquisitions in 2007 include adjustments of $(600) million and $(484) million, respectively, related to finalizing the allocation of fair value to oil and gas properties acquired from Kerr-McGee and Western in 2006. The property acquisitions in 2006 related primarily to Kerr-McGee and Western. The property acquisitions in 2005 primarily related to exploratory nonproducing leases.
Anadarko participated in a total of 1,823 gross wells in 2007 compared to 1,537 gross wells in 2006 and 688 gross wells in 2005.
The following table provides additional detail of the Companys drilling activity in 2007 and 2006.
Gross: total wells in which there was participation.
Net: working interest ownership.
The Companys 2007 exploration and development drilling program is discussed in Oil and Gas Properties and Activities under Item 1 of this Form 10-K.
Dividends In 2007, 2006 and 2005, Anadarko paid $170 million, $167 million and $170 million, respectively, in dividends to its common stockholders (nine cents per share per quarter). Anadarko has paid a dividend to its common stockholders continuously since becoming an independent company in 1986. The amount of future dividends for Anadarko common stock will depend on earnings, financial conditions, capital requirements and other factors, and will be determined by the Board of Directors on a quarterly basis.
The covenants in the Companys credit agreement provide for a maximum capitalization ratio of 60% debt, exclusive of the effect of any non-cash writedowns. As of December 31, 2007, Anadarkos capitalization ratio was 47%. Although the covenants of the agreement do not specifically restrict the payment of dividends, the Company could be limited in the amount of dividends it could pay in order to stay below the maximum capitalization ratio. Based on these covenants, retained earnings of approximately $6.6 billion were not limited as to the payment of dividends.
In 2007, 2006 and 2005, Anadarko also paid $3 million, $3 million and $5 million, respectively, in preferred stock dividends. In 2008, preferred stock dividends are expected to be $2 million.
Common Stock Repurchase Program During 2005, a $2 billion stock buyback program announced in 2004 was completed and an additional $1 billion stock buyback program was authorized in November 2005. Shares may be repurchased either in the open market or through privately negotiated transactions. During 2007, no shares were repurchased under the plan. During 2006 and 2005, Anadarko purchased 2.5 million and 21.6 million shares of common stock for $0.1 billion and $0.9 billion, respectively, under these programs. The repurchase program does not obligate Anadarko to acquire any specific number of shares and may be discontinued at any time. At December 31, 2007, $636 million remained available for stock repurchases under the program authorized in 2005.
Outlook The Companys goals include continuing to find or acquire high-margin oil and gas reserves at competitive prices while keeping operating costs at efficient levels. Anadarko completed the acquisitions of Kerr-McGee and Western in August 2006 in two separate all-cash transactions. As of December 31, 2007, the Company had reduced the initial amount owed under a facility that was used to finance the acquisitions to approximately $1.0 billion using divestiture proceeds, long-term debt financings and cash flow from operations. The Company expects to repay the remaining balance owed under the facility, which matures in March 2008, with proceeds from identified divestitures and excess cash, possibly supplemented with short-term
borrowings. As discussed previously, Anadarko intends to reduce its economic interest in certain midstream assets through the formation and initial public offering of a Master Limited Partnership. The net after-tax proceeds from this transaction will be used to reduce indebtedness under the midstream note payable to a related party.
The objective of the Kerr-McGee and Western acquisitions was to provide a more economically efficient platform with higher and more consistent growth potential, with the intent of divesting properties that were no longer deemed to be core to Anadarkos operations. During 2007, the Company successfully completed the majority of the divestiture stage of the realignment program. As expected, Anadarkos proved reserves after completing the divestitures were about equal to levels before the acquisitions. The Company estimates that approximately 7% of the sales volumes for 2007 are associated with the properties which have been divested. The new portfolio is intended to be better balanced, with lower-risk U.S. onshore resource plays complementing the volatility inherent in the Companys deepwater Gulf of Mexico and international programs. The Company believes the acquisitions and optimization of its portfolio provide:
The Company has an approved 2008 capital spending budget of $4.7 billion. The Company has allocated about 65% of capital spending to development activities, 20% to exploration activities, 10% to gas gathering and processing activities, with the remaining 5% for capitalized interest and other items. The Company expects capital spending by area to be approximately 30% for the Rockies, 20% for the Southern region, 25% for the Gulf of Mexico, 15% for International and Alaska and 10% for Midstream. Emphasis will be on production growth in the Rockies, continued development in the Gulf of Mexico, including the start-up of the Blind Faith platform, and progress toward first production in Brazil that is expected in 2010. The Companys capital discipline strategy is to set capital activity at levels that can be funded with operating cash flows. Anadarko believes that its expected level of cash flow will be sufficient to fund the Companys projected operational program for 2008.
