Title: INSURANCE 811: RISK AND CRISIS MANAGEMENT APACHE CORPORATION CASE October 13, 2005
1INSURANCE 811 RISK AND CRISIS MANAGEMENTAPACHE
CORPORATION CASEOctober 13, 2005
2AGENDA
- Background
- Value Creation in Oil and Gas EP Risks
Associated to Business Model - Current Strategy
- Alternative Hedging Strategies for Acquisitions
with High Oil Prices - Alternative Risk Management Strategies for
Acquisitions with Low Oil Prices - Industry Insights and Evidence
3PLAYERS IN THE OIL GAS INDUSTRY
- Oil and gas industry primarily composed of major
oil and independent oil firms - Independent oil firms vary in cost structure,
technological ability and strategy - Secondary mom pop Companies
- Low tech and low cost entities
- Wildcatters
- Drill speculatively for oil with limited prior
knowledge - Other Independents
- Managed both virgin and mature fields
- Apache competes in this area
- Main competitors include Ocean Energy and
Burlington Resources
4APACHE CORPORATION
- Independent oil and gas exploration production
company - Revenues equally split between oil and gas
- Develops and produces oil and natural gas in
North America, with offshore exploration and
production interests primarily in Egypt and
Australia - North American properties are more mature fields
- International operations are more
exploration-oriented - Growth occurs through acquisitions, exploratory
drilling and development of existing projects - Company strategy is to maximize production and
minimize cost - Compensation strategy that provides strong
management incentive towards maximizing
production - Limited hedging program in place to help minimize
cost on new acquisitions
5APACHE 1999-2001Once in a Lifetime Position
- Apache has grown consistently over the past 23
years - 28 growth in 2000
- Predicted 25 growth in 2001
- Apache acquired several fields from other oil
firms between 1999 and 2001 - 1999 Shell Canada, 518 million
- 2000 Repsol, Oklahoma and Texas, 149 million
- 2000 Collins Ware, South Texas, 321 million
- 2000 Occidental Petroleum, Gulf of Mexico, 365
million - 2000 Phillips Petroleum, Canada, 490 million
- 2001 Fletcher Challenge, Canada, 677 million
- 2001 Repsol, Egypt, 447 million
- Over the past two years, Apache had financed 3.7
billion worth of acquisitions, while keeping a
debt ratio of 40 and interest cover ratio of 6
times - Annual CAPEX of about 1 billion (excluding
acquisitions) - Despite heavy CAPEX requirements and
acquisitions, SP upgraded Apache from BBB to A-
6NOMINAL PRICES OF CRUDE OIL AND GAS
Nominal Price of natural gas (yearly average/KCF)
Nominal Price of oil (yearly average/bbl)
US
US
?
?
Source inflationdata.com with data from US
Department of Energy and EIA (Energy Information
Administration)
7AGENDA
- Background
- Value Creation in Oil and Gas EP Risks
Associated to Business model - Current Strategy
- Alternative Hedging Strategies for Acquisitions
with High Oil Prices - Alternative Risk Management Strategies for
Acquisitions with Low Oil Prices - Industry Insights and Evidence
8EXISTING RISKS AT APACHE
- Oil Gas exploration and production is a
risk-based business. Among the major risks faced
by any company and in special by Apache are - Geological risk
- Political risk
- Operational risk limited flexibility in oil
production rates - Oil Gas Price volatility
- Operational leverage Fixed costs
- Financial distress risk
- Agency problems
91. GEOLOGICAL RISKS Exploration Development
- SOURCE
- Existing uncertainty in the Exploration and
Development of new fields - HOW IT IS MANAGED
- In US Having a large asset base in US (80 of
proved reserves), where Apache can focus on
development of more mature properties (more
predictable) - Internationally Apache concentrates efforts and
tries to become the dominant operator in a
region. - Political risk compounds the greater geological
uncertainty - Apache avoids international areas with the most
risk, such as West Africa or territory within the
former Soviet Union
Developmental Success Rate Productive/Total Wells
Exploratory Success Rate Productive/Total Wells
2000
1999
1998
102. GEOLOGICAL RISKS Depletion of existing fields
- SOURCE
- As a field matures, oil production declines
exponentially - Cost of bringing oil to the surface increases
- Two-step recovery process
- Conventional Means
- One-third to one-half of oil recovered
- Major oil companies exploit field then sell to
secondary or independent companies who have lower
cost structures - Secondary Means
- Involve pumping various substances (pumping water
into the ground or setting field on fire to heat
viscous oil) into the ground to encourage oil to
come closer to surface, resulting in higher cost - Independent companies primarily engage in this
step - HOW IT IS MANAGED
- Apache promotes an aggressive growth strategy to
include new low cost fields in its portfolio that
help to maintain low operating costs - Aggressive strategy to replenish reserves with
new non-mature fields - Managers compensation linked to growing reserve
