Drilling on Wall Street
Posted by Dave Cohen on June 26, 2006 - 4:46pm
In an unexpectedly bold move Friday, Anadarko Petroleum Corp. announced it would purchase not one but two oil and gas companies for a combined $21.2 billion, in a ringing endorsement of U.S. energy exploration....This analyst was also a bit stunned and a little investigation turned up a number of interesting things. Let's check this deal out.It's buying Kerr-McGee, a storied energy company out of Oklahoma City that is heavily entrenched in the Gulf of Mexico's deep waters and the Rocky Mountains, and the smaller Western Gas Resources of Denver, which also has significant reserves in the Rockies.
The double deal had some analysts doing a double take.
Kerr-McGee Resources:
- Bid price per share: $70.50
- Shares outstanding: 227.0MM
- Total debt: $2.4 Bill
- Total (enterprise) bid value: $18.40 Billion
- Oil Reserves: 341MM BOE
- Natural gas reserves: 3.34 Tcf
- Total equivalent reserves: 898MM BOE (30% proved undeveloped) Price/reserve in the ground: $20.5/Boe or $3.41/Mcfe TEV/2006 EBITDA consensus estimate = 6.81x
Western Gas Resources:
- Bid price per share: $61.00
- Shares outstanding: 76.0MM
- Total debt: $515MM
- Total (enterprise) bid value: $5.15 billion
- Oil Reserves: 0.0
- Natural gas reserves: 921 Bcf
- Total equivalent reserves: 153.5MM BOE (57% Proved undeveloped) Price/reserve in the ground: $33.55/BOE or $5.60/Mcfe $$ of transaction allocated to midstream assets: $1.6 Billion Price/Reseve in ground less midstream assets: $23.12/BOE or $3.85/Mcfe TEV/2006 EBITDA consensus estimate = 10.16x
I assume these fossil fuel reverve numbers are proved reserves as reported to the SEC--see Bubba's What the hell are oil reserves anyhow? So, this was a natural gas "play", using that term loosely. The total bought is 4.26/tcf (trillion cubic feet). The US uses about 22/tcf annually, so these resources represent somewhere around 70 days of US yearly consumption. We are reminded here that
Anadarko expects ultimately to recover 3.8 billion barrels of equivalent [BOE] from Kerr-McGee and Western Gas at a price of less than $12 per barrel. By contrast, crude futures are currently trading north of $70 a barrel.Apparently, Anadarko doesn't see natural gas prices coming down any time soon. According to Minyanville, the total equivalent proved reserves are only 1.052 billion BOE. Using a standard conversion factor 1 BOE = 5487/cf, the number turns out to be 1.18 billion BOE, which is close. Anadarko must anticipate an additonal 2.8 billion BOE of additional probable or possible reserves which, if they've done their due diligence, is entirely possible. No doubt they are also hoping for some undiscovered resources -- don't you love that phrase? Kerr-McGee is involved in deepwater GOM projects (see below) and according to the MMS in Deep Water -- Where the Energy Is :"Opportunities to gain access to such large, high-margin resource opportunities at such economic full-cycle costs are rare, and we are excited about the value we expect to create for Anadarko shareholders," Anadarko said.
The Gulf of Mexico has been a major supplier of oil and gas to America for nearly half a century. With declining production from its near-shore, shallow waters, energy companies have focused their attention on oil and gas resources in water depths of 1,000 feet and beyond. Their progress in developing these resources has made the Gulf of Mexico the focal point of deep water oil and gas exploration and production in the world. The Department of the Interior's Minerals Management Service estimates that the deep water regions of the Gulf of Mexico may contain 56 billion barrels of oil equivalent, or enough to meet U.S. demand for 7-1/2 years at current rates.I'll gently remind the reader that barrels of oil equivalent of natural gas is not the same as having 3.8 billion barrels of light sweet crude in your hands, so to speak, even if we grant that all the reserves are there. While natural gas prices and oil prices are related in some mysterious way I don't fully understand, the real margins depend on where the natural gas is and what the costs will be to produce it. I wouldn't take that $12/boe production cost estimate at face value. We must look a little more closely at both acquired companies to find out what the real issues are regarding production.