If capital expenditures were to exceed operating cash flow, funds would be supplemented as needed by short-term borrowings. To facilitate such borrowings, the Company has in place a $750 million committed credit agreement, which is supplemented by various noncommitted credit lines that may be offered by certain banks from time to time at then-quoted rates. As of December 31, 2007, the Company had no outstanding borrowings under its credit facility. The Companys policy is to limit commercial paper borrowing to levels that are fully supported by unused balances from its committed credit facilities. The Company may choose to refinance certain portions of these short-term borrowings by issuing long-term debt in the public or private debt markets. To facilitate such financings, the Company may sell securities under its shelf registration statement filed with the SEC in September 2006.
The Company continuously monitors its debt position and coordinates its capital expenditure program with expected cash flows and projected debt repayment schedules. The Company will continue to evaluate funding alternatives, including property divestitures and additional borrowings, to secure funds when needed.
Recent Activities Prices for the Companys natural gas sales are a function of both the New York Mercantile Exchange (NYMEX) prices as well as basis differentials for various sales regions. The Company has been active recently trying to protect against wider basis differentials versus NYMEX index by utilizing basis hedges and firm transportation agreements. In January and February of 2008, the Company added to its existing NYMEX hedging program an additional 340 thousand MMBtu/d for 2009 using three-way option collars. The Company now has a total of 530 thousand MMBtu/d (0.5 Bcf/d) of 2009 natural gas hedged using three-way option collars. Averaging the total 2009 hedged position of the Company results in a floor of $7.50 per MMBtu in place until
$5.45 per MMBtu, at which point the Company will receive market plus $2.05 per MMBtu for prices below $5.45 per MMBtu. Additionally, the price will be capped at $11.25 per MMBtu for gas prices above that level.
For additional information on factors that could impact Anadarkos future results of operations, cash flows from operating activities or financial position see Critical Accounting Policies and Estimates below and Risk Factors under Item 1a of this Form 10-K.
Off-Balance Sheet Arrangements
In 2007, Anadarko contributed certain of its producing oil and gas properties and gathering and processing assets, with an aggregate fair value of approximately $2.9 billion, to newly formed entities in exchange for noncontrolling mandatorily redeemable interests in those entities. Subsequent to their formation, the investee entities loaned Anadarko an aggregate of $2.9 billion, which the Company used to repay its acquisition-related debt. Anadarko has a legal right to setoff and intends to net-settle its obligations under each of the notes payable to the investees and the distributable value of its interest in the corresponding investee. Accordingly, the $2.9 billion aggregate principal amount of such notes does not affect Anadarkos reported debt balance, since the notes and the carrying amount of Anadarkos investments in the investees are presented on the consolidated balance sheet on a net basis. Note 11Unconsolidated Affiliates of the Notes to Consolidated Financial Statements under Item 8 of this Form 10-K provides additional information with respect to each of these transactions. Completion of these transactions resulted in Anadarko divesting control of its interests in certain non-core exploration and production and midstream assets and operations, while retaining a participating 5% interest in profits, losses and residual value of the investees.
With respect to each investee, liquidation of the investee or redemption of Anadarkos interest in the investee is expected to result in Anadarko net-settling in cash its obligation under the corresponding note payable with the distributable value of its interest in the investee. The Company does not currently expect such net settlement to have a material effect on its future financial condition, results of operations or cash flows. Each of Anadarkos noncontrolling interests in the investees is optionally redeemable by Anadarko or the controlling investor in or after 2022 and is mandatorily redeemable in 2037.
Obligations and Commitments
Following is a summary of the Companys obligations as of December 31, 2007:
Operating Leases Operating lease obligations include several drilling rig commitments that qualify as operating leases. Over the past three years, Anadarko has entered into several agreements to secure the necessary drilling rigs to execute its drilling strategy over several years. A previous review of the Companys worldwide deepwater drilling inventory, along with the tightening deepwater and onshore rig market, led Anadarko to secure the drilling rigs it needs to execute its strategy. The Company believes these rig-contracting efforts offer compelling economics and facilitate its drilling strategy. The portion of lease payments associated with successful exploratory wells and development wells, net of amounts billed to partners, will be capitalized as a component of oil and gas properties.