through new assets acquisition and development
112. OPERATIONAL RISK Limited flexibility in
production levels
- SOURCE
- The speed of oil production is determined by the
reservoir type (sandstone, carbonate, etc.),
proportion of gas, oil and water present, and the
drive mechanism (water drive, depletion drive,
etc.) - This flexibility is specially limited in
reservoirs in secondary or tertiary recovery
(mature fields in US, 80 of Apaches Oil
reserves) - HOW IT IS MANAGED
- There is no active management for oil production
- Apaches general approach to production speed is
to run flat out, pumping as quickly as possible
Apache Production Levels Oil price
MMbbls
Oil price
123. OIL PRICE VOLATILITY
- SOURCE
- Oil Gas prices drive the overall profitability
and cash flows of the industry - Given high fixed costs, oil volatility directly
impacts the profitability and internal generation
of funds - Low oil prices cause UNDERINVESTMENT problems,
disrupting acquisitions and development of
current assets. Anadarko petroleum was forced to
sell 100M in assets due to low prices of oil in
1999 - Oil prices affect cost and availability of
drilling rigs when prices are high, rigs are
booked 18 months in advance - HOW IS IT MANAGED
- Currently, hedging with futures the production of
new acquisitions for the next 2-3 years - Existing one-way option to shut in a well
considered extremely costly (potential damage to
reservoir, starting up production again has large
start-up costs, personnel are fired resulting in
loss of institutional knowledge) - Apache avoids the shortage of rigs by growing
through acquisitions when oil prices are high
134. OPERATING LEVERAGE (I)
- Apaches cost structure is fixed
- Oil well production is costly to shut down
- Potential to damage a well
- High cost to reopen a well
- Production must be maintained at certain speeds
- Producing at an inappropriate speed may damage
the well - Difficult to layoff engineering personnel
- Experienced employees with key knowledge of the
companys assets - During the downturn in oil price in 1998, which
saw 11 oil prices, a 22.3 in revenues produced
a 28.3 decrease in EBITDA and a 49.1 decrease
in CAPEX
144. OPERATING LEVERAGE (II)
155. FINANCIAL DISTRESS RISK
- SOURCE
- The use of debt may cause the company to go
bankrupt - Apache had financed 3.7B worth of acquisitions
over the past two years - Current interest payments are over 100M and
principal repayments are over 1B - HOW IS IT MANAGED
- Limit leverage levels to 45 of
debt-to-capitalization - Issuing new equity after acquisitions to bring
the debt-to-capitalization ratio down
166. AGENCY PROBLEMS
- SOURCE
- Officers and directors as a group held less than
1.25 of the companys common stock - HOW IS IT MANAGED
- Shareholders signal the managers the corporate
strategy through the compensation system - Achieve 1B in assets growth
- Maintain a debt-to-capitalization ratio of 45 or
less - Additional compensation if the company achieves
stock prices of 100, 120 and 180 by year-end
2004 - Additional compensation if production per share
doubled to projected levels
17CURRENT COMPENSATION STRATEGY PARTLY EXPLAINS
CURRENT MANAGERS ACTIONS
Current Compensation Incentives
Managers approach
Other options Apache might consider
Keep expanding through acquisitions (even in high
oil price environments)
- Reward managers based on
- ROI vs industry average
- NPV of project based on pre-determined oil price
- Increasing assets in over US 1B
- Reward managers based on company credit rating
- Leverage lt45 (debt-to-capitalization)
- New equity issuance strategy (high costs and
dilution)
- Run flat out pumping as quickly as possible
- Manage rate of production to maximize profits
- higher production with higher prices
- Close wells if needed
- Increase (double) production level per share
- Engage in riskier-than-usual projects
Try to share downside risk with management (i.e
restricted stock)
18CORE RISKS ARE INHERENT TO THE INDUSTRY AND ARE
NOT SUBJECT TO HEDGINGNon-Core risks might be
hedged using market instruments
- Some of the discussed risks are inherent to the
Oil Gas players - Oil Gas companies are well prepared to
mitigate these risks - Investors expect to have this type of risk
exposure when buying stocks in Oil Gas companies
Geological risk Political risk Operational risk
limited flexibility in oil production
rates Operational leverage Fixed costs Oil Gas
Price volatility (price exposure)
Core Risks
- Other risks are not inherent to the Oil Gas
players - Oil Gas companies should mitigate these risks
using market based instruments
Oil Gas price volatility (underinvestment
problem) Financial distress risk Agency Problem
19AGENDA
- Background
- Value Creation in Oil and Gas EP Risks
Associated to Business Model - Current Strategy
- Alternative Hedging Strategies for Acquisitions
with High Oil Prices - Alternative Risk Management Strategies for
Acquisitions with Low Oil Prices - Industry Insights and Evidence
20HOW DOES APACHE CREATE VALUE?
