Life Begins (Again) at Forties

Executive Summary
Apache Corporation announced on January 13th that it was to acquire assets in the UK North Sea and the Gulf of Mexico from BP for US$ 1.3 billion. This represents the first deal in BP's expected portfolio rationalisation and is certainly eye-catching, with the package of assets sold including BP's 96.3% interest in the Forties field in the UK.

Value versus Volume
Wood Mackenzie believes that this deal is the first of a series which will herald a marked upturn in the volume of trading in the upstream asset market worldwide, as predicted in its recent Horizons note "Switch to Value – Asset Market Set for Action." In that report Wood Mackenzie predicted that the long awaited re-structuring of the super-majors' portfolios was set to begin in earnest in 2003, driven by a switch away from production growth targets towards a period of portfolio management aimed at the disposal of non-core assets. This portfolio re-structuring recognises that assets which were material in value to a smaller entity no longer carry the same weight in a super-majors' portfolio. By re-focusing its portfolio, BP is seeking to target its financial and human capital to achieve superior returns.

Next steps for BP
This deal sets the benchmark for what BP (and perhaps the industry) regards as "non-core" within its portfolio. The Forties field represents around 5% of the value of BP's UK portfolio and is its fifth largest UK asset by value. The total asset package of US$ 1.3 billion represents between 1 and 2% of BP's total upstream portfolio. We expect BP to announce more disposals, both within the North Sea and its international portfolio, with an indication of the full scale of this rationalisation to be presented in its February investor briefing. Based on the scale of this transaction, and an appraisal of BP's asset portfolio, Wood Mackenzie believes BP's total upstream disposals could be around US$ 5 billion. In its "Switch to Value" note Wood Mackenzie estimates that total asset disposals amongst the super-majors could reach US$ 15 billion in 2003.

BP's Major North Sea Assets

The Forties sale indicates the widespread nature of BP's internal portfolio review and the fact that there are no "sacred cows" in this process. Forties was an operated asset in a core area in which BP held a very large percentage of the equity. It was also significant in terms of value and production within the region. What it lacked, in BP's opinion, was future upside. BP saw no prospect of increasing Forties' value beyond what a willing buyer might be prepared to pay and so monetised the asset. The sale of Forties and similar assets will also allow BP to trim costs further.

BP's North Sea Portfolio

The sale of Forties inevitably raises the question, "what next?". If Forties is regarded as non-core within the UK, there are a number of other assets which fit this description. The value of BP's UK portfolio is concentrated in its top ten assets which account for two thirds of its commercial value. This leaves a tail of assets worth over US$ 4 billion from which BP could select further divestment candidates. Indeed, given the scale of the Forties divestment, there is no reason to suppose that BP might not choose to divest another of its top 10 assets such as the Brae/ Miller area field interests.

Wood Mackenzie ranks Forties around 30 th in terms of value in BP's global upstream portfolio and, at US$ 1.3 billion, the deal is larger than its entire upstream asset value in a number of countries. For example, Wood Mackenzie values BP's Norwegian portfolio at around US$ 1.3 billion and BP has commercial operations in a further 10 countries valued at between US$ 100 million and US$ 1.3 billion. Having set the benchmark with the current sale, BP has ample scope to proceed with a wide-ranging re-structuring of its global upstream portfolio.

The Future of the North Sea
BP's disposal of Forties signals the commencement of a new stage in the development of the UK North Sea industry. With UK oil production peaking in 1999 and large new development projects now a rarity, we believe that we are set to see an increase in asset trading with the super-majors set to divest non-core core assets and looking to consolidate their holdings in key areas, particularly around infrastructure hubs. It is significant that BP has chosen to retain the Forties pipeline infrastructure while disposing of the field.

This deal does not signal the end of the super-majors involvement in the UK, which remains an important part in each company's portfolio. BP's interests in the Eastern Trough Area Project (ETAP) fields, for example, remain a very important part of its global portfolio. The same can be said about assets such as Schiehallion for Shell, Shearwater for ExxonMobil, the Alwyn Area for TotalFinaElf, Elgin/ Franklin for Eni, Captain for ChevronTexaco and Britannia for ConocoPhillips. Indeed, the importance of these, in terms of each company's overall portfolio, may be enhanced through deals aimed at increasing their stake in these core assets.

However, we do believe that the super-majors are set to embark on a rationalisation programme which will increase the percentage of assets in the UK North Sea, owned and operated by smaller companies. Recent new start-up companies such as Paladin, Venture, Tuscan, Consort and First Oil, as well as new entrants, such as Apache, and others with existing positions who view the North Sea as a potential growth area, such as Talisman, are all set to benefit from this process. The benefits will flow two ways with the super-majors able to re-focus resources, cut costs and monetise non-core assets and the smaller companies seeing incremental value in assets which are immaterial to the larger companies.

Apache has, through the current deal, significantly added to the value of its upstream portfolio and diversified into a new, low political risk area. The US$ 1.3 billion purchase price compares to Wood Mackenzie's base case value of its existing upstream portfolio of US$ 7 billion. The purchase price allocated to BP's shallow water Gulf of Mexico assets of US$ 670 million looks to represent reasonable value. This equates to a price of US$ 7.83/ boe of proved reserves. While this is higher than the US$ 5.63/ boe paid by Apache in deals in 1999 and 2000 for Gulf Shelf assets, the current package has comparatively high current production and Apache has locked in a high oil and gas price on the majority of production for the first two years.

Through this deal Apache has also established the UK as a new core region with the Forties field ranking only behind the Khalda fields in Egypt in terms of value in Apache's portfolio. In the past, in Egypt and Australia, Apache has used an initial asset purchase to achieve critical mass in a region before adding value through exploration and further acquisition activity. This process is likely to be repeated in the UK.

Apache valued the Forties field at US$ 630 million in its acquisition economics. This is more than Wood Mackenzie's base case value of US$ 520 million under our base case assumptions. However, given the scope for cost-cutting, incremental investment and the strategic nature of the acquisition in adding a new core area to its portfolio Apache would appear to have obtained the asset at a reasonable price.

The Forties oil field is the largest oil discovery on the UK Continental Shelf with an estimated total 2.8 billion barrels of oil currently expected to be recovered from the field. The Forties field and infrastructure have historically been considered as core assets in BP's UK portfolio. The company has invested an estimated £9 billion in capital expenditure and significant resources in developing the field and infrastructure since development consent in 1971. BP has been successful in increasing the recovery factor from an initial estimate of 43% to its present estimate of some 65%.

However, output from the field has now declined significantly from its peak production of 500,000 b/d in 1978 with production in 2003 expected to average some 55,000 b/d (this is above the 45,100 b/d average used by Apache in its acquisition economics). As the field matures still further the opportunities to add significant volumes of reserves will continue to decline.

Opportunities do exist though further cost cutting by, for example, potentially de-manning some of the five platforms employed to produce the field. A focused infill drilling programme could further enhance the recovery factor of the field. Indeed, BP had targeted a recovery factor of 70%.

The Forties Pipeline System (FPS) remains a key asset in the UK for BP being integrated with its onshore terminal and refining facilities. The pipeline is expected to transport 900,000 barrels/ day through 2003 from over 40 fields in the UK sector and a number of Norwegian fields. The resulting tariff income is estimated at around £220 million in 2003.

Under our base case assumptions and at a 10% discount rate Wood Mackenzie estimates, utilising the information provided by Apache in their news release on the deal, that the equity transferred in the Forties field is valued at US$ 527 million.

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