Kerr-McGee and Ultra Deepwater
Kerr-McGee is involved in deepwater and ultra deepwater drilling in the Gulf of Mexico as you see in Kerr-McGee makes back-to-back discoveries in deepwater or Constitution and Hornet Discoveries Continue Kerr-McGee's Deepwater Success. The term deepwater usually refers to drilling at water depths over 1500 feet or so but ultra deepwater drilling involves the same circumstance with the additional requirement that drilling then proceeds as much as 3 miles beneath the sea bottom at total depths greater than 8000 feet. The image below is from Kerr-McGee's Deepwater Gulf of Mexico information page.
Constitution spar -- the company's
sixth operated deepwater floating
production facility in the Gulf
of Mexico.
Additionally, Kerr-McGee has a number of onshore projects (follow the link immediately above to the U.S Onshore section). Primarily, it appears that Anadarko has purchased their Gulf of Mexico expertise and properties. Needless to say, ultra deepwater drilling presents many technical challenges and higher costs, not to mention possible hurricanes that could disrupt production in any given season. But as fans of technology would say, necessity is the mother of invention. This includes their spar technology and subsea tiebacks among other things.
As the world's premier independent deepwater exploration and production company, Kerr-McGee has a history of pioneering technological innovations that give it a distinct competitive advantage. Such technologies enable us to tap hard-to-reach natural resources in a cost-effective, safe and environmentally responsible manner. Today, we're producing oil and natural gas from fields in water depths that were considered beyond reach just a few years ago.Sounds good, doesn't it? However, drilling in such high temperature / high pressure (HTHP) environments is fraught with difficulty. Check out Deepwater Research from the MMS from which we get this graphic.
Examples of offshore drilling and production
platforms and rigs -- Click to Enlarge
This paper lists ongoing investigations of problems in ultra deepwater production with catchy titles like Blowout Prevention Procedures for Deepwater Drilling and Highly Compliant Rigid-Pipe Riser Analysis. Finally, I can not resist telling you about the late fall IADC DRILLING GULF of Mexico 2005 Conference & Exhibition with the subtitle Drilling GOM explores storm prep, mooring, HPHT, operator drivers, market outlook.
Attendees will learn about industry’s preparations for severe weather, deepwater rig mooring issues, the future plans of two operators new to the Gulf, a rig outlook and the latest technology in riser and emergency disconnect procedures. And that’s only the first day!
All and all, I'd say ultra deepwater drilling is still a risky business although Kerr-McGee has had some successes. Anadarko is betting that the outstanding technology issues will get solved and the weather will cooperate. It's not just like falling off a log.
Western Gas and Unconventional Natural Gas
Western Gas specializes in the production of natural gas from unconventional sources, particularly Coal Bed Methane (CBM) and to a limited extent tight sandstone formations and shale gas. The company is headed up by Peter Dea, who gave this presentation (powerpoint) at ASPO-USA back in November of 2005. The Denver Post reported last year in Western Gas still standing alone -- After a wave of deals, Western Gas may be the most tempting target leftWestern Gas has 921 billion cubic feet of proven reserves, mostly in two prolific plays in Wyoming - the Powder River and Green River basins. That's enough gas to supply the entire state of Colorado for more than three years.So, Western Gas was ripe for takeover and Anadarko jumped on the opportunity. In addition, we learn from this Western Gas strategic and operational update thatIts longer-term reserves - gas potentially recoverable with favorable prices and technologies - total 3 trillion cubic feet....
In the realm of natural gas, most firms either drill and produce it, "upstream" in industry jargon, or gather it from wells and process it, known as "midstream."
Western Gas does both. And does both well, most analysts assert.
Western's cost for finding and developing new gas wells over the past five years has averaged 82 cents per thousand cubic feet of gas, less than half of the average $1.84 per unit for 48 exploration and production companies tracked by Credit Suisse First Boston.