- Apaches strategy is to maximize production and
to minimize cost - Profit Q (Price Cost) and price is not
under their control - Acquisitions
- Lower cost structure
- Accelerating a propertys cash flow
- Consolidating properties
- Operational improvements through
- Technical knowledge
- Higher production levels
- Hedging to lock-in returns
- Exploration Development (international)
- Clustering strategy trying to be the expert in
a region - Development of Mature Fields (USA)
- Workovers remedial operations on an producing
well with the intention of restoring or
increasing production. - Re-completions producing from another interval
within the same well. For example, after
depleting a zone at 9,000 feet, the operator may
recomplete the well at 8,000 feet. - Moderate risk drilling
EP business model based on continuous growth to
replace reserves and increase production
21APACHE NEEDS TO GROW TO KEEP ITS COSTS LOW
- As a field matures, oil production declines
exponentially - Cost of bringing oil to the surface increases
222. GEOLOGICAL RISKS Depletion of Existing Fields
23APACHES CURRENT STRATEGY TO FUND GROWTH
Acquisition
Growth
24APACHES CURRENT GROWTH STRATEGYAcquiring
properties when oil prices are high
- Apache bets on purchasing new properties when
prices are high and locks the high prices with
hedges - Other competitors avoided this strategy since
they consider that prices would not stay at these
high levels buying high, selling low - Apache management believes that this strategy
allow them to face less competition when trying
to acquire the potential companies - The real reason might be that this is the only
opportunity for Apache to grow through
acquisitions - since they do not have sufficient internal funds
to acquire new properties when prices are down
and the leverage level prevents them to have new
debt financing (EP majors use downstream CFs to
pay for acquisitions when oil prices are low) - The acquisitions are financed with debt
- More than 3.7B raised in the last 2 years
- Apache subsequently issued equity to bring its
debt-to-capitalization ratio below the 45 target
level - High prices are locked with a costless collar
over the next two or three years - Buying a put to set a floor to prices
- Selling a call that sets a ceiling to the upside
potential from an increase in price
25COSTLESS COLLAR ADVANTAGES AND DISADVANTAGES
- Advantages
- Protects Cash Flows Allows access to funding
when oil prices are high (securing payment of
debt) - Protects Value gives stability to revenues
through the period of payout (first years of the
acquisition), when the economics are
hypersensitive - Costless
- Disadvantages
- Limits upside potential
- Potential friction with investors who want to see
upside potential - Not a perfect hedge (timing, quantity)
- Impact of FAS 133 might create extra volatility
in earnings
26CURRENT HEDGING COSTLESS COLLARExample
acquisition of Occidental Petroleums gas
reserves in several Gulf of Mexico fields for
365 million in August 2000
- Purchase price amounts to 1.12 per thousand
cubic feet of reserves - Costless collar with price floor of 3.50 (long
call) and cap at 5.26 (short put)
Avg. price (2000) 3.59
3.50
5.26
As of march 2001 gas prices had continued to rise
above Apaches call price of 5.26 tcf
27APACHE LOST MILLIONS OF DOLLARS FROM COLLARS
ACQUIRED IN 2001 AND 2002
28DOES IT MAKE SENSE TO THINK IN HEDGING
STRATEGIES?Pros and Cons for hedging
acquisitions (solve underinvestment problem)
Cons
Pros
- Access to financing
- Eliminates underinvestment problem
- Improved lending terms
- Reduced cost of capital
- Better credit rating
- Higher potential leverage
- Reduces reliance on equity
- Stability in revenues and CFs
- Secure NPVgt0 for acquisitions
- Tax deferment benefits
- Signal of credible buyer
