Please ensure Javascript is enabled for purposes of website accessibility

Chevron Is Getting a Hidden Gem in the Anadarko Deal

By Matthew DiLallo – Updated Apr 22, 2019 at 12:17AM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

The oil giant is getting more than just additional land in the Permian Basin.

The main reason Chevron (CVX 1.00%) is paying $50 billion to acquire Anadarko (APC) is to bulk up its industry-leading position in the fast-growing Permian Basin. An added benefit is that the deal will also bolster the oil giant's presence in the Gulf of Mexico, add a compelling liquefied natural gas (LNG) project in Mozambique, and give it a meaningful position in two shale plays in the Rockies.

With all the focus on the oil and gas properties Chevron will acquire, most investors are probably overlooking another gem the oil giant would get in the deal: Anadarko's 55% stake in Western Midstream (WES -0.44%). The addition of Western Midstream would boost Chevron's midstream business, which could enhance the long-term value created by this combination.

Cave with skylight streaming sunlight on a treasure chest.

Image source: Getty Images.

Shining a spotlight on midstream

As an integrated oil and gas company, Chevron operates across the entire value chain. Most investors, however, know the company for its upstream production business while many consumers are familiar with its downstream retail operations. Few know much about the midstream operations of Chevron Pipe Line Company. That entity operates about 3,000 miles of pipelines that transport more than 1.2 million barrels of oil, refined products, and chemicals each day. The company also has enough storage capacity to hold about 2.6 million barrels of products. These assets help support Chevron's upstream and downstream operations by moving hydrocarbons from production basins to end users.

While Chevron buried its midstream business within its global oil and gas empire, Anadarko has worked hard to highlight the value of these assets. That led the company to form a master limited partnership (MLP) more than a decade ago to help drive midstream growth. Anadarko steadily dropped down its midstream assets to that entity, which unlocked value while providing the company with a cash infusion. The MLP also acquired several assets from third parties and built new infrastructure to support the growth of Anadarko and other producers.

Today, Western Midstream owns interests in more than 12,700 miles of pipelines in the Rockies, Texas, New Mexico, and Pennsylvania. It also operates natural gas processing plants and other midstream assets. Long-term, fee-based contracts underpin the bulk of these assets, which provide Western Midstream with predictable cash flow. The company sends more than 80% of that money back to investors -- including majority owner Anadarko -- via its high-yielding distribution.

Pipeline valves with an oil pump in the background.

Image source: Getty Images.

Several ways to win from this gem

One of the benefits Chevron will get when it assumes Anadarko's 55% interest in Western Midstream is a steady supply of cash flow via the MLP's distribution. That earnings stream should rise as Western Midstream continues expanding its footprint.

Another benefit will a competitively advantaged midstream business in the Permian Basin to more efficiently support Chevron's growth. Western Midstream operates natural gas, crude oil, and water gathering systems that handle Anadarko's production in the fast-growing region. These assets help reduce operating costs and help ensure market access for the company's output. Because of its majority stake in Western Gas, Anadarko controls the construction of infrastructure to suit its needs. Chevron can leverage this by having Western Midstream build out similar assets on its acreage position in the region.

Chevron could also follow ExxonMobil's (XOM 0.12%) midstream blueprint by helping push longer-haul pipelines over the finish line. Exxon is working with several midstream companies in the region to build out oil and natural gas pipelines to ease the bottlenecks. The oil giant is not only signing up for capacity on the lines but investing money to help build them.

Finally, Chevron could use Western Midstream as a funding vehicle. On the one hand, it could follow the approach of Anadarko and drop down its midstream assets to this entity. That would enable the company to maintain control over these assets while freeing up the capital to reinvest elsewhere or return to shareholders via its buyback program. Another option would be to sell down some of its interest in the company.

A nice pickup

Chevron's primary purpose in buying Anadarko is to bulk up its upstream oil and gas business. However, the deal has the bonus of strengthening its midstream operations. It's an aspect of the transaction that investors shouldn't overlook since Western Midstream will provide several financial and operational benefits. That increases the probability that Chevron's bold bet can create significant value for its investors in the coming years.

Matthew DiLallo has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.