Image source: Apache Corporation.
Oil prices have been excruciatingly volatile over the past year, which is making it hard for producers to plan ahead. Because of this volatility, most of Apache's (APA +4.30%) peers are in two camps, they are either just spending what's necessary to keep production flat, or doing everything in their power to stay afloat. Apache, on the other hand, is not desperate to stay afloat, nor aiming to keep production steady. Instead, it is taking this time to hone its approach so that it is ready for the next up cycle. That was clearly evident in the company's second quarter report, which was more focused on the progress it is making on its prior goals than anything else.
1. It made significant progress on reducing its cost structure
One of Apache's aims this year is to align its cost structure better with the current environment. These efforts continue to bear fruit, evidenced by the 4% sequential decline in the company's lease operating expenses (LOE). With that decline, LOE is now down 17% over the past year. In addition to that, general and administrative expenses are down by 7.2% over the previous year.
By pushing down costs, Apache was able to boost its cash flow from operating activities to $744 million during the quarter, which is up nearly 170% from last quarter. While an almost 37% increase in the average oil price from last quarter certainly helped boost cash flow, it would not have been up nearly as much if expenses did not continue to fall.
2. It is accelerating strategic testing, not production
Apache set its initial capex budget in the range of $1.4 billion to $1.8 billion so that it could remain cash flow neutral at a $35 oil price. With oil above that level, the company is comfortable with spending at the high end of its guidance range. That said, while it is employing incidental capital, it is doing so to accelerate its testing initiatives, not to speed up production growth.
That is worth noting because an increasing number of its peers are accelerating spending to increase production heading into 2017. Rival Devon Energy (DVN +0.83%), for example, boosted the range of its 2016 capex budget by $200 million, pushing it up to $1.1 billion to $1.3 billion. That capital will enable Devon Energy to deliver incremental production by early 2017. Apache, on the other hand, does not want to boost production just yet but instead wants to drive further efficiency gains to push its costs even lower.
3. The balance sheet is getting even better
Another of Apache's goals is to end the year with debt that is flat to slightly lower than it had at the end of last year. Last quarter the company fell short of that goal after its debt ticked up a bit as a result of outspending cash flow amid crashing crude prices. This quarter, however, rebounding crude prices when combined with cost reductions enabled Apache to generate nearly $200 million in excess cash flow, which resulted in a similar reduction in net debt. That has it on pace to end the year with net debt that's lower than it began the year.
Balance sheet improvement is an industrywide goal this year. Devon Energy, for example, set a goal to sell $2 billion to $3 billion in assets to bolster its balance sheet. The company recently exceeded that goal by announcing $3.2 billion in assets sales, which is one reason why it is comfortable boosting its capex budget. That said, the company plans to use at least two-thirds of its asset sale proceeds to reduce debt, and to that end announced a tender offer to repurchase $1.2 billion of its outstanding bonds. While Apache is not going as far as Devon to improve its balance sheet, it is still placing a high priority on maintaining its balance sheet strength this year.
Investor takeaway
Apache's second-quarter report can be summed up in one word: progress. The company took steps forward to cut costs and maintain a solid balance sheet, which is putting it in the position to accelerate development testing. This progress is providing critical stabilization during the downturn while setting it up to pivot back toward growth when conditions improve.
