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Re: Please Teach Me how to Value Oil Companies

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By Burghy
October 11, 2006

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I finished my pretty amateurish valuation of Apache and I will post it here for criticism and comments. I am by no means an expert in this industry so don't expect insight along the lines of those provided by RedneckRoleModel. There are major inaccuracies in the valuation which I wish I could narrow down but I can't because I lack either the information or the method to do so. These inaccuracies are probably deal-breakers for valuation purposes, so don't go and buy this stock based on this write-up.

So the major weaknesses that I am aware of are that firstly, I have only looked at comparable companies for multiple comparison purposes and I have absolutely no idea what their strengths and weaknesses are. Definitely it would be better if I was proficient in several companies so I would have a better frame of reference for Apache. Secondly, while I was able to find figures for proven reserves, I was unable to do so for probable reserves. Obviously this throws a pretty medium-sized spanner into the works since I have no idea how valuable those probably reserves would be, although it's an upside spanner.

Some more unavoidable things that happen when you do valuations, is that many of the estimates are sensitive to small changes and so the confidence interval on the imputed value is pretty huge. Pretty much expected, although because of the multiple moving parts (extraction costs, acquisitions, not to mention the extreme volatility in the oil and gas prices) this is a larger factor than normal. Also I feel that the management deserves some sort of bonus for its track record of smart acquisitions, and ideally I would have liked to do some sort of option valuation of the chance of profitable acquisitions. But then I realized no one actually does that in real life so I gave them a lump sum bonus instead.

So without further preamble, since brevity is the soul of wit, and tediousness the limbs and outward flourishes, I shall begin. I put a link to the .doc and .xls files at the end, they probably make easier reading. So skim through this and see if you're interested.

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Executive Summary

Apache Corporation is a U.S. based oil & gas exploration and production company with worldwide operations. The valuation focuses on the NAV of its existing reserves. The basis for this recommendation focuses on the undervaluation of its proven reserves.


Business Description

From the 2005 10-K: "Apache Corporation is an independent energy company whose principle business includes exploration, development and production of crude oil, natural gas and natural gas liquids. The Company operates in five core countries which, collectively, contained over 99 percent of the Company's 2005 year-end estimated proved reserves and accounted for over 98 percent of the Company's 2005 oil and gas production revenues. These principle operations are located in the United States, Canada, Egypt, Australia and offshore the United Kingdom in the North Sea."

In comparison with its peer group such as Devon Energy Corp (DVN) or EOG Resources Inc (EOG), it has a more even oil/gas mix with proven reserves of 53% oil and 47% natural gas. It is also more geographically diversified as its comparables are based in the U.S. For valuation purposes, this has historically given Apache a slight discount relative to its peers because of the perceived greater political risk of its international operations.

Apache's current reserves are approximately 1,000 million barrels of oil & natural gas liquids (NGLs), and 7,000 Bcf of natural gas. Annual production is approximately 89 million barrels of oil & NGLs, and 461 Bcf of natural gas. Its market value as of October 9, 2006 stood at $21.5 billion, with a price per share of $63.61 and 338 million shares outstanding.


Highlights and recent activity

Apache's valuation is highly correlated to both oil and natural gas prices because only around 10% of its oil and gas production is hedged (fig 1.) This makes it possible to value Apache using a NAV approach, as valuations based on multiples are hard to do because of the cyclical nature of the oil business. At the time of writing, front month NYMEX crude oil and natural gas futures were priced at $60.45 and $6.611 respectively.

The Company's value was impacted by the 2005 hurricane season. Hurricanes Katrina and Rita caused extensive damage, reducing Apache's 2005 average annual daily production of natural gas by 59 MMcf/d and of crude oil by 10,813 b/d. The company forecasts that the majority of the production will be restored by the end of 2006.

The Company is known as a savvy acquirer and its management, although not known to be overly communicative with shareholders, is considered one of the better teams in the industry. It has a good long term track record of making acquisitions that grow shareholder value, often acquiring properties when the rest of the industry is afraid.

It relies on acquisitions as its main growth driver, yet it still maintains reasonable debt loads. Its total debt to common equity ratio ranges has trended downwards from around 80% in 1996-1999 to 29% as of 2nd quarter 2006.

Recently, it completed an acquisition of Gulf of Mexico properties from BP of approximately 19.5MM barrels of oil & NGLs and 148Bcf of natural gas for approximately $845 million, a purchase price of $20/boe. It also acquired properties in Argentina from Pioneer Natural Resources for $675 million of approximately 22 MM barrels of oil & NGLs and 297 Bcf of natural gas. Historically the Company has been able to locate further reserves on acquired properties using its know-how.

Fig 1. Apache's valuation is correlated to oil and gas prices, sort of.


Catalysts

Possible catalysts for Apache �

� The hurricane affected producing properties in the Gulf of Mexico returning to full production;
� Price spikes in crude oil or natural gas;
� Announcement of a new major acquisition


Risks

Possible downside risks for Apache �

� The current M&A market is quite competitive so the Company may have difficulties finding acquisition targets in the near term.
� The lease operating costs have increased from an average of $3.69/boe in 2001 to $11.11/boe as of June 2006 and continue to rise, putting pressure on margins.
� Although unlikely, a large decline in crude oil price would reduce the value of the company.


Valuation

A simplified valuation is presented, please refer to the accompanying spreadsheet for detailed valuation procedures.

USD millions

NAV of oil & gas reserves 33,153 - value of debt (3,476)
- taxes, estimated net 25% (7,419)
NAV value of equity 22,258
- value of preferred stock (100)
NAV value of common equity 22,158
+ value of probable reserves @ 50% ???
+ option value of acquisitions 663
Total value of common equity 22,821+

Current shares outstanding 338 million

Implied value of common equity per share $67.48+

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Thingy

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As always, I love criticism and comments! But not ad hominem criticism. I like the criticism that teaches and loves.

Here's the link to word/excel files (Warning - the excel spreadsheet will anger anyone who likes reasonably accurate valuations):
http://rapidshare.de/files/36057125/Apache.zip


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