Chevron Joins the Ranks of Exxon Mobil and Shell After Buying Anadarko

Image Source: Chevron Corporation – IR presentation

Chevron is buying Anadarko. Chevron will have to show that the projected operational synergies and related capital intensity reductions actually materialize through this acquisition, as execution risk is very material in the oil & gas world. We will be monitoring the industry as further consolidation is possible with interest rates remaining low for the time being and in light of oil prices moving sharply higher since January.

By Callum Turcan

Energy stocks moved upwards last Friday, April 12, on the news that Chevron Corporation (CVX) is purchasing Anadarko Petroleum Corporation (APC) for $33.0 billion in a cash and stock deal, for a total enterprise value of $50.0 billion when taking debt into consideration. This deal will put Chevron’s upstream production on par with the likes of Exxon Mobil Corporation (XOM) and Royal Dutch Shell plc (RDS.A) (RDS.B), and far ahead of its European rivals BP plc (BP) and Total SA (TOT). On a pro forma basis, the combined entity produced 3.6 million barrels of oil equivalent per day net last year and was sitting on 13.5 billion BOE of proven reserves at the end of 2018. Chevron yields almost 4.0% as of this writing.

Transaction Overview

As part of this deal Chevron will issue out ~200 million shares and offer ~$8.0 billion in cash to Anadarko’s shareholders, which at the time of the announcement amounts to a $65 per share offer. Specifically, Chevron is offering 0.39 shares of Chevron and $16.25 in cash for each share of APC. This sent Anadarko’s share price up 32% to $62 on April 12, while Chevron’s share price dropped 5% to just under $120. That was likely due to the expected dilution. Chevron plans to divest $15.0-20.0 billion in assets during the 2020-2022 period to help cover this acquisition and expected share buybacks. In order to highlight how Chevron would offset that dilution over time, management increased the energy giant’s targeted annual share repurchases by 25%, to $5.0 billion.

Reportedly, Occidental Petroleum Corporation (OXY) bid over $70 per share for Anadarko, which also was supposed to include a larger cash component than Chevron’s bid. However, Anadarko chose Chevron over Occidental due to closing execution risk, as Occidental would have likely needed to get shareholder approval first before moving forward on such a relatively large transaction. The breakup fee Chevron agreed to was said to be 3% of the deal price, which would net Anadarko close to $1.0 billion, but it’s quite likely this acquisition will get completed. On the other hand, Occidental shareholders could have very well shut this deal down due to financing concerns and other considerations.

Occidental is rumored to be considering its options, but it doesn’t appear the company has the capacity to engage in a serious bidding war considering Occidental is limited by both its own net debt load of $7.3 billion at the end of last year and the relatively large net debt load of Anadarko and its midstream family, which stood at $15.1 billion on a consolidated basis at the end of 2018. While Chevron had a net debt position of $24.1 billion at the end of last year (cash, time deposits, and marketable securities less short-term and long-term debt), keep in mind Chevron is vastly larger than Occidental (for reference, Chevron’s market capitalization stands at $227.6 billion as of this writing versus $48.9 billion for Occidental).

Assuming this deal gets approved, Chevron is targeting $1.0 billion in annual operating expense savings and another $1.0 billion annual capital expenditure savings. The operating cost synergies are more straightforward as there is plenty of operational overlap in key producing regions that Chevron will likely retain as core assets going forward, but the capital expenditure synergies are slightly less obtainable. What that means is Chevron is forecasting it will be able to produce a similar amount of upstream production while spending less on capital expenditures, largely by capitalizing on centralized production and midstream infrastructure in key regions like the Gulf of Mexico and the Permian Basin.

Operational Overlap and Synergies

Chevron is acquiring a significantly larger upstream position in the US Gulf Coast region, in part because Anadarko purchased Freeport-McMoRan Inc’s (FCX) Gulf of Mexico assets back in 2016 for $2.0 billion and due to Anadarko long operating in the region. There are obvious synergies as Chevron is also a huge player in the Gulf of Mexico. Last year, Chevron pumped out 220,000 BOE/d on a net basis (assuming a 6 MMcf gas:1 BOE conversion ratio) with crude oil representing the bulk of that output, making these production streams very valuable. During the fourth quarter of 2018, Anadarko produced over 140,000 BOE/d net in the region, which was primarily represented by crude oil.

One way Chevron can save on capital expenditures is by leveraging the combined entity’s numerous existing offshore production platforms to develop smaller oil fields and other bolt-on opportunities in the Gulf of Mexico that are too small to justify sanctioning construction of new platforms. As production infrastructure and subsea pipeline systems are already in place, the project cycles of these bolt-on endeavors are much shorter than greenfield developments. Anadarko was already in the process of deploying this strategy before Chevron’s bid was announced. For example, Anadarko’s partially-owned Constellation bolt-on project was turned online back in January and those production streams are being routed to Anadarko’s fully-owned Constitution spar.

