ConocoPhillips’ Curtailments A Good Decision (NYSE:COP)

With a carefully reduced budget, eagle-eyed strategy driven by returns to shareholders instead of headlong growth, good balance sheet allowing targeted second-quarter curtailments of 25% at low oil prices, now fully-restored production mix in the U.S. and worldwide operations, increasing Libyan revenues, investor-friendly dividend of 4.9% and resumption of its $1 billion share repurchase program, ConocoPhillips (COP) is a worthwhile stock for energy investors.

The company’s preliminary results for the third quarter showed good recovery in oil production and prices from the tough second quarter.

Macro Environment

The oil and gas macro environment has many cross-currents. The biggest of these remain the follow-on effects of the stepwise demand drop and slow recovery from COVID-19 global pandemic shutdowns and the Russia-Saudi supply war, which further depressed oil prices. Especially note in the chart above the time lag between the demand drop and production decline. This is what yielded the rare negative oil price last April and low oil prices in the second and third quarters.

U.S. oil production has fallen from a high of 13.1 million barrels per day (MMBPD) in February 2020 to 10.7 MMBPD in the week ending September 25. Companies like ConocoPhillips that explicitly or were forced to curtail in the second quarter contributed to this supply drop. Other factors are the halt in new drilling and the normal but precipitous decline rate of horizontal wells.

Production profiles are changing globally as countries seek to rescind their cuts. And notably for ConocoPhillips’ interest in the Waha concession in the Sirte basin, Libya is ramping up oil volumes that were 1.2 MMBPD at the beginning of the year, fell as low as 90,000 BPD, and are now at 300,000 BPD.

Of course, hurricanes have caused several Gulf of Mexico (GOM) temporary shut-ins of production and refining. GOM platforms are shutting for Category 2 Hurricane Delta, which is projected to reach the Louisiana Gulf Coast possibly as a Category 4 by Friday night.

Finally, overhanging the U.S. macro environment are the upcoming presidential and Congressional elections in less than a month. The two major parties have quite different policies on energy production and consumption.

West Texas Intermediate Crude Oil Price, $/BBL

(Left axis is $/bbl; Source: Macrotrends)

Natural gas prices at Henry Hub, Louisiana, $/MMBTU

(Left axis is $/MMBTU; Source: Macrotrends)

Oil and Gas Prices

The October 5th spot price was $39.22 per barrel for West Texas Intermediate (WTI) crude oil. Henry Hub natural gas closed at $2.61/million British Thermal Units (MMBTU). The North Dakota Sweet oil price was $30.12/barrel.

Shutdowns resulting from the COVID-19 pandemic reduced world oil demand by a step change of as much as 30% (30 MMBPD) at one point; demand is now estimated to have recovered to 90-95 MMBPD, with the growth back to pre-COVID-19 levels of 100 MMBPD not seen occurring until 2021 at the earliest. Natural gas prices have ticked up with winter weather, the resumption of LNG loadings, gas as the leading fuel choice for electricity generation, and the reduction of oil-associated gas in the U.S.; however, due to vast reserves, natural gas remains oversupplied.

ConocoPhillips Production and Curtailments Strategy

ConocoPhillips explores for and produces oil, natural gas, and natural gas liquids in six geographic regions: Alaska, Lower 48, Canada, Europe and North Africa, Asia Pacific/Middle East and other international. In the U.S. Lower 48, the company produces from several unconventional-reserve basins with a “Big 3” emphasis on the Eagle Ford, Bakken, and the Delaware sub-basin of the Permian.

Budget cutting is now the norm, but COP was an early mover. As chief operating officer Matt Fox said at a recent conference, ConocoPhillips executives identified two key correlations. While these seem obvious, not all public, private, and national oil companies act on them. The first is that shareholder returns are positively correlated with oil price. The second is that oil price is negatively correlated with oversupply (relative to demand.) When demand fell 30% due to the pandemic and the oil price war was started by Saudi Arabia and Russia, ConocoPhillips was one of the first to curtail production.