- Creditors confidence results in less due
diligence - Allows for better evaluation of management
performance during first years after acquisition - Not subject to price risk
- Costly
- Cost of premium
- Loss of part of upside potential
- Management time
- Friction with market expectations
- Shareholders would expect greater profitability
- No increase in profits when oil prices go beyond
ceiling - Signaling Potential volatility in earnings due
to mark-to-market (effect of FAS 133) - Misuse of secured cash flows
- Risk assessment of properties not properly
considered - Basis risk (depending on the hedging instrument)
- Responsible for physical transporting risk to hub
29AGENDA
- Background
- Value Creation in Oil and Gas EP Risks
associated to business model - Current Strategy
- Alternative Hedging Strategies for Acquisitions
with High Oil Prices - Alternative Risk Management Strategies for
Acquisitions with Low Oil Prices - Industry Insights and Evidence
30ALTERNATIVE STRATEGIES FOR NEW ACQUISITIONS WITH
HIGH OIL PRICES
- Acquire with internal funds
- Not enough internal funds to support planned
acquisitions - Operating cash flow of 1,529M vs 2,229M CAPEX
and acquisitions requirements in 2000 - Acquire with new equity
- Loses tax advantages to debt
- Costly, higher cost of equity than after tax cost
of debt - May signal that you believe that you are
overvalued - Causes dilution to current shareholders
- Acquire using debt
- Must decide whether to hedge or not
- Past experiences (I.e. Anadarko divestitures to
reduce leverage) suggest downside risk is real - Without hedge, having access to debt will be
harder and more costly
1
2
3
The key question is to find the best hedge
instrument (lowest cost leaving the highest
upside potential)
31ALTERNATIVES CONSIDEREDHedging acquisitions with
high oil or gas prices
- Futures or Forwards
- Put Options
- Costless Collars
- Costly Collars
- Hedge Tail Risk
- Structured debt
321. FORWARDS AND FUTURES
- Forward contracts enable you to sell at a future
date, but at a price fixed now - Futures are a sequence of rolling daily forward
contracts - Advantages
- Lock-in profits
- Low risk strategy
- Easy to implement
- Cash flow stability
- Low transaction costs
- Disadvantages
- No upside potential
Eliminates all risk, but limits upside potential
332. PUT OPTIONS
- Long Put on Oil
- Current share price 27
- End of year price 11 or 40
- Strike price 14
- Interest rate 10
- Hedge ratio
- (0 - 3)/(40 - 11) -(.103)
- Cost of put per BBL
- -(.103)(27) 3.76 0.97
LONG PUT
Strike price is set to the lowest level that
Apache would need to cover annual interest
expense and reassure lenders
342. PUT OPTIONS
353. COSTLESS COLLARS (current strategy)
- Costless Collar Short Call and Long Put
- Current share price 27
- End of year price 11 or 40
- Strike price 38.35 (short call) or 14 (long
put) - Interest rate 10
- Short Call
- Hedge ratio
- (-1.65 - 0)/(40 - 11) -(.057)
- Value of call per BBL
- -(.057)(27) 0.57 - 0.97
- Long Put
- Hedge ratio
- (0 - 3)/(40 - 11) -(.103)
- Value of put per BBL
- -(.103)(27) 3.76 0.97
- Total Cost 0
SHORT CALL
LONG PUT
Apache uses the proceeds from selling a call to
buy a put
363. COSTLESS COLLARS (current strategy)
374. COSTLY COLLARS
- Costless Collar Short Call and Long Put
- Current share price 27
- End of year price 11 or 40
- Strike price 35 (short call) or 14 (long put)
- Interest rate 10
- Short Call
- Hedge ratio
- (-5 - 0)/(40 - 11) -(.172)
- Value of call per BBL
- -(.172)(27) 1.72 - 2.93
- Long Put
- Hedge ratio
- (0 - 3)/(40 - 11) - (.103)
- Value of put per BBL
- -(.103)(27) 3.76 0.97
- Total Cost - 1.96 (negative values indicate
profit)
SHORT CALL
LONG PUT
Costly collars allow for more control over the
range that is risky
385. HEDGE TAIL RISK
- Tailing Risk Short Call and Long Call
