Apache Corporation Learned Its Lesson – Apache Corporation (NYSE:APA)

Apache Corporation (APA) over-promised and under-delivered its Alpine High discovery, but the company is doing a better job of managing expectations related to its latest oil find which, I believe, has bolstered Apache’s long-term outlook. The company may not generate strong levels of free cash flows this year, particularly if it diverts capital to develop the new offshore oil block, but its stock could still perform well if the company announces additional oil discoveries in that region.

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Last month, Apache, which has been carrying exploration work in offshore Suriname, informed investors about the status of its first exploratory well in the offshore block. The markets have been expecting an update regarding the region’s oil potential, but the company did not provide any production results. Instead, it said that it will drill deeper to carry additional testing activities. That disappointed the market, fueled speculations related to the oil field’s viability and pushed Apache stock lower. But earlier this month, Apache released another update in which it announced a significant oil discovery at the Maka Central-1 well drilled in Block 58 in offshore Suriname. The company not only eliminated investors’ fears that this major project could be a bust but also improved its long-term outlook.

It seems like Apache may have learned its lesson with how it handled the Alpine High discovery. The Alpine High is a wet-gas play located in Texas which Apache discovered in late-2016 and was touted as a potential “game-changer” for the company by analysts. Just eight months ago, Apache said that Alpine High could become the “the lowest cost, most efficient and most environmentally-friendly rich gas play in the country.” Production costs at Alpine High have been high, but I expected the company to bring the costs lower as it improves well performance and benefits from infrastructure investments. But following persistent weakness in natural gas prices and the company’s inability to bring the costs down to a point where it can profitably grow Alpine High production, it decided to reduce drilling activity and increase focus on other oil-rich regions. With Alpine High, Apache over-promised and under-delivered, but it likely won’t make the same mistake with offshore Suriname.

Apache is, currently, the operator and holds a 50% interest in Block 58 which the company is developing by partnering with the France-based oil major Total SA (TOT). Block 58 is spread over 1.4 million acres in water depths ranging from less than 100 meters to more than 2,100 meters. Apache will operate three exploration wells in the block, including Maka Central-1 where it has discovered oil. Any additional wells will be operated by Total which acquired 50% working interest in the block from Apache in late-2019.

Apache hasn’t released any estimate regarding the Block 58’s resource potential. Instead, the company said that it has made a “significant oil discovery” after it “successfully tested for the presence of hydrocarbons” and “encountered both oil and gas condensate” at Maka Central-1. So far, the company is being tight-lipped and hasn’t made any overly optimistic projections. But I think there’s every reason to be positive about Apache’s future, considering now we know that Block 58 holds oil reserves and it is located right next to Exxon Mobil (XOM) operated Stabroek Block in offshore Guyana. In fact, the distance between Noble (NE) Sam Croft drillship, which discovered oil in Block 58, and the Liza Destiny vessel, which is pumping oil from the Liza field in the Stabroek Block, is less than 80 miles, as per data from VesselFinder.

The Stabroek Block is widely regarded as one of the biggest oil finds of the recent past. So far, Exxon Mobil has made 15 major oil discoveries in this area, including the Mako-1 discovery announced three weeks ago, which can hold more than 6 billion barrels of oil equivalent gross recoverable resources. The oil is of high reservoir quality and the offshore block entails low development costs on a per-unit basis. In terms of size, Stabroek Block is bigger than Apache’s Block 58, spreading over 6.6 million acres. But even if Block 58 holds 10% to 20% as many hydrocarbons as Stabroek, then we’re looking at 600 million to 1.2 billion boe resources. Analysts believe that the market is pricing between 1.45 billion and 1.78 billion boe of gross resources. Either way, a major discovery could be a big deal for Apache which had 1.23 billion boe reserves, including oil reserves of 581 million barrels, by YE-2018.

Apache may have to increase spending in 2020 to develop Block 58 and it could take a few years before production starts to flow. In this period, the company will not generate any cash flows from Block 58. This project can hamper Apache’s ability to generate high levels of free cash flows in the near term. Note that the company faced a cash flow shortfall of $243 million in 9M-2019, as per my calculations based on Apache’s definition of free cash flows. I originally expected the company to swing to free cash flows in 2020 as it moves capital away from Alpine High, increases focus on oil-rich regions in the Permian Basin, cuts costs, and reduces capital expenditures. The company has forecast 10% to 20% cut in upstream CapEx for 2020. But now, following the oil discovery, if the company makes an upward revision to its capital budget, then it might continue outspending cash flows. Apache could still stick with its plan of reducing expenditures, but then, it might move some capital away from the onshore US or international operations to Block 58. In this case, the company might still swing to free cash flows in 2020, albeit the FCF yield could be lower than its peers.

That being said, the Suriname discovery has bolstered the company’s near-term production outlook, which wasn’t looking great after Apache reduced activity at Alpine High which has been driving the company’s growth. In Q3-2019, Apache reported a 14% increase in production from the Permian Basin to 254,000 boe per day. That increase came as Alpine High production jumped to 76,000 boe per day in Q3-2019 from 49,000 boepd in Q3-2018. The persistent weakness in natural gas and NGL price forced the company to scale back drilling activity to preserve cash flows. The company was working with two rigs at Alpine High by late-2019, down from Q3-2019 average of five rigs. The company could further cut drilling work at Alpine High in 2020 as commodity prices (particularly natural gas and NGL) stay low. But now, investors will be looking forward to Block 58’s development schedule and eventual start-up.

In my opinion, if Apache announces additional oil discoveries in the region, releases a resource estimate, and gives a development time frame, then such positive updates will likely please Wall Street. The markets will likely ignore any weak levels of cash flows Apache might report in the short term, considering any cash flow outspend will be temporary. In the long-run, once the company starts producing oil from Block 58, its production and cash flows will surge.

Apache’s shares have risen by 21% in the last six months, easily outperforming the broader exploration and production space (XOP) which fell by 19% in the same period. But Apache stock is still trading 5.9x on an EV/EBITDA (fwd) basis, lower than the sector’s median of 7.06x, as per data from Seeking Alpha Essential. I believe the stock still has room to move higher and any positive updates from Block-58 can act as a catalyst for upside.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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