The Company also has $1.0 billion in commitments under noncancelable operating lease agreements for production platforms and equipment, buildings, facilities and aircraft.
For additional information see Note 21Commitments of the Notes to Consolidated Financial Statements under Item 8 of this Form 10-K.
Midstream and Marketing Activities Anadarko has entered into various transportation, storage and purchase agreements in order to access markets and provide flexibility for the sale of its natural gas and crude oil in certain areas. The above table includes amounts related to these commitments.
Oil and Gas Activities As is common in the oil and gas industry, Anadarko has various long-term contractual commitments pertaining to exploration, development and production activities, which extend beyond the 2008 budget. The Company has work-related commitments for, among other things, drilling wells, obtaining and processing seismic and fulfilling rig commitments. The preceding table includes long-term drilling and work- related commitments of $1,262 million, comprised of $391 million in the United States, $45 million in Algeria and $826 million in other international locations.
The Company also has option and swap contracts in place to manage price risk associated with a portion of its expected future sales of its oil and gas production. Both exchange and over-the-counter traded derivative instruments are subject to margin deposit requirements. Margin deposits are required of the Company whenever its unrealized losses with a counterparty exceed predetermined credit limits. Given the Companys price risk management position and price volatility, the Company may be required from time to time to advance cash to its counterparties in order to satisfy these margin deposit requirements. During 2007, the Companys margin deposit requirements have ranged from $21 to $119 million. The Company had margin deposits of $51 million outstanding at December 31, 2007.
Marketing and Trading Contracts The following tables provide information as of December 31, 2007 regarding the Companys marketing and trading portfolio of physical delivery and financially settled derivative instruments. See Critical Accounting Policies and Estimates for an explanation of how the fair value for derivatives is calculated.
Environmental Anadarko is also subject to various environmental remediation and reclamation obligations arising from federal, state and local laws and regulations. As of December 31, 2007, the Companys balance sheet included a $132 million liability for remediation and reclamation obligations, most of which were incurred by companies that Anadarko has acquired. The Company continually monitors the liability recorded and the remediation and reclamation process, and believes the amount recorded is appropriate. For additional information see Legal ProceedingsEnvironmental Matters under Item 3 of this Form 10-K.
Other In 2007 the Company made contributions of $16 million to its funded pension plans, $74 million to its unfunded pension plans and $22 million to its unfunded other postretirement benefit plans. Contributions to the funded plans increase the plan assets while contributions to unfunded plans are used for current benefit payments. In 2008, the Company expects to contribute $15 million to its funded pension plans, $11 million to its unfunded pension plans and $22 million to its unfunded other postretirement benefit plans. Future contributions to funded pension plans will be affected by actuarial assumptions, market performance and individual year funding decisions. The Company is unable to accurately predict what contribution levels will be required beyond 2008 for the pension plans; however, they are expected to be at levels similar to those planned to be made in 2008. The Company expects future payments for other postretirement benefit plans to be at levels similar to those made in 2007.
For additional information on contracts, obligations and arrangements the Company enters into from time to time, see Note 9Debt and Interest Expense, Note 10Financial Instruments, Note 21Commitments, Note 12 Asset Retirement Obligations, Note 22Pension Plans, Other Postretirement Benefits and Employee Savings Plans and Note 23Contingencies of the Notes to Consolidated Financial Statements under Item 8 of this Form 10-K.
In November 2006, Anadarko sold its wholly-owned subsidiary, Anadarko Canada Corporation, for approximately $4 billion before income taxes. Accordingly, the Canadian oil and gas operations have been classified as discontinued operations in the consolidated statements of income and cash flows. The following table summarizes selected data pertaining to discontinued operations.
Income from discontinued operations for 2007 related primarily to marketing activities that were exited during 2007 and the effect of foreign currency translation on the indemnity liability discussed in Note 23Contingencies of the Notes to Consolidated Financial Statements under Item 8 of this Form 10-K.
Income from discontinued operations, net of tax, for 2006 increased compared to 2005 primarily due to the gain on the sale of Canadian operations, a decrease in Canadian tax rates and higher oil prices, partially offset by an increase in Canadian taxes associated with the gain on sale and a decrease in recognized sales volumes as a result of the November 2006 sale.
Under the Companys initial 364-day term loan agreement, the Company was required to use net cash proceeds from significant dispositions to repay debt. Because the Canadian assets were subject to this requirement, approximately $58 million of interest expense related to the portion of debt that was repaid with proceeds from the sale of the Canadian operations is included in results of discontinued operations for 2006.
