Some Perspective on the Anadarko Incident

Abstract: When Anadarko Petroleum Corporation announced significant layoffs last week, the question was whether the incident was company-specific or indicative of an unfolding industry trend. Analysts fear the answer to both is "yes."

Analysis: Twice is coincidence. Three times is a conspiracy.

That old saying seems apt for the moment as the onshore drilling sector casts a wary eye toward the most active E&P firms.

Anadarko Petroleum Corporation's announcement last week that it had front-loaded capital expenditures for the year and planned to cut back on drilling plans, reverberated through the financial community prior to the company's earnings announcements late in the week.

It was the second time this year that field activities for a major independent blew up. El Paso Corporation had announced similar cutbacks for its high-flying domestic drilling program in the first quarter.

It brings to mind the urban legend concerning the jinx that seems to haunt those who appear on the cover of a major sports magazine. Almost invariably, a contender who appears in the cover shot turns in subpar performance at the actual event.

Both El Paso and Anadarko were the leading employers of onshore drilling rigs when their respective announcements came.

In El Paso's case, the rigs were picked up in a rising market. Early word on Anadarko's rigs is that most of those let go have found other employment.

But the question is whether these are company-specific events, or whether they represent an emerging trend. There is some concern that the Anadarko announcement signals the beginning of the end for this year's stellar natural gas play.

Analysts, witnessing rapidly rising winter storage and weakening commodity prices, have been anxiously scrutinizing the tea leaves in recent weeks as the rig count flattened, trying to discern whether the current cycle is about to roll over.

So far, the stories in each instance indicate company-specific challenges.

El Paso Corporation was caught in a liquidity squeeze because of fallout from the collapse in the merchant trading sector in the post-Enron environment.

The Anadarko story is a little more complex. There are persistent rumors that the company is for sale, something company officials deny, then hedge by reciting the mantra that they will "do what is best for shareholders."

Several variations on this rumor have appeared in the American and British trade press over the last 10 days. The general storyline is that an investment banker with European and North American ties is making inquiries on behalf of the independent. Indeed, of those listed as potential suitors, at least four are integrated, European-based oil and gas companies. Purchasing Anadarko would provide European multinationals additional leverage in the international arena in both Algeria and Qatar, coupled with a significant entree into the North American gas play.

One London-based publication indicated Royal Dutch Shell was readying a $10 billion bid for Anadarko last week. All suitors have declined comment.

Shares in Anadarko finished the week below $43, representing about $10.6 billion in value, not including $5 billion in debt. That is down from $12.5 billion earlier in the second quarter, while analysts place net asset value at roughly $13.7 billion, or $55 per share.

And there are succession issues. When Anadarko announced last Thursday it was laying off 400 people and closing offices in Midland and Amarillo, Texas to save $100 million, five senior managers were included in the ranks. Just last March, the board of directors accepted the resignation of CEO John Seitz and brought back Robert Allison, 64, who had built the company into the nation's fifth largest independent during his 30-year tenure. But Mr. Allison has had health problems and affirmed in the company's conference call on Friday that he did not plan to be working when he turned 70.

Clearly the Anadarko dust-up startled the oil and gas industry last week. And what a week it was. The company's operations people met the preceding Thursday with service providers and announced the company was cutting back rig employment. By Friday morning, word had filtered to senior management at several publicly held drillers. On Monday, the news literally exploded across the financial community as attempts were made to clarify how many rigs were going down.

Those discussions took on a life of their own. Rig attrition ranged from 10 to 44 units, depending on the source. Then came Anadarko's Thursday announcement of significant layoffs in the face of strong earnings performance.

What was said during a conference call on Friday ultimately failed to provide resolution.

On the issue of dropping rigs, Mr. Allison noted during the call that Anadarko was the nation's most active driller and would remain so in the aftermath. The net loss would be 10, 12, or 15 rigs, he told listeners. But he cryptically added that the number included employing another eight rigs in Canada when winter drilling season picks up.

Drilling is unlikely to change offshore or internationally for Anadarko.

The company finds itself caught between pressures to continue growth through the drill bit and to become more profitable. Those expectations are mutually exclusive. As a result, the company will underspend cash flow and direct free cash either to debt retirement or to further acquisitions if the cycle turns down. Though known as a drill bit company, Anadarko has used selective acquisitions to expand its holdings in the U.S. and Canada.

Meanwhile, the company will be selling an estimated $100 million in non-core offshore properties to fund continued capital expenditures in drilling.

The background whisper campaign cites a third reason. The theory is that the company is having to run faster than the decline curve just to stay even, a problem that bedeviled Union Pacific Resources Group, which Anadarko purchased for $6.7 billion in 2001.

And that, too, is another reason observers are concerned. Ironically, Anadarko has been the leading proponent of the "lack of quality prospects" issue to the financial community over the last couple years, which is why it was fascinating listening to Mr. Allison talk up the company's diverse portfolio of projects.

Still, the other shoe has dropped. It is one more dot in a growing pattern where super-independent E&P firms find themselves on the same path the majors stumbled down a decade ago. Having grown sufficiently large, it is difficult to effect meaningful gain from a financial standpoint in an industry that is always face-to-face with the decline curve endemic to a natural resource-based business.

This trend is evident in recent asset sales in the North Sea and Gulf of Mexico. It explains BP's interest in Russia and a handful of other seemingly isolated news stories over the last six months.

Outside the Anadarko incident, permits remain strong, rig count is high, and contractors report expectations--encouraged by customers--of additional work.

But some of the financial folks are heading towards the exits on oil service equities, which peaked in May. While the industry drew a pass on the El Paso incident, last week's Anadarko event will increase the percentage looking for the door as they nervously monitor the weekly gas storage number and softening natural gas prices.