The cost advantage comes in part from Western's heavy emphasis on production from coal-bed methane wells, which are cheaper to drill than wells in tight sandstone formations that characterize much of the Rocky Mountain West.
Western's gas production grew 13 percent from 2004 to 2005, compared with the peer group increase of 8.4 percent.
In Canada, the Company has drilled two wells in prospective unconventional gas reservoirs and is progressing on leasing, joint venture discussions and play evaluation in the Western Canadian Sedimentary Basin [WCSB]. The focus is exclusively on finding, developing, gathering and processing unconventional natural gas. The WCSB contains a large, yet immaturely developed resource base offering coal bed methane, shallow tight sands and shale gas opportunities. In coal bed methane alone, resource estimates for gas-in-place in the U.S. Rocky Mountain basins and WCSB are comparable at several hundred trillion cubic feet of gas in each area. However, Western Canada represents only a few percent of the combined areas’ current coal bed methane production, hence providing significant opportunities in future years.This is important due to the fact that developing CBM resources in the Canadian WCSB is projected to be an important source of natural gas for further production of the tar sands. Naturally, producing CBM is not without its attendant problems. The main problem is that the operations are very water-intensive. For example, from my unconventional gas post cited above, we learn that "the volume of water produced by CBM production is staggering. For example, in the Wyoming Powder River Basin alone, over 1.5 billion gallons of water is produced daily".
Acquiring Western Gas would appear to be a good strategic move for Anadarko providing that the natural gas market remains bullish. High prices will continue to fuel CBM production although there are resource problems as I just pointed out.
North American Natural Gas
The most surprising aspect of Anadarko's Wall Street drilling was that both companies acquired work almost exclusively in North America. From the Houston Post article cited at the very top, we learnOne question is, what will Anadarko do with the international properties picked up in this deal?This is a startling revelation. "There's no place like home". Apparently, Hackett's cost/benefit analysis concluded that the cost of doing business internationally over the long term was higher than trying to exploit difficult to produce natural gas in North America in a friendly political climate. There are still exceptions like Algeria or Brazil where the geopolitical risks are lower but many other regions of the world are becoming increasingly unpredictable from a business point of view given the long lead times necessary to put new projects online.When [Anadarko's Chairman and CEO ] Hackett came on board two and a half years ago, he quickly began an international program that would take Anadarko to far-flung spots such as Tunisia, the Black Sea, Gabon, Nigeria and Sao Tome.
But in that short time frame, the world changed.
International doors are closing on U.S. companies in places such as Ecuador where Occidental Petroleum lost concessions and Russia and Venezuela where shape-shifting tax programs make it hard to plan for future investment.
Hackett would not say what he plans to do with international assets, but he did say the "international cost of rent is high."
[Managing director of AIG Financial Products] Russell Sherrill said it's unlikely Anadarko would exit the international scene altogether because Anadarko and Kerr-McGee have some very attractive plays in Algeria and offshore Brazil and China.
To conclude, Anadarko has adopted a strategy that makes two key assumptions.
- Natural gas prices will remain high indefinitely in the future. LNG imports will not affect this situation.
- Ultra deepwater from the Gulf of Mexico and unconventional sources from the North American western provinces will be profitable. Both types of production have a high potential payoff despite the technical and logistic challenges mentioned here. Hurricanes in the GOM will not cause sufficient future disruptions that will affect the bottom line.
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Depwater Gulf of Mexico has been of interest to the oil business for years. H. Ben Carsey published an analyses of the prospects in the mid-sixties. He was a Humble geologist (now Exxon) and was cited in Halbouty's book" Salt Domes of the Gulf Coast and Mexico". Halbouty's second edition includes a map of all the offshore salt dome prospects, and there are dozens. There are a number of drilling problems unique to ultra deep water. How do you keep a string of pipe rigid enough to drill in a fith of a mile or more of water, and how do you hook up wells to a pipeline when human's can't dive? The answer to the first has been drill motors located at the end of the drill pipe like in horizontal drilling and the answer to the second has been robotics. Needless to say this is all extremely expensive cutting edge stuff.