Critical Accounting Policies and Estimates
Financial Statements and Use of Estimates In preparing financial statements in accordance with generally accepted accounting principles, management makes informed judgments and estimates that affect the reported amounts of assets and liabilities as of the date of the financial statements and affect the reported amounts of revenues and expenses during the reporting period. On an ongoing basis, management reviews its estimates, including those related to determination of proved reserves, litigation, environmental liabilities, income taxes and fair values. In 2006, significant estimates were also involved in accounting for business combinations. Changes in facts and circumstances may result in revised estimates and actual results may differ from these estimates. Management considers the following to be its most critical accounting policies and estimates that involve judgment and discusses the selection and development of these policies and estimates with the Companys Audit Committee.
Change in Accounting Principle In the third quarter of 2007, Anadarko changed its method of accounting for its oil and gas exploration and development activities from the full cost to the successful efforts method. In accordance with SFAS No. 154, Accounting Changes and Error Corrections, financial information for prior periods has been revised to reflect retrospective application of the successful efforts method, as prescribed by SFAS No. 19, Financial Accounting and Reporting by Oil and Gas Producing Companies. For additional information on the impact of the change to the successful efforts method of accounting see Note 1Summary of Significant Accounting Policies Properties and Equipment, Note 2Change in Accounting Principle and Note 8Properties and Equipment of the Notes to Consolidated Financial Statements under Item 8 of this Form 10-K.
Business Combinations Accounting for the acquisition of a business requires the allocation of the purchase price to the various assets and liabilities of the acquired business and recording deferred taxes for any differences between the allocated values and tax basis of assets and liabilities. Any excess of the purchase price over the amounts assigned to assets and liabilities is recorded as goodwill. In connection with Anadarkos August 2006 acquisitions of Kerr-McGee and Western, the Company recorded goodwill for the excess of the purchase price over the value assigned to individual assets acquired and liabilities assumed.
Purchase Price Allocation The purchase price allocation is accomplished by recording the asset or liability at its estimated fair value. Anadarko uses all available information to make these fair value determinations, including information commonly considered by the Companys engineers in valuing individual oil and gas properties and sales prices for similar assets. Estimated deferred taxes are based on available information concerning the tax basis of the acquired companys assets and liabilities and carryforwards at the merger date, although such estimates may change in the future as additional information becomes known. The amount of goodwill recorded in any particular business combination can vary significantly depending upon the values attributed to assets acquired and liabilities assumed relative to the total acquisition cost.
Goodwill The Company is required to assess goodwill for impairment annually, or more often as circumstances warrant. The first step of that process is to compare the fair value of the reporting unit to which goodwill has been assigned to the carrying amount of the associated net assets and goodwill. If the estimated fair value is greater than the carrying amount of the reporting unit, then no impairment loss is required. The Company completed its most recent annual goodwill impairment test, with no impairment indicated. Although Anadarko cannot predict when or if goodwill will be impaired in the future, impairment charges may occur if the Company is unable to replace the value of our depleting asset base or if other adverse events (for example, lower sustained oil and gas prices) reduce the fair value of the associated reporting unit.
Proved Reserves Proved oil and gas reserves, as defined by SEC Regulation S-X Rule 4-10(a) (2i), (2ii), (2iii), (3) and (4), are the estimated quantities of crude oil, natural gas and NGLs that geological and engineering data demonstrate with reasonable certainty to be recoverable in future years from known reservoirs under existing economic and operating conditions, i.e., prices and costs as of the date the estimate is made. Prices include consideration of changes in existing prices provided only by contractual arrangements, but not on escalations based upon future conditions.
The Companys estimates of proved reserves are made using available geological and reservoir data as well as production performance data. These estimates are reviewed annually and revised, either upward or downward, as warranted by additional data. Revisions are necessary due to changes in, among other things, reservoir performance, prices, economic conditions and governmental restrictions as well as changes in the expected recovery rates associated with infill drilling. Decreases in prices, for example, may cause a reduction in some proved reserves due to reaching economic limits sooner. A material change in the estimated volumes of reserves could have an impact on the DD&A rate calculation and the financial statements.
