The Toxic Past Haunting Anadarko’s Future

by Aaron Levitt | June 19, 2012 7:30 am

The Toxic Past Haunting Anadarko’s Future

Despite Anadarko‘s (NYSE:APC[1]) recent drilling successes in unconventional assets in Mozambique and Utah, shareholders may not want to jump for joy just yet. A major lawsuit stemming from the company’s past has finally made its way into the U.S. judicial system. The suit involves environmental events that occurred back in the 1970s. But Anadarko and its shareholders could be in a world of hurt soon if the verdict doesn’t go their way.

Similar to BP’s (NYSE:BP[2]) legal issues resulting from the Deepwater Horizon disaster, which killed 11 workers and created one of the worst oil spills in recent history[3], Anadarko’s problems could create the same kind of legal overhang that threatens to weigh on shares for years to come. Some analysts have even postulated a potential breakup or bankruptcy for the firm due to the pending legal issues.

Yet, the independent exploration and production (E&P) firm is one of the rising stars in unconventional energy assets and continues to generate production and earnings gains. At Monday’s closing price of $64.63, Anadarko has a market cap of just of $32 billion, and the stock is down some 15% so far this year. So, the questions now are: Just how serious are Anadarko’s problems, and should investors just walk and choose another E&P option?

Kerr-McGee, Karen Silkwood and Tronox

Anadarko’s legal headache can be traced back to its June 2006 acquisition of Kerr-McGee’s oil and gas assets. Anadarko paid nearly $17 billion, including an estimated $1.6 billion worth of debt and other liabilities, for the assets, which were a key part of former CEO Jim Hackett’s plan to expand the firm into an independent giant.

According to the U.S. EPA, Kerr-McGee left a toxic legacy[4] in its wake. The company, which was founded in 1929, was responsible for various environmental “atrocities”[5] that span everything from uranium mines to creosote wood treatment plants in Mississippi and Pennsylvania. Perhaps the most famous — or infamous — event occurred in the 1970s when labor activist Karen Silkwood died mysteriously after bringing several of Kerr-McGee’s issues to light. Silkwood claimed that the company was contaminating her and other workers at its plutonium pellet plant in Crescent, Okla., and she died shortly afterward in an alleged car crash that was never fully investigated.

Overall, the EPA and state environmental agencies estimate that Kerr-McGee fouled over 2,772 sites across the country. The company’s former assets in Chicago are home to five superfund sites, alone. After a 2000 lawsuit, in which 5,100 Columbus, Miss., residents sued Kerr-McGee for alleged creosote damage and illegal dumping, is where Anadarko’s headaches really begin[6].

Due to these various environmental issues, Kerr-McGee started an internal reorganization in 2001. As a result, it eventually spun off its chemicals business and a paint pigment plant into Tronox (NYSE:TROX[7]) in 2005. That spin-off took many of Kerr-McGee’s old environmental liabilities with it. Three months after it was complete, Anadarko offered to buy Kerr-McGee’s oil and gas assets.

Since its spin-off, Tronox reported that it was spending as much as $126 million a year on Kerr-McGee’s old environmental liabilities and had spent over $27 million on related tort claims. The chemical firm declared bankruptcy in 2009 and then later sued Anadarko, claiming that Kerr-McGee had begun to separate oil and gas assets from toxic liabilities and purposely launched the bad stuff onto shareholders through the Tronox IPO. Top managers and the most profitable assets went to Anadarko, according to the suit.

The Justice Department seems to agree with Tronox, saying the deal was a “two-step fraudulent scheme” in order to transfer assets to Anadarko where they would be out of reach of future creditors of the defunct chemical firm. Also, Justice has alleged that Anadarko knew about the issues and deliberately concealed material knowledge. Lawyers for the U.S. estimate the value of assets transferred at nearly $15 billion, plus an additional $10 billion for interest and appreciation.

A Massive Hit

A potential $25 billion dollar lawsuit is nothing to sneeze at, especially when Anadarko’s entire market cap is only around $32 billion. With testimony only just beginning, the case can go either way.

Anadarko has maintained its innocence in the matter, arguing that separating the chemical business from the oil and gas assets was done to maximize shareholder value. Counsel for Anadarko has countered that the Justice Department is attempting to recoup the costs of cleanup by manipulating the facts.

At the same time, internal documents from Merrill Lynch back in 2002, show the bank was hired by Anadarko to look at ways it could buy Kerr-McGee’s oil and gas assets without the 70 years’ worth of chemical liabilities. Likewise, several former Kerr-McGee executives are scheduled to testify about “Project Focus,” a plan designed to isolate the environmental liabilities so the energy assets couldn’t be used to satisfy them.

While energy companies can bounce back from environmental litigation — Occidental Petroleum (NYSE:OXY[8]) and the Love Canal disaster in Niagara Falls, N.Y., comes to mind — Anadarko shouldn’t be taking this suit lightly. The case will ultimately test whether feds can recover money decades later from a descendant of a polluting company, even when a bankruptcy has cleaned the slate.

Like BP’s oil spill and Chesapeake’s (NYSE:CHK[9]) recent CEO and financial issues[10], Anadarko’s legal overhang will continue to put pressures on the stock price. Currently, based on where it’s trading relative to its peers, the market seems to be pricing in only a $2 billion settlement. However, various analysts and legal experts estimate that Anadarko will have difficulty minimizing the effect of the $25 billion lawsuit. So far, it has taken charges of just $525 million for the case.

Given Kerr-McGee’s past and this lawsuit, I can’t see getting behind Anadarko’s shares until the dust settles. Investors could be discounting a whole heap of trouble at current prices, if the verdict is worse than the company expects. Anadarko has tremendous promise, given its leadership in unconventional assets. However, this environmental litigation will cast a dark cloud over its prospects until the case is resolved.

Investors would be wise to stay away, especially because other energy firms offer as much exciting growth potential[11] — minus the litigation risk.

As of this writing Aaron Levitt doesn’t own any securities mentioned here.

Endnotes:
  1. APC: http://studio-5.financialcontent.com/investplace/quote?Symbol=APC
  2. BP: http://studio-5.financialcontent.com/investplace/quote?Symbol=BP
  3. worst oil spills in recent history: http://investorplace.com/2012/03/is-bp-back-only-partly/
  4. Kerr-McGee left a toxic legacy: http://www.epa.gov/region5/cleanup/kerrmcgee/
  5. environmental “atrocities”: http://investorplace.com/2012/06/energy-independence-frackings-downside/
  6. Anadarko’s headaches really begin: http://www.bloomberg.com/news/2012-05-15/anadarko-was-part-of-25-billion-scheme-u-s-says.html
  7. TROX: http://studio-5.financialcontent.com/investplace/quote?Symbol=TROX
  8. OXY: http://studio-5.financialcontent.com/investplace/quote?Symbol=OXY
  9. CHK: http://studio-5.financialcontent.com/investplace/quote?Symbol=CHK
  10. recent CEO and financial issues: http://investorplace.com/2012/06/just-walk-away-from-chesapeake/
  11. exciting growth potential: http://investorplace.com/2012/05/talisman-best-play-on-vietnams-energy-riches/

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