The shallow gulf waters are gas-prone, in other words in the US waters there is a whole lot more gas than oil. Lake Washington and Mobile Bay are the only giant fields, although sveral other domes have produced a little oil. Hurricane Katherine and Rita really whacked them. The deeper stuff in the Green Canyon area had the platforms whacked too. But the deeper stuff that is the exploration frontier may be produced without a rig reaching to the seafloor. The continental slopes have a lot more oil that the shallow Miocene offshore trend.
I'm guessing that the deep continental shelf is going to be the major oil companies last hurrah in exploration. Overseas has been shut off by national oil companies, and they can't make money on smaller fields. But, they still can make money by purchasing companies. If the prospects are as good as I think, Anadarko will now become a target for the multinational oil companies. Although this fancy technology may slow the exhastion of conventional oil, it won't stop resource depletion.
Your comment sort of confirms everything I was thinking when I wrote this post.
Good post! When mining Wall Street offers less risk than independently punching holes way, way offshore or overseas--Just another sign that we are reaching the Peak.
Makes one wonder if we have reached the point globally where some seemingly benign problem cascades quickly into major dislocations. The 'unknown unknown' as a previous poster attributed to Rumsfeld.
Bob Shaw in Phx,AZ Are Humans Smarter than Yeast?
Consolidation in the oil (and most other industries) has been going on for years and Dave did not coin the term "drilling on Wall Street". What is unusual this time around is that consolidation is happening at a time of oil high prices. That does indicate that supplies are getting harder and more expensive to find - but no one really denies this.
Fishermen protesting removal of oil subsidies in Thailand is proof of the peak, Bangladeshi power outages during a football game is proof of the peak, China reducing gas exports is proof of the peak, Zimbabwe falls apart and once again proof.
I am starting to think peak oilers are like frightened tribesmen who see proof that the gods are angry in the weather, flights of birds, or tree falling.
As I have mentioned before, I believe there is plenty of evidence of peak oil, but mostly I see these is field depletion figures. About 99% of the peak proof citations here are easily explained by something else.
Did you actually read the post I wrote? It was about natural gas in North America and the economics of Anadarko's acquisitions. It is a fair treatment. I don't believe the phrase "peak oil" occurs in the article.
Certainly not. If you look here, you will see that The Economist magazine used the term last year (pdf warning).
I just thought the title was appropriate.
best, Dave
http://www.australiancoal.com.au/environmentmethane.htm since the combustion products CO2 and water have less greenhouse impact. Apart from accelerating the release this is breathtaking hypocrisy since they also assure us that there will be no underground gas leakages from FutureGen type plants. We'll probably go back to old fashioned coal based syngas and to hell with the environment.
Good informative stuff, Dave, but your stuff usually is, you should try to get a deal with Gas and Oil Journal...technically as good or better than their stuff! :-)
I am surprised that more observers didn't see this for what it is, especially when you combine it with COP (Conaco Phillips) recent deal for Burlington Resources, and start breaking out the old "dash for gas" slogan.
Despite some hysteria, there is still a lot of natural gas in the world, and if you can go deepwater and go unconventional, still a good deal in North America, over and above the onshore conventional gas we have. Our problem is NOT that we are in any way "out of natural gas" but instead that the growth in consumption has been so great in a relatively short span of years. But natural gas, even at $6.00 to $7.00 per MM/btu is a good margin product, and if it goes back to somewhere around $10 plus, it's like printing money for the gas producers, even if you factor in the expense of deep water drilling.
The nation can stand natural gas prices up to $10.00 per MM/btu on a long term basis....not comfortable, but it can be done, since apparently most everyone else in the world is starting to suffer on price and supply right along with us (except for the big OPEC gas producers like Qatar). At over $10.00 on a sustained basis, as Alan Greenspan testified a couple of years ago, it becomes a threat to the economy, construction and industrial trades.
So the question is not, as some seem to think, "Will we run out of gas and the lights go dark? (No), But instead, we should ask, "What are the odds that we can keep natural gas prices at what is now the new "sweet spot" of over $7.00 but under $10.00 per MM/btu?"