Unproved Leasehold Costs Leasehold acquisition costs are initially capitalized. Acquisition costs of unproved leaseholds are assessed for impairment during the holding period and transferred to proved oil and gas properties to the extent associated with successful exploration activities. Significant undeveloped leases are assessed periodically for impairment individually, based on the Companys current exploration plans, and a valuation allowance is provided if impairment is indicated. For unproved oil and gas properties with individually insignificant lease acquisition costs, such costs are amortized on a group basis (thereby establishing a valuation allowance) over the average lease terms of the leases at rates that provide for full amortization of unsuccessful leases upon expiration. Costs of expired or abandoned leases are charged against the valuation allowance, while costs of productive leases are transferred to proved oil and gas properties. Amortization of individual insignificant leases and impairment of unsuccessful leases, are included in exploration expense. As of December 31, 2007, the Company had approximately $12.6 billion of capitalized unproved leasehold costs, primarily from its August 2006 acquisitions of Kerr-McGee and Western.
Significant undeveloped leasehold costs are assessed for impairment at a lease level or resource play (for example, Greater Natural Buttes area in the Rocky Mountain region), while leasehold acquisition costs associated with prospective areas that have had limited or no previous exploratory drilling are generally assessed for impairment by major prospect area.
A majority of the Companys unproved leasehold costs are associated with leases or concessions to which proved developed producing reserves are also attributed. Generally, economic recovery of unproved reserves in such areas is not yet supported by actual production or conclusive formation tests, but may be confirmed by the Companys continuing exploitation program. Ultimate recovery of potentially recoverable reserves in areas with established production generally has greater probability than in areas with limited or no prior drilling activity.
A portion of the Companys unproved leasehold costs are associated with the Companys exploration program, in which drilling activities have not yet commenced or are inconclusive, and the disposition of such costs will be determined by the success of the Companys exploration program.
Another portion of the Companys unproved leasehold costs are associated with the Land Grant acreage in which the Company owns mineral interests in perpetuity and plans to explore and evaluate the acreage through a 10- to 12-year program.
An estimate as to sensitivity to earnings if assumptions other than those used for impairment of unproved properties is impractical given the broad range and number of assumptions involved and the relatively low level of exploration activities which have occurred during 2007 on assets acquired in the Kerr-McGee and Western acquisitions.
Suspended Exploratory Drilling Costs Under the successful efforts method of accounting, exploratory drilling costs associated with a discovery well are initially capitalized, or suspended, pending determination of whether proved reserves can be attributed to the area as a result of drilling. At the end of each quarter, management reviews the status of all suspended exploratory drilling costs in light of ongoing exploration activitiesin particular, whether the Company is making sufficient progress in its ongoing exploration and appraisal efforts or, in the case of discoveries requiring government sanctioning, whether development negotiations are under way and proceeding as planned. If management determines that future appraisal drilling or development activities are not likely to occur, associated suspended exploratory drilling costs are expensed. Therefore, at any point in time, the Company has capitalized costs on its consolidated balance sheet associated with exploratory wells that may be charged to exploration expense in a future period. At December 31, 2007, suspended exploratory drilling costs were $308 million compared to $312 million at December 31, 2006.
Impairment of Assets A long-lived asset other than unproved oil and gas property is evaluated for potential impairment whenever events or changes in circumstances indicate that its carrying amount may be greater than its future net cash flows. Impairment loss, if any, is measured as the excess of its carrying amount over the assets fair value. Such evaluations involve a significant amount of judgment, since the results are based on expected future events or conditions, such as sales prices for oil, gas or NGLs; estimates of future oil and gas production; development and operating costs and the timing thereof; economic and regulatory climates and other factors. The Companys estimates of future net cash flows used in the impairment assessments are inherently imprecise because they reflect managements expectation of future conditions that are often outside of managements control. However, assumptions used reflect managements long-term outlook on prices, costs and other factors, and are consistent with assumptions used in the Companys business plans and investment decisions.
Derivative Instruments Current accounting rules require that all derivative instruments, other than those that meet specific exclusions, be recorded at fair value. Quoted market prices are the best evidence of fair value. If quotations are not available, managements best estimate of fair value is based on the quoted market price of derivatives with similar characteristics or on valuation techniques.
The Companys derivative instruments are either exchange traded or transacted in an over-the-counter market. Valuation is determined by reference to readily available public data. Option fair values are based on the Black-Scholes option pricing model and verified against the applicable counterpartys fair values.
