Anadarko Petroleum’s preemptive bids for Kerr-McGee and Western Gas Resources say a great deal about the state of the oil business. Most of it is bad for American consumers.

In a nutshell, the acquisitions highlight the difficulty of replacing domestic oil and natural gas reserves – and the increasing need to do so. As foreign governments move to maximize the benefits from their natural resources, American producers may have to pay up for the relative security of homegrown reserves.

The huge premiums being paid for the two companies – 40% for Kerr-McGee and 49% for Western Gas – also signal Anadarko’s confidence that oil prices will not be coming down any time soon, that the current softness in gas markets will be short-lived. Here’s the problem: Although the purchases bode well for Anadarko’s long-term production outlook, the $21 billion it is spending could have been spent on exploring for oil or bringing new technologies to the gas markets. Instead, the money will go into shareholders’ pockets.

In other words, the day-to-day gyrations in the oil and natural gas markets should not be a distraction.The oil outlook for America is bleak, and the government should be doing more to stifle gasoline demand and to stimulate domestic crude production. The absurd posturing in Washington about excessive oil industry profits or oil market manipulation continues to hamper any intelligent discussion of energy policy. This was understandable while the Democrats were in power; that the Republicans are equally ineffectual when a good number of administration bigshots actually know something about the oil business is unforgivable.

Anadarko is placing a huge bet on the value of domestic oil and gas reserves,a bet that will load their pristine balance sheet with more than $20 billion in debt. Why? Andy Byrne of John S. Herold Inc. describes Anadarko’s move as “acknowledging that international rents on oil production are rising.” That’s a sober way of saying that producers have got to be terrified of the rampant nationalism that is threatening property rights around the world. Anadarko, after all, is active in Venezuela. It has seen up close the casual manner in which a leftist government can abolish contract rights.

The chairman of Cambridge Energy Research Associates, Daniel Yergin, has written optimistic (and controversial) pieces about oil supplies climbing in coming years. Where will new production come from? Mainly from Kazakhstan, Azerbaijan, Nigeria, Angola, Russia, Saudi Arabia, Algeria, Libya, and Nigeria, as well as Brazil and Canada.

Other than the latter two, where would you want to place your bets? With the governments of Ecuador, Venezuela, Bolivia, and Russia increasingly using oil interests as political bargaining chips, will American producers feel secure with an increasing amount of production coming from Angola or Libya? At the least, the economics are likely to worsen.

It is not chicken-hearted to want to line up domestic reserves. It also is not profligate. The stock market, according to time-tested pricing models, was recently valuing domestic producer stocks on the basis of natural gas selling at $5.75 per mcf,or about $35 BOE.That’s a bargain. Natural gas prices have sagged in recent months, and are now hovering around $6.50/mcf, down from close to $11/mcf in late 2005. While that price was inflated by Katrina-related dislocations, a high level of gas in storage and unusually benign weather-related demand has caused the recent downdraft, which is expected to be short-lived.

Anadarko’s management claims (rather aggressively, some analysts feel) to be buying reserves at Kerr-McGee and Western Gas for less than $12/BOE. Herold’s review of 220 oil and gas companies shows that exploration and development costs in 2005 amounted to $11.95/BOE. If the price were equal, wouldn’t most rational companies choose to lock up reserves through acquisitions rather than take on the risk of exploration?

A goodly amount of Anadarko’s exploration prospects are concentrated in the deepwater Gulf of Mexico, where high drilling costs can make year-toyear results highly variable. Having an expensive well turn up dry does nothing for a company’s stock price. By acquiring Kerr-McGee’s large Gulf of Mexico portfolio, in addition to both companies’ Rocky Mountain gas properties, drilling risks are better spread over a greater number of prospects.

Being risk averse seems an incongruous description for a company about to borrow $24 billion. On the other hand, the increasing depth of the futures markets provides some insurance. Anadarko’s management has said it will hedge up to 75% of the company’s production through 2008, to guard against an unexpected downdraft in prices undermining the economics of the deal.

Another feature of the acquisitions is that Anadarko will be acquiring a good number of experienced engineers and technical people. There is evidently some tightness in the labor market for trained oilfield hands – no doubt the legacy of waning oilfield activity during the 1980s and 1990s. Oilfield technology has continued to advance; as a consequence, increasing numbers of skilled technical people are needed to produce our domestic reserves. Evidently, this is a challenge.

Bottom line: This is a huge bet by the country’s largest independent oil and gas producer. It is not, certainly, the first company to resort to drilling for oil on the stock market. Last year, ConocoPhillips bought Burlington Resources for $36 billion and Chevron bought Unocal. At the end of the day, despite the benefits such deals yield for individual companies, America is no better off, and policies that should encourage Anadarko and its peers to funnel monies directly into exploration have yet to evolve.

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