Why is that the "sweet spot"? Wouldn't it be better if it were at $3.00 or $4.00 bucks? ANSWER: NO.
At too low of a price, waste grows even more prolific, and the return on investment in deep water drilling, LNG projects, the Arctic pipeline, and development of 'stranded" and "unconventional gas" becomes impossible to repay the capital costs of the projects.
So when we say, "Cheap oil is a thing of the past", we should probably just go ahead and add, "and if your dreaming of a return to cheap natural gas, get over it."
In closing we should recall one thing: Right now, there are two major industries that still must wish and dream with all of their heart of a return to cheap natural gas, despite all indications that it will not happen: The tar sand oil industry, and the ethanol fuel industry. Kinda' ironic, ain't it? :-)
Roger Conner known to you as ThatsItImout
They all make expensive gas. I know the Barnett Shale is averaging about $4.00 a MCF, and maybe someone has the figures for costs on the other plays. I know the coalbed methane is a horizontal play and probably expensive since the wells have a low volume long lived flow, and the Cotton Valley/ Bossier are deep and require fracs, also expensive.
I agree that there is plenty of natural gas left, but its the expensive stuff. $6.00 or more is needed just to pay out the wells and have a decent profit.
One thing about the habitat of oil. Its almost all found at depths between about 2,000 ft and 10,000 ft. Yes, I know there is lots shallower, but it tends to be heavy and not have enough pressure to drive it through the rock into the wells. Deeper the oil tends to get naturally cracked by the heat and pressure into natural gas. Since we can now drill and produce gas down to at least 20,000 ft. technology has more than doubled the amount of prospective gas. Expensive gas.
What we are calling peak oil is cheap,light,sweet crude that is easy to refine. The holy annointed saviors of the refining industry and automotive industry, tar sands and oil shale kerogen, coal to liquids although common aren't cheap to recover or process, and the CO2 is killing all of us. We have craven politicians pandering to everyone and not telling the truth. The mainstream media won't tell the truth because of the advertising budgets of the car and gasoline industries. We are going to have to change our ways quickly or we are all face a world that is very bleak.Six Billion People!Its the real root of peak oil.
This is true. Very few are willing to face up to it. Everything else, every conservation step is a wasted unless we also address this issue. It's completely obvious.
We either bring world population under control at our own inititiative or nature does it for us. But it would take an uprecedented degree of mutual cooperation between countries, a world-wide education campaign, a change in our world culture.
It won't happen yet. Disaster of some scale will befall us. But I am not a long term pessimist. At some point, realism will prevail. There have been many world-wide bodies functioning in the second half of the 20th century addressing global problems, maybe not with great success always, or even mostly. But their existence shows what's possible. It's just a matter of how much suffering it will take to get our full attention.
Most countries that are developing into industrialized economies see the need to address population growth. Not all of them do, and not all of them will, but if they don't, they are the ones that are going to suffer. The amount of oil a country can afford is based off of its relative wealth, not its population. If India has 2 billion people, each person will get half as much energy.
In the end the whole situation will be self regulating. We can increase efficiency and use better technology to get by with less energy. Beyond that, if the energy is not available we'll end up going without. The burden will not be equally felt, but countries like India and China will feel great incentive to solve their population issues (as China already is doing). If the first world is any guide, basic economics will do the rest, as population is beginning to decline in the first world, sans the United States.
Nagorak,
Thank you for pointing out what should be to most people self obvious, but somehow never is.
I would go even further than your excellent sentence, "The amount of oil a country can afford is based off of its relative wealth, not its population.", and add a corallory:
"The amount of oil a country must afford to have compared to it's relative wealth is based on it's relative waste."
Let's deal with those two facts, and keep our eyes on that prize first, before we attempt to socially reengineer the world, which has always had dubious chances of success anyway.
Roger Conner known to you as ThatsItImout
That article made a few points not mentioned so far.
- One positive aspect was keeping experienced personnel. We're now in a condition where M&A can be partially justified as a way to KEEP people, not to cut headcount.