Image Shown: Chevron and Anadarko both have a sizable presence in the American region of the Gulf of Mexico. Image Source: Chevron – IR presentation

Pivoting to West Texas, the combination of Chevron and Anadarko’s Delaware Basin operations excited many analysts last Friday, April 12. The Delaware Basin is one of the two most prolific sub-basins within the Permian Basin, with the other prolific region being the Midland Basin. Anadarko has a sizable presence in three of the core counties in West Texas that house Tier 1 Delaware Basin development opportunities including leaseholds in Loving, Reeves, and Ward County. For Chevron, its best Delaware Basin acreage is in Culberson County (Texas), Eddy County (New Mexico), and Lea County (New Mexico), with a modest footprint in the core parts of Reeves County (Texas). These opportunities are being unlocked through hydraulic fracturing and horizontal drilling strategies, dubbed fracking by the financial world.

Chevron’s non-contiguous acreage that was previously stranded due to lack of scale near where Anadarko operates will now be able to be developed alongside its new leaseholds in an economical manner. Centralized developed programs on both the upstream and midstream front are how fracking opportunities can generate strong returns. For instance; rigs and completion crews can move from one pad to another faster which cuts down on expensive downtime, centralized gathering and water handling systems sharply reduce both ongoing operating costs and required capital expenditures as it relates to supporting upstream volume growth, and personnel don’t have to jump from county to county on a daily basis. Pad drilling is utilized to bring numerous wells online on the same drilling spacing unit to save on development costs (numerous wells are drilled and fracked next to each other) and to make centralized infrastructure strategies feasible. 

Image Shown: Chevron has a large position in several of the Delaware Basin’s core counties including Lea and Eddy County up in New Mexico and Culberson County down in Texas, while Anadarko Petroleum has a major footprint in Loving, Reeves, and Ward County in Texas. Image Source: Chevron – IR presentation

As of the end of last year, Chevron had an economic interest in 1.2 million net acres in the Delaware Basin, along with another 0.5 million net acres in the Midland Basin. The company produced almost 310,000 BOE/d net out of the Permian Basin last year, with liquids (oil and natural gas liquids) representing almost three-quarters of that output. Anadarko had an economic interest in 240,000 net acres in the Delaware Basin at the end of 2018, and produced 127,000 BOE/d net during the fourth quarter (with liquids representing the majority of that production). Those production streams are expected to grow materially over the coming years.

Midstream Questions

Anadarko spun-off the vast majority of its midstream operations to Western Midstream Partners LP (WES), which recently consolidated into one entity (that was a good move). The company retains a ~56% interest in the midstream master limited partnership. Both BP and Shell have midstream MLPs as well, BP Midstream Partners LP (BPMP) and Shell Midstream Partners LP (SHLX). Long-term, it’s quite possible those MLPs get rolled back up into the C-Corp as the tax advantages have become less advantageous, largely due to FERC removing the once generous income tax allowance from cost-of-service tariffs.

Now that Chevron is becoming the majority owner of Western Midstream, it will be important to see how well the company leverages those assets to support its Permian growth story. Management had this to say during the presentation covering the acquisitionthe acquisition:

“Western Midstream is a successful midstream company and strong pipeline operator, whose assets are well aligned with our upstream positions and are a key enabler as we further accelerate development in the Permian.”

Chevron has a AA credit rating from S&P Global Ratings with a stable outlook and a Aa2 credit rating with a stable outlook from Moody’s Corporation (MCO), while Western Midstream’s credit rating from Moody’s isn’t investment grade at Ba1 with a stable outlook. Management had this to say on that issue when asked about whether Chevron or Western Midstream would finance midstream investments due to Chevron sporting a lower cost of capital: 

“I mean, you’re absolutely right, we’re different credits, I mean, we’re committed to having a strong balance sheet, we’re AA credit. That changes how you look at financing through the MLP and the midstream company. But it comes with a lot of capability, it comes with a lot of connections to our business. And as Mike said, it’s a business that we didn’t – we did not pursue and we didn’t have the assets to pursue. Anadarko has done a nice job to build up that business and to have an attractive value proposition. We intend to work with it and manage it going forward for the benefit of their shareholders and ours.”

It’s possible that Western Midstream gets rolled up into Chevron, which could justify why Western Midstream was bid up last Friday by almost 9%. That being said, no clear answer was given during the call as that may be an ongoing topic of conversation at Chevron. We would be supportive of Chevron rolling that MLP up into the C-Corp over the long-term, if not sooner, as the benefits of the old complex midstream structure are no longer apparent. Chevron needs to build out its midstream presence in the Delaware to support its upstream growth trajectory, particularly as its output has been growing at breakneck pace since 2016. Keep in mind that the picture below was before Chevron announced it was buying Anadarko, as management hasn’t provided updated Permian production growth guidance yet.

Image Shown: Chevron has lofty Permian growth ambitions. Image Source: Chevron – IR presentation

Concluding Thoughts

There are other important operations Chevron is acquiring from Anadarko including; the upstream firm’s DJ Basin operations in Colorado, its offshore Ghana position, and Anadarko’s very promising LNG project in Mozambique, all of which could provide significant upside over the coming years. That being said, Chevron will have to show that the projected operational synergies and related capital intensity reductions actually materialize through this acquisition, as execution risk is very material in the oil & gas world. We will be monitoring the industry as further consolidation is possible now that interest rates are being kept low for the time being and in light of oil prices moving sharply higher since January. Our updated reports and fair value estimates are now live.

Oil & Gas – Major: BP, COP, CVX, RDS, TOT, XOM