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GOM Shelf Hasn't Lost its Allure for Apache, Others

April 24, 2006
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Every year Gulf of Mexico Continental Shelf producers drill deeper holes to produce less gas from reserves that deplete faster. And then Mother Nature gives them a whupping (or several) during hurricane season.

Makes one wonder why anyone would stay.

As it happens, plenty in the oil and gas business see value in one of the nation's traditional natural gas breadbaskets. Apache Corp. stepped up its presence in the Gulf's Outer Continental Shelf (OCS) with a $1.3 billion deal with BP, announced last week. Also last week, former executives of Gryphon Exploration Co. announced formation of Phoenix Exploration Co. to target the Gulf on and offshore (see related story). In January W&T Offshore Inc. bought the remaining OCS assets of Kerr-McGee Crop. for $1.34 billion (see NGI Jan. 30). Meanwhile, lawmakers are haggling over making more of the OCS available to drilling (see NGI, April 17, April 10).

Last week's acquisition announcement by Apache marks BP's exit from the Shelf. The super-major is still very active in the deepwater Gulf. And it would be wrong to infer that BP is running away from the Shelf. Rather, the company is running to assets elsewhere in the world where it can get a bigger bang for its buck, explained spokesman Hugh Depland.

Apache is picking up 18 producing fields (11 of which are operated) covering 92 blocks with estimated proved reserves of 27 million bbl of liquid hydrocarbons and 185 Bcf of natural gas. Apache has identified 50 drilling locations on the properties and an additional 4 million bbl of liquids and 26 Bcf of gas in probable and possible reserves. Some of the fields are subject to exercise of preferential rights to purchase by other interest owners. The transaction is subject to government approvals and is expected to close by the end of the second quarter.

"We're very aware that the Gulf of Mexico assets are out of favor with the conventional Wall Street wisdom," CEO Steve Farris told analysts during a conference call last week. "However, with Apache the Gulf of Mexico plays an important part in our overall portfolio. It's one of seven regions in a balanced portfolio.

"You really have to take what the Gulf gives you and try not to turn it into something it's not. It is a cash-generating machine. In the last three years we have taken nearly three dollars out for each dollar we've invested."

From April 1, the effective date of the transaction, to year-end, the assets are expected to provide average daily production of 7,100 bbl of oil, 1,500 bbl of natural gas liquids and 108 MMcf of natural gas, generating $320 million of operating cash flow based on prices factored into the deal. Production and cash flow are expected to rise next year as fields damaged during the 2005 hurricane season are brought back online.

Apache has been active in the Gulf for 25 years and touts its successes there in a white paper it released last week. "Through a quarter-century of hard work, Apache has learned how to take everything the Gulf will give it." Indeed, Apache even finds a silver lining in hurricane activity.

"In a global energy market already characterized by a fragile balance between supply and demand, hurricane-related interruptions in Gulf production acted as a built-in hedge for producers, creating offsetting price increases that held cash flow constant and oftentimes higher than before the storms," the company's Gulf white paper says.

In 2005 Apache's production was 54% natural gas. Pro-forma with the Gulf acquisition production will be 52% gas. U.S. offshore grows from 18% to 21%.

For the BP asset acquisition, Apache used gas price assumptions of $7.61/MMBtu for 2006, $9.13 for 2007 and $8.69 for 2008. For the second half of this year Apache bought $7.00 puts on 50 MMcf/d of production for $4.7 million. Apache did not sell calls, though, said CFO Roger Plank, in anticipation of a gas price spike later in the year.

"We've protected our acquisition economics should prices fall while retaining upside should prices rise," Plank told analysts. "What is somewhat different this time is we have factored into our approach the possibility for a significant gas price spike, either from hurricanes as we saw last year or perhaps strong demand from hot summer weather. Therefore, whereas ordinarily we've taken a costless approach to hedging, primarily with collars, for 2006, we bought a floor but we did not sell a ceiling."

For 2007 Apache sold $11.00 calls and bought $8.65 puts, and for 2008 sold $10.47 calls and bought $8.15 puts.

"Nearly half of the reserves in the transaction are in properties in which we already own an interest, including the Grand Isle 40s/West Delta complex -- one of the largest fields ever discovered in the Gulf," said Farris. "We know these assets very well, and gaining operatorship will enable Apache to drive the development program, leverage infrastructure and realize significant operating synergies.

"Apache built its Gulf of Mexico Shelf core area over the past 15 years through $2.7 billion in acquisitions of producing assets... Over the years, Apache has drilled more than 350 wells on the acquired properties and reinvested in the Gulf more than $2.3 billion of the $6.2 billion of cash flow generated in the Gulf."

In another $1.3 billion deal, this one in 2003, Apache acquired a package of legacy oil- and gas-producing assets from BP, with 61 producing fields in the Gulf of Mexico and two in the North Sea (see NGI, Jan. 20, 2003). In 2000, Apache agreed to buy the offshore Gulf of Mexico interests of Occidental Petroleum Corp. for $385 million (see NGI, July 24, 2000).

"At the end of 2005, we have recovered all of our original investment, paid for all of the additional capital incurred and generated in excess of $1 billion of free cash, with proved remaining reserves from these properties of 270 MMboe at the end of 2005," Farris said.

Apache plans to finance the deal with commercial paper. Post-transaction, Apache's debt is projected to remain below 23% of total capitalization. The company has hedged about half of the projected 2006, 2007 and 2008 oil and gas production from the acquired properties at prices that protect deal economics while giving Apache upside exposure to higher prices.

This is the latest of three deals that are expected to add 14,700 bbl of liquids and 142 MMcf of natural gas to Apache's 2006 average worldwide daily production, based on expected closing dates. The added production is equal to 9.3% of Apache's 2005 average daily output.

"Over the last five years, we have acquired, in negotiated transactions primarily from companies far larger than ourselves, more than $4.2 billion of assets with proven reserves of 669 MMboe," Farris said. "Over that same period we have drilled nearly 7,800 wells that added 1.2 billion boe."

When it announced the BP deal, Apache also said it would be repurchasing up to 15 million shares, about $1 billion worth at recent share prices. Neither Moody's Investors Service nor Standard & Poor's Ratings Services flinched at news of the BP transaction. Both affirmed their ratings on Apache, each with a "stable" outlook.

"The stable outlook assumes Apache will continue to fund capital expenditures with free cash flow and that its stock buyback activity does not materially escalate leverage on developed reserves. Moody's notes management's decision to initiate a share buyback program while pursuing debt-financed acquisitions is more aggressive... and reflects the company's expectations for a continued robust price environment."

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