Shale and deepwater investments spur Anadarko to record volumes

Don Stowers, Editor, OGFJ

AN INTERVIEW WITH ANADARKO PETROLEUM'S JAMES T. HACKETT

OIL & GAS FINANCIAL JOURNAL: Anadarko's just-released second-quarter results show net income of $544 million on revenues of about $3.5 billion – a 46% increase over the second quarter of 2010. The company achieved record liquids sales volumes of 297,000 barrels per day. There were some other milestones as well. Things seem to be going pretty well for Anadarko at the moment.

JAMES HACKETT: Yes, as you say, we achieved record liquids sales volumes during the quarter, enhancing margins, and generating excellent cash flows. Nearly all of the year-over-year volume growth was attributable to a 34,000 barrel-per-day increase in liquids volumes. These results contributed to strong discretionary cash flows of more than $1.8 billion – approximately $117 million above our capital expenditures, which included a one-time cash investment of $518 million associated with the acquisition of the Wattenberg processing plant.

On the exploration side of the business, we expect the next six to nine months to be the most active period of deepwater exploration and appraisal drilling in our company's history. Our exploration program is designed to deliver upon our goal of discovering more than 500 million BOE of net risked resources this year.

OGFJ: Anadarko has firmly established itself as one of the leading players in North American shale development. Would you give our readers your thoughts on the impact shale gas and oil will have on the United States?

HACKETT: This is one of the most exciting things that has happened in my career. And particularly being an American, it's terrific. We have a domestic source of oil and gas that has allowed us for the first time in recent memory to really grow domestic oil and gas production. Now we had a brief period in the late '70s where that occurred for oil, but it was very short in duration. On the natural gas side, this is an incredible time. It's happening at the very time we need it. Natural gas is an abundant, very reasonably priced resource both for industrial demand, for power generation, for its traditional uses for cooking and heating, and for transportation. And further, this is all occurring during a time when we are most at risk from a security standpoint and need a clean-burning alternative fuel for the environment. So you've got this wonderful resource that is being developed, and I see an opportunity for us to actually increase the market demand for natural gas. If you had asked me four years ago if we should be targeting the transportation sector as a potential market for natural gas, I would have said no because we would be crazy to use up a precious fuel in that way. And I would have also told you that the baseload fuel supply for natural gas would be LNG. Today, the situation is completely different. LNG will be a peaking fuel that will help moderate prices for consumers, and that's a wonderful set of circumstances for our country in that we won't have to rely on foreign sources for this fuel. This has been so beneficial because a steady and reliable domestic supply takes the price peaks out of natural gas. And it's not just coming from one region like the Gulf of Mexico where you can have hurricanes and other disruptions in supply. All the major utilities are now talking about increasing natural gas in their portfolios, and this is good for our industry and good for the United States. Natural gas is a better environmental answer and is also a huge job creator. I mean – how much better can it get?

OGFJ: Anadarko has steadily expanded its position in domestic shale plays, including the Eagle Ford Shale in South Texas. In the second quarter, you closed a $1.6 billion joint venture with the Korean National Oil Company. Can you elaborate a little on this and how the JV has strengthened your position in the Eagle Ford?

HACKETT: The JV we created is driven toward a capital-sharing model that is disproportionately to our advantage during the early years. So for about three years, [KNOC] pays both parties' capital costs, and that's a tax-efficient way to create value out of those properties. What they get is the right to 80,000 net acres, assuming they perform – and they will. The 80,000 acres are in the Eagle Ford, and they get about 16,000 additional acres in the Pearsall Shale, which is more of a gas-oriented formation. So there is a longer-term gas play here in addition to the liquids-rich Eagle Ford play. What it allows us to do, instead of spending that capital, is to put that towards advancing other projects that we otherwise wouldn't have been able to advance because of our commitment to stay within our cash inflows.