Derivative accounting rules require that fair value changes of derivative instruments that do not qualify for hedge accounting be reported in current period earnings, rather than in the period the derivatives are settled and/ or the hedged transaction is settled. This can result in significant earnings volatility. Through the end of 2006, Anadarko applied hedge accounting to some of its commodity derivatives. Derivative accounting rules are complex, subject to interpretation in their application, and interpretative guidance continues to evolve. As a result of this accounting risk, effective January 1, 2007, Anadarko discontinued hedge accounting on all existing commodity and interest rate derivatives. Such a change did not affect Anadarkos reported financial position or cash flows and did not require adjustments to previously reported financial statements.
Benefit Plan Obligations The Company has defined benefit pension plans and supplemental pension plans that are noncontributory and a foreign contributory defined benefit pension plan. The Company also provides certain health care and life insurance benefits for retired employees. Determination of the projected benefit obligations for the Companys defined benefit pension and postretirement plans is important to the recorded amounts for such obligations on the balance sheet and to the amount of benefit expense in the income statement. This also impacts the Companys decisions for amounts contributed into the plans.
Accounting for pension and other postretirement benefit obligations involves numerous assumptions, the most significant of which relate to discount rate for measuring the present value of future plan obligations; expected long-term rates of return on plan assets; rate of future increases in compensation levels; and health care cost projections. Anadarko develops demographics and utilizes the work of third-party actuaries to assist in the measurement of these obligations.
Discount rate The discount rate assumption used by the Company is meant to reflect the interest rate at which the pension and other postretirement obligations could effectively be settled on the measurement date. The Company currently uses a yield curve analysis, for a majority of the plans, to support the discount rate assumption. This analysis involves the creation of a hypothetical Aa spot yield curve represented by a series of high-quality, non-callable, marketable bonds, then discounts the projected cash flows from each plan at interest rates on the created curve specifically applicable to the timing of each respective cash flow. The present values of the cash flows are then accumulated, and a weighted-average discount rate is calculated by imputing the single discount rate that equates to the total present value of the cash flows. The consolidated discount rate assumption is determined by evaluation of the weighted-average discount rates determined for each of the Companys significant pension and postretirement plans. The weighted-average discount rate assumption used by the Company as of December 31, 2007 was 6.0% for pension plans and 6.25% for other postretirement plans.
Expected long-term rate of return The expected long-term rate of return on assets assumption was determined using the year-end 2007 pension investment balances by category and projected target asset allocations for 2008. The expected return for each of these categories was determined by using capital market projections, with consideration of actual five-year performance statistics for investments in place. The weighted-average expected long-term rate of return on plan assets assumption used by the Company as of December 31, 2007 was 7.75%.
Rate of compensation increases The Company determines this assumption based on its long-term plans for compensation increases specific to employee groups covered and expected economic conditions. The assumed rate of salary increases includes the effects of merit increases, promotions and general inflation. The weighted- average rate of increase in long-term compensation levels assumption used by the Company as of December 31, 2007 was 5.0%.
Health care cost trend rate The health care cost trend assumptions are developed based on historical cost data, the near-term outlook and an assessment of likely long-term trends. For year-end 2007 measurement purposes, the Company used separate assumptions of cost increase rates for medical, prescription drugs and dental benefits covered by the plans. A 7.0% annual rate of increase in the per capita cost of covered medical benefits was assumed for 2008, decreasing gradually to 5.0% in 2015 and later years. For prescription drug benefits, a rate of increase of 11.0% in the per capita cost was assumed for 2008, decreasing gradually to 5.0% in 2015 and later years. For dental care costs, the Company assumed a flat rate of increase of 5.0%.
Environmental Obligations and Other Contingencies Management makes judgments and estimates in accordance with applicable accounting rules when it establishes reserves for environmental remediation, litigation and other contingent matters. Provisions for such matters are charged to expense when it is probable that a liability has been incurred and reasonable estimates of the liability can be made. Estimates of environmental liabilities are based on a variety of matters, including, but not limited to, the stage of investigation, the stage of the remedial design, evaluation of existing remediation technologies, and presently enacted laws and regulations. In future periods, a number of factors could significantly change the Companys estimate of environmental remediation costs, such as changes in laws and regulations, or changes in their interpretation or administration, revisions to the remedial design, unanticipated construction problems, identification of additional areas or volumes of contaminated soil and groundwater, and changes in costs of labor, equipment and technology. Consequently, it is not possible for management to reliably estimate the amount and timing of all future expenditures related to environmental or other contingent matters and actual costs may vary significantly from the Companys estimates. The Companys in-house legal counsel and environmental personnel regularly assess these contingent liabilities and, in certain circumstances, outside legal counsel or consultants are utilized.
