Patience may be a virtue, but it's tough to be patient with a turnaround investment as the turnaround gets delayed... and delayed... and delayed some more.
Just ask shareholders of Apache Corporation (NYSE:APA). While peer oil and gas exploration and production companies such as ConocoPhillips (NYSE:COP) saw their shares rise in 2017, Apache was sitting on double-digit losses. The stock market was impatient with Apache as the production gains management had predicted never seemed to materialize.
But here's why 2018 may be the year an investment in Apache pays off.
Alpine High: high cost, high reward
Apache's shares got a big boost in 2016, when it announced that an acreage position it had been quietly building up in sleepy West Texas -- dubbed "Alpine High" -- was, in fact, a monster find. Thanks to misconceptions about the amount of oil and gas in the area, Apache had been able to pick up the land on the cheap, for only about $1,300 an acre. But Apache discovered at least 3 billion barrels of oil and 75 trillion cubic feet of natural gas underneath its acreage -- and that was in just 40% of the shale formations under the land.
Those same misconceptions that allowed Apache to pick up the land on the cheap, though, were a double-edged sword for the company. They also meant there was hardly any oil and gas infrastructure in the region to bring oil and gas from Alpine High to market. So the company busily set out building pipelines, wells, and storage facilities, but even though that work ran ahead of schedule for much of 2017, it still ate up company resources while contributing hardly any income -- at least for now.
Q3 2017 was supposed to have been the quarter when Alpine High production finally took off, but Mother Nature had other plans. in late August, Hurricane Harvey damaged some Houston-area manufacturing sites where critical components of Alpine High facilities were being built. As a result, those facilities won't be fully operational until Q1 2018, upending Apache's production projections for 2017.
However, that's a delay and not a failure, so assuming there's no further negative impact to Apache's Alpine High schedule, investors should begin seeing the major 2017 investment in Alpine High bear fruit this year.
Production: all about the numbers
Another reason the market was so bearish on Apache in 2017 was that its production numbers went down on both a sequential and year-over-year basis in both Q1 and Q2. Apache also lowered its production guidance through 2018 and in Q2 reported negative adjusted earnings.
But Apache had been predicting those lower production numbers for months, as a result of scheduled maintenance in its North Sea rigs while a subsea tieback was installed, and the time it would take to install necessary infrastructure at Alpine High. In fact, Q2 production came in higher than originally expected.
Production also fell thanks to Apache's exit from Canada in July. It sold off its entire Canadian portfolio for about $713 million, which lowered its overall production but improved the company's margin. Management believes that Alpine High will replace the lost production by May. Other companies, including ConocoPhillips, have made similar moves to rid their portfolios of low-margin Canadian assets recently. Apache's production was also affected by some unscheduled downtime in the North Sea in December, thanks to a third-party pipeline issue, and lower volumes in Egypt because of improving Brent Crude oil prices.
The flip side of this lower-than-expected production is higher-than-expected margin into 2018. Improving oil prices mean the company is making more money for each barrel it pumps, and even with the Alpine High delays, Apache's management expects its North American production numbers to come in at the high end of its guidance range. That should set Apache up nicely to beat expectations in Q1 2018, and hopefully beyond.
What could go wrong
All indications are that Alpine High is in fact the bonanza that Apache predicted it would be when it announced the find back in 2016. And with each positive update, the potential that the company is just plain wrong about the find gets smaller and smaller. With Alpine High firing on all cylinders and an improved oil price coupled with high margin, Apache's 2018 could indeed be its best year yet.
Of course, that's what the company thought about 2017, too, before Hurricane Harvey and North Sea issues were factored in. While both of those events seem to have been beyond the company's control, there's no guarantee that some other event beyond the company's control -- OPEC production increases that lower oil prices, for example, or another third-party maintenance problem -- won't throw the company's projections off track again.
For now, though, Apache's future is looking bright. And for me, that makes it a buy in 2018.