IEEFA update: Rich Uncle Chevron swoops in to save fracking industry. But at a 39% premium?
Why would Chevron buy Anadarko, a company that amassed $11.4 billion negative free cash flow over the past nine years while racking up massive amounts of debt? What did Chevron see in Anadarko’s future that the market missed when it sent its stock tumbling by 30 points in the final months of 2018, from $70 to $40? Chevron ignored these negatives when it offered a 39% premium to buy the smaller exploration and production (E&P) company. The $33 billion deal ($50 billion when Anadarko’s debt is included) suggests Big Oil is now looking to become Big Shale.
Naturally, the Anadarko board took the gift horse.
Anadarko was open to an acquisition because its fracking-centric business model was failing. Production growth from well formations with short life cycles did not create positive cash flow. The wells and revenues ran dry before capital costs were covered, requiring massive borrowing to fund growth.
Chevron will now take on Anadarko’s legacy $16 billion debt. This is likely to crimp, though not derail, Chevron’s financial metrics. Like other oil giants, Chevron’s strong financials and portfolio of sellable assets will allow it to move aggressively into fracking.
Fracking needs a rich uncle.
CHEVRON HOPES TO SUCCEED WITH FRACKING WHERE SMALLER, MORE NIMBLE COMPANIES HAVE CONSISTENTLY FAILED for nearly a decade. An ongoing IEEFA/Sightline analysis of 29-fracking focused companies reveals these companies, in aggregate, have posted annual negative cash flows for nine consecutive years, including quarterly losses since 2016. (Even Chevron, prior to its potential purchase of Anadarko, did not expect its Permian basin efforts to produce positive cash flow until 2020.)
The trick for Chevron will be to ferret out wells that can produce both product and profits – a mix of science, engineering and art. More broadly, it must make this new technological model of production financially successful. Horizontal drilling and hydraulic fracturing (fracking) have generated impressive and prodigious production but have failed to generate positive cash flow.
The road to impairment?
The question remains: Is the 39% premium worth it for Chevron? If you are a betting person, the answer is always: maybe. But for Chevron investors: no. The initial market reaction was that Chevron overpaid. Its stock tumbled nearly 6% the day the deal was announced and has since recovered only slightly.
Some analysts have spoken of the opportunities for Chevron to leverage Anadarko’s LNG facilities, particularly in Mozambique, but more have focused on fracking opportunities in the Permian basin of Texas and New Mexico, where Anadarko has roughly 250,000 acres, many of them contiguous to Chevron’s two million acres.
Billions of capex have been written off, and billions more are at risk.
Anadarko and other smaller, debt-funded oil and gas companies see a bright future ahead if the deal goes through. These are the E&P companies that have withstood their financial battering. (Many, of course, were wiped out in a rash of more than $140 billion in bankruptcies filings between 2015 and 2018.) They may get hefty paydays for failing to produce positive cash flows in an industry riven with misspent investor capital and bankruptcies.
But it’s not only the smaller fracking companies that have made disastrous capital investments over the past decade. The global oil and gas majors have made enormous mistakes. Billions of capex have been written off, and billions more are at risk.
Climate-savvy investors: beware
For climate-savvy investors, opposition to this deal is a no brainer. Big Oil’s view – burning through investor equity, cash and assets to pivot toward Big Shale will lower risk – is dubious. It rests on the assumption that shareholders do not pay attention. In large measure, they do not. An aggressive drill, drill, drill play is bad financially and inconsistent with efforts to combat climate change.
This potential acquisition will come before Chevron shareholders. Climate activists who engage with oil and gas companies have a choice. A vote “yes” for this deal signals that Chevron should pursue highly risky financial strategies that are detrimental to the climate. A “no” vote tells the company to give its shareholders their money back, or pivot away from fossil fuels.
Kathy Hipple ([email protected]) is a financial analyst at IEEFA.
Tom Sanzillo ([email protected]) is IEEFA’s director of finance.
Related Items:
IEEFA/Sightline Institute update: Chevron’s Permian refrain – “Wait ‘til next year”
IEEFA/Sightline Institute report: More Red Flags on Fracking