- Current share price 27
- End of year price 11 or 40
- Strike price 14 (short call) or 35 (long
call) - Interest rate 10
- Short Call
- Hedge ratio
- (-26 - 0)/(40 - 11) -(.897)
- Value of call per BBL
- -(.897)(27) 8.96 - 15.24
- Long Call
- Hedge ratio
- (5 - 0)/(40 - 11) (.172)
- Value of put per BBL
- (.172)(27) - 1.72 2.93
- Total Cost - 12.31 (negative values equal
profit)
SHORT CALL
LONG CALL
Hedging tail risk allows you to raise capital
395. HEDGE TAIL RISK
406. STRUCTURED DEBT TO SECURE ACCES TO FUNDS AND
REDUCE INFORMATION RISK
- These instruments may be used when managers are
more optimistic (based on private information
about the firm) and believe that investors are
charging too high a risk premium. If firm begins
to experience difficulty, lenders can change the
terms of debt. - Rating sensitive notes
- Spread over LIBOR variable with Apaches credit
rating - This would lower the initial cost of the debt
- This instrument does not provide a full hedge,
since interest costs would increase if the firms
credit is downgrade, but WOULD GIVE ACCESS TO
FUNDS - Putable bonds
- Investors can put the bonds back to the firm
- They will do so when their value falls below the
face (strike price), due to interest rate
increases or credit downgrades - This instrument does not provide a full hedge,
but WOULD GIVE ACCESS TO FUNDS
41EVALUATION OF ALTERNATIVE STRATEGIES TO HEDGE
AQUISITIONS
Std. Debt
Costless Collar
Costly Collar
No Hedge
Tail Risk
Futures
Puts
- Access to financing
- Upside given up
- Cost
Not hedging and costless collars are the best
hedging instruments
42AGENDA
- Background
- Value Creation in Oil and Gas EP Risks
Associated to Business model - Current Strategy
- Alternative Hedging Strategies for Acquisitions
with High Oil Prices - Alternative Risk Management Strategies for
Acquisitions with Low Oil Prices - Industry Insights and Evidence
43WHAT HAPPENS WITH LOW OIL PRICES?
- Financial distress risk
- Cash flows not enough to fulfill debt payments?
- Underinvestment problem
- How to fund the need for growth?
Apache Faces Two Costly Risks
1
2
44APACHES BALANCE SHEET PROVIDES A NATURAL HEDGE
AGAINST FINANCIAL DISTRESS COSTS
- With current 45 debt-to-capitalization ratio it
is unlikely to face financial distress costs
45THERE ARE ADDITIONAL COSTLESS OPTIONS TO HEDGE
LOW PRICE OIL FINANCIAL DISTRESS
Operational Hedges
- Reduce production costs by outsourcing non-core
functions to oilfield services companies - Apache directly operates properties representing
80 of its production - Reduction in workforce and associated GA expense
- Can more easily shut off expenses in a downturn
- Reduce exploration and development capital
expenditures - Outsource to contract drillers and oilfield
service companies - Improve existing technology
- Defer new capital projects or acquisitions (cause
underinvestment?)
46HEDGING 100 OF THE PRODUCTION WOULD CAUSE HUGE
FRICTION WITH APACHES INVESTORS
- Hedging would cause huge friction problems with
shareholders - 80 of shareholders buy EP stock to gain
exposure to Oil Gas price risk(1) - The net impact of hedges in Cash Flows is
usually negative - Apaches current bullish perception of the
market would not recommend expanding the current
hedging program to 100 of the asset base
Hedging effect on Cash Flows ()
Large Capitalization
Small Capitalization
Production ()
Production ()
Total effect ()
Total effect ()
- According to JP Morgan estimates small
shareholders with no access to the oil and gas
futures market use Independent Oil Gas players
stock as - a way to gain Oil Gas price exposure
47WHAT HAPPENS WITH LOW OIL PRICES?
- Apache may face 2 costly risks
- Financial distress risk
- Cash flows not enough to fulfill debt payments?
- Underinvestment problem
- How to fund the need for growth?