Income Taxes The amount of income taxes recorded by the Company requires the interpretation of complex rules and regulations of various taxing jurisdictions throughout the world. The Company has recognized deferred tax assets and liabilities for temporary differences, operating losses and tax credit carryforwards. The Company routinely assesses the realizability of its deferred tax assets and reduces such assets by a valuation allowance if it is more likely than not that some portion or all of the deferred tax assets will not be realized. The Company routinely assesses potential uncertain tax positions and, if required, establishes accruals for such amounts. The accruals for deferred tax assets and liabilities are subject to a significant amount of judgment by Company management and are reviewed and adjusted routinely based on changes in facts and circumstances. Although Company management believes its tax accruals are adequate, material changes in these accruals may occur in the future, based on the progress of ongoing tax audits, changes in legislation and resolution of pending tax matters.
Recent Accounting Developments
New Accounting Principles In April 2007, the FASB issued FASB Staff Position (FSP) FASB Interpretation (FIN) No. 39-1, Amendment of FASB Interpretation No. 39 (FSP FIN 39-1), which addresses certain modifications to FIN No. 39, Offsetting of Amounts Related to Certain Contracts. The FSP provides for offsetting fair value amounts recognized for the right to reclaim cash collateral (a receivable) against fair value amounts recognized for derivative instruments executed with the same counterparty under the same master netting arrangement. FSP FIN 39-1 is effective for Anadarko as of January 1, 2008. As of December 31, 2007, Anadarko had approximately $50 million in current assets for the right to reclaim cash for derivative instruments. Upon adoption in the first quarter of 2008, Anadarko will offset the right to reclaim cash collateral against net derivative positions for which a master netting agreement exists. Because FSP FIN 39-1 requires retrospective application, the Companys historical balance sheets will be revised accordingly. Anadarko does not expect the impact to be material.
In December 2007, the FASB issued SFAS No. 141 (revised 2007), Business Combinations (SFAS No. 141(R)), a replacement of SFAS No. 141, Business Combinations. SFAS No. 141 (R) modifies the accounting for business combinations under SFAS No. 141 and will apply to Anadarko prospectively for future business combinations with an acquisition date on or after January 1, 2009.
In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial StatementsAn Amendment of ARB No. 51. SFAS No. 160 establishes new accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. Specifically, this statement requires the recognition of a noncontrolling interest (minority interest) as a component of consolidated equity. This is a change from the current practice to present noncontrolling interests in liabilities or between liabilities and stockholders equity. Similarly, SFAS No. 160 requires consolidated net income and comprehensive income to be reported at amounts that include the amounts attributable to both the parent and the noncontrolling interests. Anadarko will be required to adopt accounting provisions of SFAS No. 160 prospectively with respect to transactions involving noncontrolling financial interests that occur on or after January 1, 2009. Presentation and disclosure requirements of SFAS No. 160 will also be applied effective January 1, 2009, but with respect to all periods presented. After adopting SFAS No. 160 in 2009, the Company will apply provisions of this standard to noncontrolling interests created or acquired in future periods.
For additional information on recently issued accounting standards not yet adopted, see Note 1Summary of Significant Accounting Policies of the Notes to Consolidated Financial Statements under Item 8 of this Form 10-K.
The Companys primary market risks are fluctuations in energy prices and interest rates. These fluctuations can affect revenues and the cost of operating, investing and financing activities. The Companys risk management policy provides for the use of derivative instruments to manage these risks. The types of derivative instruments utilized by the Company include futures, swaps, options and fixed price physical delivery contracts. The volume of derivative instruments utilized by the Company is governed by the risk management policy and can vary from year to year. For information regarding the Companys accounting policies and additional information related to the Companys derivative and financial instruments, see Note 1Summary of Significant Accounting Policies, Note 9Debt and Interest Expense and Note 10Financial Instruments of the Notes to Consolidated Financial Statements under Item 8 of this Form 10-K.
Energy Price Risk The Companys most significant market risk is the pricing for natural gas, crude oil and NGLs. Management expects energy prices to remain volatile and unpredictable. If energy prices decline significantly, revenues and cash flow would significantly decline. In addition, a non-cash write down of the Companys oil and gas properties could be required under successful efforts accounting rules if future oil and gas commodity prices sustained significant decline. Below is a sensitivity analysis of the Companys commodity price related derivative instruments.