The company’s second-quarter 2020 production was 0.98 million barrels of oil equivalent/day (BOE/D) compared to 1.29 million BOE/D in the first quarter, or about 24% less. Alaskan production was cut about 25%, or 50,000 BOE/D, and Lower 48 production was cut by 34%, or 160,000 BOE/D.

(Source: Author)

By product, 58% of the curtailments was oil, 21% was natural gas, and the remainder was evenly split between bitumen and natural gas liquids. The company’s second-quarter production is illustrated below.

(Source: Author)

Some curtailments continued into the third quarter: 90 MBOE/D, of which 65 MBOE/D were in the Lower 48. The company is now back to full production.

(Source: Company website)

Second-Quarter 2020 Results and Third-Quarter Guidance

ConocoPhillips’ second-quarter net income was rare-in-the-sector positive at $260 million, or $0.24/share. This compares to 2Q net income in 2019 of $1.6 billion. Cash from operations was $157 million, compared to $2.9 billion in the second quarter of 2019. Prices were much lower than in the second quarter of 2019, with bitumen averaging a negative price for the entire quarter:

* Crude oil $25.10/bbl in 2Q20 vs. $64.88/bbl in 2Q19

* Natural gas liquids $9.88/bbl in 2Q20 vs. $21.65 in 2Q19

* Bitumen -23.11/bbl in 2Q20 vs. $37.20 in 2Q19

* Natural gas $3.22/mcf in 2Q20 vs. $4.76 in 2Q19.

On July 30, 2020, ConocoPhillips’ trailing twelve months of operating cash flow was $7.6 billion and levered free cash flow of $876 million. Trailing twelve months’ EBITDA (earnings before interest, taxes, depreciation, and amortization) was $8.4 billion. Annual dividends represent about $1.8 billion.

The company’s preliminary third-quarter results showed average production back up to about 1.06 MMBOE/D from 0.98 MMBOE/D in the second quarter, with most of the increase in oil volumes. On September 30, 2020, the company said it had fully restored production; however, as noted above, companies like ConocoPhillips are shutting in GOM production in advance of Hurricane Delta.

Expected crude oil realizations for the third quarter of $39-40/bbl also beat the second quarter’s abysmal $25.10/bbl. The company estimates average third-quarter realizations across all hydrocarbons (oil, natural gas liquids, bitumen, and natural gas) to be $30-32/BOE.

Capital expenditure estimates, excluding acquisitions, for the third quarter are $750-820 million.

Dakota Access Pipeline Update

In July 2020, a Washington D.C. judge ordered the August 5, 2020 closure of the Dakota Access Pipeline. The order would have shut in this key 570,000-BPD Bakken pipeline, in operation since 2017. A federal appellate court reversed the decision.

There are many safety, environmental (fewer spills and fires), and economic reasons to prefer continued operation of the Dakota Access Pipeline. I covered the effects of a potential DAPL shutdown on ConocoPhillips in an earlier analysis.

Reserves and PV-10 Value

At the end of 2019, ConocoPhillips had 5.26 billion BOEs of net proved reserves. Half of the total was crude oil, natural gas was 37%, natural gas liquids were 8%, and bitumen was 5%.

As of December 31, 2019, the SEC PV-10 discounted cash flow of ConocoPhillips’ proved oil and gas reserves was $34.5 billion, of which $27.4 billion was consolidated operations and $7.2 billion was Asia Pacific/Middle East equity affiliates. By region, the biggest areas of consolidated operations were Alaska at $9.7 billion and Lower 48 at $10.0 billion. Asia Pacific/Middle East was $10.1 billion, most of which was due to equity affiliates.

(Source: Author)

Bakken and Eagle Ford Competitors

Companies with whom ConocoPhillips competes in the Bakken include Continental Resources (CLR), EOG (EOG), Equinor (EQNR), Hess Corp. (HES), Marathon Oil (MRO), and Exxon Mobil (XOM). In addition, emblematic of oil sector change and consolidation, other Bakken competitors are the now-bankrupt Oasis Petroleum, Whiting Petroleum, which just emerged from bankruptcy with old shares exchanged for new shares at a 75:1 ratio, and WPX Energy (WPX), which is being acquired by Devon Energy Corp. (DVN).