- The CEO of Anadarko was asked why they didn't take their $21 billion in cash and go drill. His reply, seconded by analysts, was that they lacked prospects. That is, there were few good places to drill in government approved areas. At some point price will increase to where any prospect with a reasonable shot looks drillable but when?
- Some analysts thought that these acquistions help to position Anadarko to in turn be bought at a premium.
As to coal bed methane and ultra deep offshore, both have US tax and royalty advantages as a way for the government to encourage their development.Agree with both your assessment, and with the fact that NG prices will be higher than forecast.
Also, let's not forget COP's recent purchase of Burlington Resources to make them the largest NG producer in the U.S. In my opinion, that was also a bet that long-term NG prices will be high, and supply will be tight.
RR
Also remember in the short run how vulnerable offshore production is to hurricanes and probably LNG terminals located anywhere near the coast, so they might get a huge windfall from runup of prices on the onshore production COP and Anadarko just purchased. Other onshore gas producers might also be vulnerable to the merger mania, particularly Devon and XTO.
"Using a standard conversion factor 1 BOE = 5.487/cf, ..."
I'm not sure I understand this. Is the cf of natural gas? It doesn't seem possible that so little gas could equal a barrel of oil in energy. What am I not understanding?
BTW, great article.
Is it possible that they are not anticipating this, but rather a further rise in oil prices?
I saw some analysis yesterday that said the very high price paid for reserves indicated that Andarko was paying for future discoveries.
When a company has a lot of cash they can 1.sit on it waiting for an acquisition. 2.increase dividends, possibly attracting the attention of people who hate "windfall" profits3.do a stock buy-back program or 4.expand exploration.
There are only so many prospects that a company can handle at once because people can't work 24 hours a day. There is already a huge shortage of people with mature exploration experience. Buying either company increases their pool of mature talent plus gives them a bunch of prospects on the shelf. Exploration and management are as much art as science, and we suffered a 25 year depression in E & P that cut new trainees to practicially nothing in the domestic oil and gas business. It takes at least 10 years of experience to make a good explorationist and I think that Anadarko made a great, strategic move. Yeah, its drilling on Wall Street, but the reserves are only part of the deal.
I'm not a cornucopian. There are a finite amount of resources on this beautiful blue-green home of ours, and we are using them up at a tremendous accelerating rate. The exhuast is poisoning the earth, but 3 billion Indians and Chinese want to live a prosperous high energy lifestyle. The 600 million people of the West used at least half the oil in only a hundred years. How long is it going to take to use the rest? Twenty, thirty years?
I belong to the Episcopal Church. One of our teachings is hat we are Stewards, not owners of the earth and its resources. That attitude is taught by every major spiritual tradition in the world, and I know its right as well as believe that its right. So I'm taking the personal responsibility to change, and I hope the whole world will join in this. So conserve,use contraception, inform others of the immediate importance of this mission. All our children's lives depend on this.
The various monotheist religions have their good and bad points, I particularly dislike those which try to convert or kill others or outbreed the competition - by that token I guess I must say that recent catholic Popes have been evil. I'm most encouraged that Episcopalians are being more responsible.
Dave, that was a very excellent post, touching on many interesting facets. My guess is there is a lot of upside to NG prices over the next few years, Anadarko probably made a very smart play.
This reserve acquisition by takeover has been happening apace in the metals and energy sectors, and is very likely a tacit admission that this planet is nearing its limit of exploration for these resources. There is more to find but it is now very hard and expensive to find it. We seem to be running a bit low on grain, too:
http://www.fas.usda.gov/grain/circular/2006/05-06/graintoc.htm
You know where I'm heading so I won't drone on ;)
They also have large areas in play onshore that needs more exploration and developement. Did they need outside help here?
Wall Street views these mergers as a way to keep independence. Who wants to pay a super premium on a debt ladden company? Prior to merger, Anadarko was excellent take over prospect with lots of cash on hand and low risk oil and gas projects. Now, they are high risk projects due to expensive technology required and high debt.