1
2
48ALTERNATIVES TO FUND GROWTH WITH LOW OIL
PRICESContingent Financing
- Apache requires access to liquidity to pursue its
acquisition and exploration development plan - 1.5 million in operating cash flow and 2.2
million in cash flow from investing activities in
2000 - Apache has raised over 3.3 billion in debt, 307
million in preferred stock and 922 million in
common equity from 1998 through 2000 - A drop in oil and gas prices will reduce
operating cash flow and limit access to external
capital - A 30 decrease in the price of oil and gas will
decrease operating cash flow by 35.5 - Debt-to-Total Book Capitalization will increase
from 37.1 to 39.7 - A shortage in capital will reduce Apaches future
growth rate and will reduce equity value - Apache must protect against this downside
scenario by considering contingent financing - Put Options on Apache Stock
- Reverse Convertible Debt
- Other Options
49 PUTS ON APACHE STOCK PERFECT HEDGEUsing
in-the-money (klt0) puts (i)
- Apache can buy put options on its stock to hedge
against future decreases in operating cash flow - Apache could acquire in-the-money (K
constantlt0) put options on its own stock to
achieve a perfect hedge against decreases in its
stock price - However, several factors make such a hedge
impractical to protect against a decrease in
operating cash flow - The relationship between oil and gas prices, cash
flow and stock price are different - A 1 decrease in oil and gas prices will lead to
a .241 and .42 decrease, respectively, in
Apaches stock price - A 1 decrease in oil and gas prices will lead to
a 1.2 decrease in operating cash flow - The upfront cost of these put options are
significant - The feasibility of such hedges will depend on the
probability we assign to the loss of equity value - The following binomial option pricing model was
used to price the put options on Apaches stock
1. The statistic for the change in oil price
regression coefficient is -1.81. As a result, we
cannot say with 95 confidence that this
coefficient is significantly different than 0.
50 PUTS ON APACHE STOCK PERFECT HEDGEUsing
in-the-money (klt0) puts (ii)
?P
K16.30
C/m(2.02)
C/m(4.04)
C/m(6.06)
Loss C per share
0
h.37
h.25
h0.12
511. PUTS ON APACHE STOCK IMPERFECT HEDGEUsing
out-of-the-money (kgt0) puts (i)
- Apache could also form an imperfect hedge on its
stock by buying put options on its stock - Apache could reduce the upfront cost of these
options by buying out-of-the-money put options - However, our analysis still reveals that the
options would be too costly given the probability
of a significant loss - The following binomial option pricing model was
used to price the put options on Apaches stock
521. PUTS ON APACHE STOCK IMPERFECT HEDGEUsing
out-of-the-money (kgt0) puts (ii)
?P
K3.70
Loss C per share
0
h.3
h.2
h0.1
532. REVERSE CONVERTIBLE DEBT
- What if Apache refinanced its existing debt with
Reverse Convertible Debt (RCD)? - Bankruptcy would be nearly impossible thereby
reducing expected bankruptcy costs and increasing
leverage capacity - If oil prices fell dramatically, shareholders
would convert debt into equity enabling Apache
to - Raise new financing in order to pursue its
acquisition and exploration development growth
plan - Enhance cash flow by eliminating interest expense
on the existing RCD - Consider the following example
- Apache refinances all of its existing debt with
RCD - The RCD has a strike price of 50.00 and
underlying common shares of 44.37 million - What would Apaches financial statements look
like?
542. REVERSE CONVERTIBLE DEBT
552. COMPARISON OF APACHE WITH AND WITHOUT RCD
56OTHER OPTIONS
- Apache might also use put options to hedge its
cash flows against a decrease in the price of oil
and gas - 1.00 puts on oil with a strike price of 14.00
would cost 80 million to fully hedge production - 80 million is 11.1 of 2000 net incomea very
significant cost - As a result, we do not believe that Apache should
hedge against a decrease in the price of oil
using puts on oil prices
57AGENDA
- Background
- Value Creation in Oil and Gas EP Risks
associated to business model - Current Strategy
- Alternative Hedging Strategies for Acquisitions
with High Oil Prices - Alternative Risk Management Strategies for
Acquisitions with Low Oil Prices - Industry Insights and Evidence
- Apache and Oil Today
- Industry Highlights
58NOMINAL PRICES OF CRUDE OIL AND GAS
Nominal Price of Natural Gas (yearly average/KCF)
Nominal Price of Oil (yearly average/bbl)
US
US
?
?