HACKETT: Sure. As you know, some of the largest discoveries in the world in the last several years have been in offshore West Africa and off the coast of East Africa, where we have been active. After it began production, our Jubilee deepwater project in Ghana has contributed significantly to our liquids growth. In addition to Phase 2 for that, there have been a lot of successes around that area, like Mahogany and Teak, and we're still trying to decide how big that area could be and whether it will mean subsea tiebacks or new facilities. We also were successful on an adjoining block in finding oil and gas in two areas called Tweneboa and Enyenra (formerly called Owo). We think the two together have a lot of potential. In Ghana itself we have a lot of running room beyond our existing platform which is going to be producing about 120,000 barrels a day – that's what the facility is designed for, at least Phase 1. Beyond that, we have some 30 prospects that are look-alikes. We have scores of other prospects that are similar sized to those that we have discovered, at least on seismic. They extend all the way from Sierra Leone, where we have had two successful wells, to Liberia, where we're drilling another well, as well as two more in Sierra Leone this year. And then over to Cote de Ivoire, which had been in a civil war through the early part of this year, where we hope to be drilling two wells there later this year or in the early part of next year. We have two blocks there and like what we see.

In East Africa, our discoveries were in Mozambique. Many years ago, we saw evidence of hydrocarbons in Tanzania, so we used that as an analog when we went into Mozambique, where we have huge acreage positions and a development base where we've had numerous natural gas discoveries. It turns out that it is natural gas prone, so far, but there is evidence of oil in the southern portion of our block where we're doing more seismic. The rock was just too tight to get flow assurance, so we've actually found oil in the southern part of that block and a lot of gas in the northern and middle parts to the point that it is clearly at a minimum size for LNG. So what we're doing right now is continuing to explore and appraise to see what sizing we would do for an LNG project in that northern portion, and then shooting seismic and eventually going in and drilling up some of that oil-oriented block. So things are going forward in Mozambique. We also have a huge acreage block in Kenya that we acquired after we made our original forays in Mozambique, and we're having seismic shot there now.

OGFJ: Anadarko ranks 7th among all US producers in capital expenditures, according to the OGJ150 Quarterly Report. Your 2011 capex program is in the range of $6.2 billion to $6.6 billion. What decisions go into your capital allocation and where will most of the capital be invested?

HACKETT: The first starting point is that we want to keep a robust exploration program, so the capex for this is generally between 20% and 25% of our budget. It's been as low as 15%, but we don't like to get that low. When commodity prices collapsed, we were willing to take it down that low, but when prices are robust, we want to keep it in the higher range. We easily spend $1 billion annually on wildcat exploration. That's a very important part of the budget. The next part goes to these mega-projects because they are great arbitrage opportunities where we have a relatively benign cost environment today in the deepwater or in the middle of the desert in Algeria, and when that production comes on in the next year or two, we'll be in a very robust oil environment. We continue to fund those two areas aggressively because they are kind of obligatory. The next best set of economics is generally going to be liquids-rich, US onshore plays, so this will typically get about half the budget. We look at reserves growth and consistent revenue streams when we're funding the programs, so that's the typical thought process that goes into our decisions. We also spend about $500 million or so on midstream. In that arena, we have an MLP with assets that, over time, mature. So you get a funding cycle that comes back to us through the public markets. When it makes sense for that entity to purchase the assets from us, when they get more mature and more cash-yielding, there's a way to regenerate that capital back into the E&P business. So eventually, the $500 million that we spend on midstream will become self funding.

OGFJ: Let's move on to the Gulf of Mexico. First, Anadarko was a non-operating investor in the Macondo well that blewout in the Gulf last year. Can you give us an update on your issues with BP over this incident?

HACKETT: We've been very specific about that. We stand by our original announcement that we made in June of last year about the conditions that we see in the operation of the well. That being said, we have stated publicly that we don't believe we owe anything to BP, but we are open to discuss this under the right conditions with the operator.

OGFJ: Anadarko recently announced a unitization agreement with ExxonMobil and other companies to develop the Lucius field in the deepwater GOM. Can you expand a little on the significance of this?

HACKETT: The Lucius field is a great example of what can happen for America if we're allowed to be aggressive with domestic exploration and production. This is a field we discovered at the end of 2009, and even during the [drilling] moratorium [in the Gulf of Mexico] we were able to advance production handling and partnership agreements around that particular discovery. The good news is that these are all big players. They understand what is going on, and they understand the economics. We'll be operating this facility on behalf of companies such as ExxonMobil (15% working interest); Plains Exploration & Production (23.3% working interest); Apache Deepwater, a subsidiary of Apache Corp. (11.7% working interest); Petrobras (9.6% working interest); and Eni Petroleum (5.4% working interest). These are some of the world's largest oil companies, and we all know that together we can all make this more magical from an economic perspective than doing things independently with separate facilities.

OGFJ: Thanks very much for your time today.

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