Apache Corporation (APA +2.33%) stunned the oil and gas world in late 2016 by announcing the discovery of the Alpine High play in a long-overlooked spot of the Permian Basin. The company believed that it had uncovered more than 3 billion barrels of oil and even more natural gas, which would drive growth for years to come. However, that growth wouldn't materialize overnight because Apache first had to build out the infrastructure needed to develop the field from scratch.
While this process has been slow, Apache has methodically created a large-scale midstream business that could be worth far more in the future than investors realize. That untapped upside makes Apache a compelling oil stock to consider these days.
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Building value one pipe at a time
Over the past year, Apache has invested more than $700 million in building a fit-for-purpose midstream system in the Alpine High region. It's constructed five central processing facilities and over 150 miles of pipeline to move production from newly drilled wells to long-haul pipelines. There are plans to spend another $500 million on infrastructure this year and up to $1 billion through 2020 to complete the initial buildout of its midstream system in the region.
This large up-front investment will enable Apache to quickly ramp up its production from the play in the coming years. The company is already off to a fast start. After achieving first sales last May, Apache ended 2017 producing 25,000 barrels of oil equivalent per day (BOE/D) from the play. If everything goes according to plan, its output will average 160,000 to 180,000 BOE/D in 2020, representing a more than 150% compound annual growth rate from 2017's starting average.
Optional upside
In addition to building out infrastructure within its Alpine High acreage, Apache has been working with third-party midstream companies to secure pipeline takeaway capacity to move its production out of the region. However, the company has taken a unique approach. Instead of just signing long-term contracts for capacity on new pipelines, the company has also secured an option to buy a stake in these lines, which will bolster the value of its midstream business.
One of those projects is the Gulf Coast Express Pipeline, which would move natural gas from the Permian Basin to the Gulf Coast. The pipeline is under development by a joint venture led by Kinder Morgan, which owns a 50% stake. Targa Resources and DCP Midstream each holds a 25% interest in the project and have committed to shipping significant volumes on the pipeline. Another major shipper committed to the project is Apache, which also secured an option to buy a 15% stake in the project from Kinder Morgan.
Apache also recently signed an agreement with Enterprise Products Partners to commit 100% of the natural gas liquids (NGLs) produced out of Alpine High to the midstream giant. Apache will ship this output on the Shin Oak pipeline, which Enterprise is building in the region to move NGLs to its hub in Mont Belvieu, Texas. Aside from securing that takeaway capacity, Apache has the option to buy a 33% stake in Shin Oak after Enterprise finishes the project.
A catalyst on the horizon
These options to acquire stakes in those two pipeline projects could come in handy because one of Apache's priorities for 2018 is to find a joint venture partner for its Alpine High midstream business. The aim of that deal would be twofold: offload a portion of the $1 billion of future capital spending and monetize its previous investments. However, by also including the option agreements in a deal with the infrastructure it has developed, the whole package is much more valuable to a buyer because it's a fully integrated system.
The market doesn't yet recognize this value considering that Apache's stock is down nearly 30% since it discovered Alpine High even though oil prices are up almost 60%. Because of that, Apache could have significant upside in the coming year as it unlocks the value it has created in building out its midstream business, let alone start ramping output from Alpine High. These factors make it quite the bargain for value-conscious investors.