Source inflationdata.com with data from US
Department of Energy and EIA (Energy Information
Administration)
59NOMINAL PRICES OF CRUDE OIL AND GAS
Nominal Price of Natural Gas (yearly average/KCF)
Nominal Price of Oil (yearly average/bbl)
US
US
Source inflationdata.com with data from US
Department of Energy and EIA (Energy Information
Administration)
60APACHE TODAY (I)From UBS and Citigroups
Summary of September 2005 Analysts Meeting
- Forecast of 1.4B in Free Cash Flow for 2005 and
1.8B for 2006 - One of the strongest balance sheets among its
peers - Net to debt-to-cap stood at 22(1) at the end of
second quarter (well below peer group average of
35) - UBS projects debt-to-cap ratio to decline to 9
by year end 2005 - Management appears unwilling to do a
transforming acquisition in the near future
(I.e. Forties field) but expects to continue
tactical acquisitions - Un-replicable acreage position and deep inventory
puts them in a good position to grow organically
(1) Below 25 since year-end
2003 Source Direct Transcriptions from
September 2005 UBS and Citigroup analyst reports
61APACHE TODAY (II)From UBS and Citigroups
Summary of September 2005 Analysts Meeting
- Apache remains a very active driller (gt2000 wells
planned fro 2005 up9 vs 2004) as it believes
drill bit returns are above those base on high
acquisition costs - Apache continues to hedge small percentage of
production (5-10 of 06 production), as the
companys use of a conservative pricing forecast
for project planning constitutes downside
commodity protection - Uses of cash include (in order of priority)
re-investment (primarily drilling), debt
reduction, dividend increase, cash building, and
finally share buybacks.
Source Direct Transcriptions from September 2005
UBS and Citigroup analyst reports
62AGENDA
- Background
- Value Creation in Oil and Gas EP Risks
associated to business model - Current Strategy
- Alternative Hedging Strategies for Acquisitions
with High Oil Prices - Alternative Risk Management Strategies for
Acquisitions with Low Oil Prices - Industry Insights and Evidence
- Apache and Oil Today
- Industry Highlights
63AUGUST 2004 JP MORGAN EQUITY RESEARCH HIGHLIGHTS
August 2004
- Our updated hedging survey find that, on
average, EPs have hedges in place covering
roughly one-quarter of both anticipated oil and
gas volumes over the next 12 months. This hedge
position is nearly unchanged relative to our
midyear report update, which indicated that 26
of total volumes were hedged - Since most hedges are still under water, and
free cash flow have shored up producer balance
sheets appreciably, the incentive to hedge
remains generally lackluster. - We are seeing greater usage of 3-way collars,
which preserve greater optionality on the upside
while still protecting from downside moves
Source 3Q-04 JP Morgan Hedging Update
64AVERAGE HEDGE PROTECTION OF 25 OF ESTIMATED NEXT
12 MONTHS PRODUCTION FOR EP COMPANIES
August 2004
Independent Oil and Gas Producers
Source 3Q-04 JP Morgan Hedging Update
65AVERAGE HEDGE PROTECTION OF 41 OF ESTIMATED
NEXT 6 MONTHS PRODUCTION FOR EP COMPANIES
August 2005
Independent Oil and Gas Producers
Source 3Q-05 JP Morgan Hedging Update
66APACHE AMONG THE COMPANIES WITH SMALLER
PERCENTAGE OF PRODUCTION HEDGED
August 2004
Oil Hedging Positions
Natural Gas Hedging Positions
of Next Twelve Months North American Oil
Production Hedged
of Next Twelve Months North American Gas
Production Hedged
Source 3Q-04 JP Morgan Hedging Update
67BEST- HEDGED PRODUCERS OF 2005The Best Kind
of Hedge to Have for 2005 is Still no Hedge
August 2005
Impact of Current Hedge Portfolios on Projected
Oil and Gas Revenue Based upon current 6-month
strip prices (64.8 oil and 9.51 gas)
Source 3Q-05 JP Morgan Hedging Update
68THE LATEST TREND THREE WAY COLLARSIllustrative
Example
Costless Collar
Payout
49
Three Way Collar
Payout
34
Three way collar
/Barrel
Two way costless-collar
Long Position in Oil Puts
Payout
Strike price 25
/Barrel
/Barrel
A standard 2 way collar plus a short put Allows
for higher upside plus still protecting some
downside risk
69COVERED COMPANIES
Backup
Source 3Q-04 JP Morgan Hedging Update
70RISK MANAGEMENT AT APACHE
71Appendix Sensitivity Analysis Apache Base Case