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Avinash Gandhi

APA AT A GLANCE

P/E ► -9.67   EV/EBITDA ► 13.7 HIGH ROA ► -10% AVG ROE ► -19.5% AVG Debt to Equity ► 0.765 AVG Current Ratio ► 1.93 AVG Interest Coverage Ratio ► -28.5 LOW

 

 

 

 

 

 

Exxon's trash is Apache's treasure. For an independent oil and gas producer, Apache Corporation has a unique strategy: buy up "depleted" reserves from the larger, integrated oil companies and extract every last possible bit of oil and gas from them. Thanks to high oil prices and low purchase costs, Apache does it all at lower production costs and with higher returns on capital than its competitors.

In the past two years, most of the company's growth has come from zones like Egypt and the North Sea, where acquisitions of properties from companies like BP have yielded high value. The success of the mature extraction strategy, however, depends on a sustained state of high oil prices; a downturn in the price level would greatly damage the company's margins since it depends on efficient extraction, rather than producing a large volume of product, to turn a profit.

Currently, most of Apache's reserves are in North America, making its expansion dependent on international growth; since many of the most productive oil and gas properties are in highly unstable countries, Apache's future may be more affected by political risk and terrorism. Furthermore, the company faces production halts and equipment damage from the storms that sweep the North Sea in the winter and the Gulf of Mexico in the summer.

Business Financials

Apache has seen growth of almost 300% since 2002, with operating margins averaging almost 50%.

Source: Company Data^[1] as Compiled by RBC International Markets

Though revenue growth has been relatively constant, operating income fluctuated lightly between 2004 and 2006. This can be attributed to change in realized natural gas prices in the same period. Though oil prices continued to rise, albeit at a slower rate from 2005 to 2006, natural gas prices dropped from 2005 to 2006, causing the average price per barrel of oil equivalent to fall with it. Because profit margins for smaller oil and gas companies like Apache are highly sensitive to price fluctuations, these erratic prices led to erratic income. It should be noted, however, that Apache produces at especially low costs by industry standards, and so has a slight hedge, if not by much, against volatile pricing.

Source: Company Data^[2] as Compiled by RBC International Markets

The general trend to be observed is that profits rise and fall with oil prices. This should have made 2007 an especially profitable year for Apache, considering that the price level for the year built up to $100/barrel at the New Year.

Trends and Forces

Oil and Gas Prices Are Highly Cyclical...and So Is Apache's Profitability

Oil and gas prices have fluctuated heavily over the past few years, though the most recent trend is a rise in prices, with a barrel of oil trading in international market a day after the new year at just over $100. Because both are nonrenewable forms of energy (they will eventually run out), slowing discoveries of new sources combined with increasing pricing has led to speculation that production is approaching peak oil quantities. Whether this is true or not, oil and gas are commodities: one company's gas can only be differentiated from another company's gas based on price. While Apache currently benefits from high prices, the profitability of the current market will drive increased exploration and production, which could eventually cause prices to fall and margins to drop.

Apache's Mature Extraction Strategy Requires High Oil Prices to Be Successful

Apache's expansion strategy involves buying up mature properties from larger oil companies and drying them out. This involves the use of complicated, expensive technologies that allow old wells to be more fully depleted and new wells to be drilled where the terrain was too difficult before. In the current high-price environment, Apache can make a killing by extracting from these more difficult wells, especially if it can keep its costs as low as possible (primarily by buying the properties at lower rates because they are mature). If oil and gas prices fall, however, the company's margins would fall significantly.

Apache's Growth is Rife with Political Risk

With 70% of its reserves in the dying North American region, Apache's growth is strongly dependent on its ability to obtain new international reserves. The company's strategy of buying reserves that larger oil companies to not want to continue to drill means that current international markets, many of which are situated in politically unstable regions that are either rife with terrorism or have high risk of asset nationalization, are going to end up as part of Apache's holdings in the future. This makes the company's growth very sensitive to international political currents.

Apache's Increased Investment in the Gulf Means Increased Exposure to Natural Disasters

Because of the geological position of many of Apache's sites, the company risks production failures and rising costs from natural disasters. Hurricanes in the Gulf of Mexico during the third quarter and storms in the North Sea during the fourth quarter can damage equipment, hurt employees, and make transportation of products very difficult. This leads to higher costs and lower profits all around.

A Renewable Future Could Mean Long-Term Decline for Oil

Fossil fuels, though highly cost-efficient forms of energy, are heavy polluters when burned. Increasing environmental concern over environmental degradation and global climate change as well as anger over rising oil prices and the link between oil-producing countries and terrorism are fueling a consumer-driven push away from dirty forms of energy toward cleaner forms like wind, solar, biofuels, and/or nuclear. This is most apparent in developed, politically-progressive regions like Europe, where [renewable energy|renewables]] are catching on. Renewables growth could lead to a long-term decrease in the demand for oil and gas. In emerging markets like China and India, however, the drive for economic growth supersedes environmental concerns, and oil and gas are still cheaper than solar. Since emerging markets are where most of the future opportunities in the global economy lay, EnCana and other oil and gas companies could continue to grow despite growth in the renewables sector.

Competition

Apache's main competitors lie in the independent oil and gas sector, since the major oil companies like Exxon Mobil and BP are too large and diverse to fairly be called "competition". Among Apache's independent competitors are Anadarko Petroleum, Cabot Oil & Gas, Comstock Resources, and EnCana. Anadarko Petroleum is by far the largest of these, and about the same size as Apache, producing 25,000 less barrels of oil and three hundred million more cubic feet of gas. Comstock Resources is the smallest of Apache's competitors, and is betting on deepwater exploration to deliver in the future. Cabot Oil & Gas has natural gas in 97% of its reserves^[3]), but is focused only on onshore North American development, possibly limiting its growth potential. Of these competitors, EnCana is the largest producer of natural gas, though Canadian regulations and a dependence on the exchange rate for short-run margins health makes it more vulnerable to macroeconomic conditions than Apache.

Notes

1. ↑ http://sec.gov/Archives/edgar/data/6769/000095012907001091/h43727e10vk.htm#102
2. ↑ http://sec.gov/Archives/edgar/data/6769/000095012907001091/h43727e10vk.htm#102
3. ↑ Reuters, Cabot Oil & Gas Corp, http://stocks.us.reuters.com/stocks/fullDescription.asp?rpc=66&symbol=COG

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