ConocoPhillips’ larger competitors in the Eagle Ford include BP plc (BP), EOG Resources, ExxonMobil and Marathon Oil. Significant competitor Chesapeake (CHKAQ) has declared bankruptcy.

Eagle Ford oil, natural gas liquids, and natural gas also compete with other basins, most notably the Permian.

ESG

Environmental, social and governance scores (ESG) are measured with many different formulas – there isn’t an agreed-upon metric. But as reported by Sustainalytics, Inc., ConocoPhillips’ total ESG risk score is 29, which puts it at “medium” and the 54th percentile. Its sub-scores are environmental risk (15.0), social risk (7.8), and governance risk (6.5). Its controversy level is judged as (2), or moderate.

In a recent Wall Street Journal article about shale company CEO pay that rose when shareholder results were down, ConocoPhillips was noted as one of a handful of companies that had not increased CEO pay at the same time that returns were negative.

Insiders own a negligible fraction (0.04%) of the stock. Effective September 15, 2020, stock shorted as a percentage of float was 0.84%.

ConocoPhillips’ beta is 1.68. While this is considerably more volatile than the market, 2020 results from global pandemic shutdowns, the spring oil price war initiated by Saudi Arabia-Russia and stop-start demand recovery have combined to keep oil markets uneven.

ChartData by YCharts

Financial and Stock Highlights

ConocoPhillips’ market capitalization is $36.8 billion at an October 5, 2020 stock closing price of $34.28 per share.

The company’s one-year target price is $49.81/share, putting its October 5, 2020 closing price at 69% of that level. The closing price relative to its 52-week range is shown below.

(Source: Author)

Trailing twelve-months’ EPS attributable to ConocoPhillips per share of common stock is $2.03, for a price/earnings ratio of 16.9. For full-year 2020, the average of analysts’ EPS predictions is -$0.81, and for 2021, the average is $0.62.

ConocoPhillips’ dividend of $1.68/share represents a 4.9% yield at the October 5, 2020 closing price of $34.28/share. On September 30, the company announced it was resuming its share repurchase program and expects to buy back $1 billion in shares in the fourth quarter.

On June 30, 2020, ConocoPhillips had $31.6 billion in liabilities and $63.0 billion in assets, giving it a liability-to-asset ratio of 50%. Long-term debt was $14.85 billion. The company ended the second quarter with cash and cash equivalents of $2.9 billion.

The company’s mean analyst rating is a 2.0, or “Buy,” from 21 analysts, and its third-quarter conference call will take place on October 29, 2020.

Notes on Valuation

Book value per share of $29.36 is below market share price, implying positive investor sentiment.

The company’s ratio of enterprise value to EBITDA is favorable (less than 10) at 5.1.

Comparing overall totals, the company’s December 31, 2019 SEC PV-10 discounted cash flow value is $34.5 billion, its market capitalization is $36.8 billion, and its enterprise value is $43.2 billion.

Positive and Negative Risks

ConocoPhillips is most sensitive to global oil prices, since so much of its revenues come from crude oil, and the oil supply-demand balance remains fragile.

Political and regulatory changes, including the outcome of U.S elections or changes to DAPL operations – along with global risk, especially in countries like Libya – add uncertainty.

Recommendations for ConocoPhillips

I recommend ConocoPhillips for its strong balance sheet, investor-friendly 4.9% dividend and $1 billion share repurchase program, strategy of curtailing production when needed and resuming growth only at levels sustained by supply needs, U.S. and global diversification, which includes improvements in Libyan volumes, and an early and continued willingness to prioritize shareholder returns.

(Source: Company website)

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Disclosure: I am/we are long COP, EOG, WPX, BP. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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