Derivative Instruments Held for Non-Trading Purposes The Company had derivative instruments in place to reduce the price risk associated with future equity production of 582 Bcf of natural gas and 57 MMBbls of crude oil as of December 31, 2007. As of December 31, 2007, the Company had a net unrealized loss of $264 million on these derivative instruments. Utilizing the actual derivative contractual volumes, a 10% increase in underlying commodity prices would reduce the fair value of these instruments by approximately $527 million. However, this loss would be substantially offset by an increase in the value of that portion of the Companys production covered by the derivative instruments.
Derivative Instruments Held for Trading Purposes As of December 31, 2007, the Company had a net unrealized gain of $11 million (gains of $41 million and losses of $30 million) on derivative financial instruments entered into for trading purposes. Utilizing the actual derivative contractual volumes, a 10% increase in underlying commodity prices would result in an additional loss on these derivative instruments of $8 million.
For additional information regarding the Companys marketing and trading portfolio, see Marketing Strategies under Item 7 of this Form 10-K.
Interest Rate Risk As of December 31, 2007, Anadarko had outstanding $5.2 billion of variable-rate debt (including the midstream subsidiary note payable to a related party) and $9.5 billion of fixed-rate debt. A 10% increase in LIBOR interest rates would increase gross interest expense approximately $26 million per year.
In January 2008, Anadarko entered into forward-looking 18-month interest rate swaps effective March 2008 with an aggregate notional value of $1.0 billion whereby the Company will pay a weighted-average fixed interest rate of 2.74% and receive a floating interest rate indexed to the three-month LIBOR rate.
CONSOLIDATED FINANCIAL STATEMENTS
ANADARKO PETROLEUM CORPORATION
REPORT OF MANAGEMENT
Management prepared, and is responsible for, the consolidated financial statements and the other information appearing in this annual report. The consolidated financial statements present fairly the Companys financial position, results of operations and cash flows in conformity with U.S. generally accepted accounting principles. In preparing its consolidated financial statements, the Company includes amounts that are based on estimates and judgments that Management believes are reasonable under the circumstances. The Companys financial statements have been audited by KPMG LLP, an independent registered public accounting firm appointed by the Audit Committee of the Board of Directors. Management has made available to KPMG LLP all of the Companys financial records and related data, as well as the minutes of the stockholders and Directors meetings.
MANAGEMENTS ASSESSMENT OF INTERNAL CONTROL OVER FINANCIAL REPORTING
Management is responsible for establishing and maintaining adequate internal control over financial reporting. Anadarkos internal control system was designed to provide reasonable assurance to the Companys Management and Directors regarding the preparation and fair presentation of published financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Management assessed the effectiveness of the Companys internal control over financial reporting as of December 31, 2007. This assessment was based on criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on our assessment, we believe that as of December 31, 2007 the Companys internal control over financial reporting is effective based on those criteria.
February 28, 2008
The Board of Directors and Stockholders
Anadarko Petroleum Corporation:
We have audited Anadarko Petroleum Corporation and subsidiaries internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Anadarko Petroleum Corporations management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Managements Assessment of Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Companys internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, Anadarko Petroleum Corporation and subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Anadarko Petroleum Corporation and subsidiaries as of December 31, 2007 and 2006, and the related consolidated statements of operations, stockholders equity, comprehensive income, and cash flows for each of the years in the three-year period ended December 31, 2007, and our report dated February 28, 2008 expressed an unqualified opinion on those consolidated financial statements.
/s/ KPMG LLP
February 28, 2008
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
Anadarko Petroleum Corporation:
We have audited the accompanying consolidated balance sheets of Anadarko Petroleum Corporation and subsidiaries as of December 31, 2007 and 2006, and the related consolidated statements of income, stockholders equity, comprehensive income and cash flows for each of the years in the three-year period ended December 31, 2007. These consolidated financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Anadarko Petroleum Corporation and subsidiaries as of December 31, 2007 and 2006, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2007, in conformity with U.S. generally accepted accounting principles.
As discussed in Note 1 to the consolidated financial statements, the Company changed its method of accounting for oil and gas producing activities and its method of accounting for uncertainty in income taxes in 2007.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Anadarko Petroleum Corporation and subsidiaries internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated February 28, 2008 expressed an unqualified opinion on the effectiveness of the Companys internal control over financial reporting.
/s/ KPMG LLP
February 28, 2008
ANADARKO PETROLEUM CORPORATION
CONSOLIDATED STATEMENTS OF INCOME