Anadarko: Buy, Hold or Sell?

 | Mar 25, 2013 | 4:00 PM EDT  | Comments
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Should you buy, sell or hold Anadarko Petroleum (APC) right now? The decision comes down to how you weigh Anadarko's huge discovery at its Shenandoah-2 well in the deep waters of the Gulf of Mexico against the company's potential liability in the $15 billion Tronox lawsuit.

The find at the Shenandoah-2 well in the Lower Tertiary trend of the Gulf of Mexico could produce more than 500 million barrels of crude, and it's part of a deep-water play that could hold up to 15 billion barrels of oil. Developing this find will be expensive. The Shendoah-2 well was drilled through almost six miles of rock in water a mile deep. A well under those conditions can easily cost $130 million. And because of the complicated geology of the area with a salt layer that makes seismic imaging essential but tough to interpret dry holes at $10 million apiece are likely to be relatively common.

But the upside is substantial. This discovery could easily add $3 a share to Anadarko's price and the stock could get an even bigger boost from nearby discoveries at Coronado. Anadarko's discovery in the Shenandoah formation isn't an isolated find. Since 2010 ExxonMobil (XOM) has found the 700-million barrel Hadrian field, Royal Dutch Shell (RDS) has discovered the 500-million barrel Appomattox field, and Chevron has found the 200-million barrel Moccasin field, all in the Gulf of Mexico's Lower Tertiary trend. BP (BP) estimates that its Mad Dog field could hold up to 4 billion oil-equivalent barrels. And Anadarko has a share in some of the most promising areas for exploration beyond its own Shenandoah discovery. I can easily see a target price of $99 a share for the stock, up roughly 15% from recent levels.

But since everyone knows about this discovery, which was announced on March 20, and everyone can do the same math that I've done, why isn't Anadarko trading at a higher price than it is? Because of Tronox.

Tronox is the name of a company spun off from what is now the Kerr-McGee subsidiary of Anadarko (before Anadarko bought Kerr-McGee in 2006). Tronox, a maker of titanium-dioxide pigments for paint, declared bankruptcy in 2009. A lawsuit brought by trustees of a fund created to recover cash for Tronox creditors at the time of the bankruptcy brought suit against Kerr-McGee and Anadarko, charging that in the spinoff Kerr-McGee knowingly saddled Tronox with immense environmental liabilities, which finally forced Tronox into bankruptcy.

The presiding judge on the case has refused to cap potential damages, which could run as high as $25 billion. Final arguments in the case were presented in December. A ruling is expected in the first half of 2013.

A $25 billion judgment against Kerr-McGee would hurt but Anadarko could also settle the case for something along the lines of $2.5 billion, analysts estimate. An attempt at reaching a settlement failed back in August.

So how do you handicap the results and the stock? Wall Street analysts think a judgment of $25 billion or more is unlikely. The market is currently pricing in a judgment of about $2.5 billion, but there's a good chance that this is a low estimate. Some experts in environmental litigation think a $4 billion minimum is more likely, since that's roughly the cost of a cleanup. I think a settlement is possible but unlikely after the failure last summer. You're looking at a roll the dice gamble on the opinion of a single judge -- and then the subsequent appeal.

Given that uncertainty, I would prefer to wait for legal clarity on Anadarko (with the possibility of picking up shares at a bargain price if the decision goes badly.) There are other ways to play the deep-water Gulf of Mexico boom. ConocoPhillips (COP), for example, has a 30% share in the Shenandoah discovery, the same as operator Anadarko's share. And ConocoPhillips doesn't have the big Tronox lawsuit hanging over its share price.

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