Should You Buy This Upstream Giant?

Jordo is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

ConocoPhillips (NYSE: COP) recently announced that it will be selling its Nigerian oil fields for $1.8 billion to Oando Energy Resources. The company will now concentrate on its assets in North America, primarily in the liquids-rich Eagle Ford, Bakken, and North Barnett Shale plays.

ConocoPhillips also announced a 2013 capital budget of $15.8 billion, which is approximately the same as the expected 2012 capital expenditure.

ConocoPhillips plans to invest heavily in its diverse portfolio of global assets in 2013, with approximately 60% of capital allocated to North America, and 40% allocated to Europe, Asia Pacific and other international businesses. Approximately 10% of ConocoPhillips' capital budget will be used for maintenance of its high-quality legacy assets. This includes activities in Alaska, the Lower 48, western Canada and the North Sea. Turnaround activity is expected within the Greater Kuparuk Area, Greater Ekofisk Area and various fields in the North Sea. Approximately 40% of the capital budget is allocated to the highly profitable exploitation programs in its legacy portfolio, which includes 21 million net acres of onshore leasehold in the Lower 48 states and western Canada.

Production growth from these programs will help to offset  natural depletion of the currently producing assets. Approximately two-thirds of this amount will be spent in the Lower 48 and focus on liquids-rich unconventional drilling and infrastructure development in the Eagle Ford, Bakken, Barnett and Niobrara, as well as conventional and unconventional plays in the Permian Basin. The remaining amount will be used for other conventional and unconventional opportunities, mainly in the North Sea, Alaska and western Canada. Expenditure on North American dry gas plays will continue to be minimal.


ConocoPhillips reported third-quarter 2012 earnings of $1.8 billion, or $1.46 per share, compared to third quarter 2011 earnings of $2.6 billion, or $1.91 per share. Excluding special items of $26 million, third quarter 2012 adjusted earnings were $1.8 billion, or $1.44 per share, compared to third quarter 2011 adjusted earnings of $1.9 billion, or $1.40 per share. Production for the quarter was 1.525 million BOE per day, compared with 1.538 million BOE per day for the same quarter of the previous year.  In line with expectations, production was lower due to the effect of asset disposals. Normal field decline was offset by additional production from major projects as well as higher production in China and Libya. Sales volumes for the quarter exceeded production, resulting in a favorable impact on earnings of approximately $80 million.

ConocoPhillips’ realized prices fell in the third quarter compared to the same quarter of the previous year. Realized crude oil prices decreased by $3.89 per barrel to $102.72 per barrel. Realized natural gas prices decreased by 16% from $5.45 per thousand cubic feet (MCF) in the third quarter of the previous year to $4.56 per MCF for the current quarter. Realized natural gas liquids (NGL) prices decreased by 27% to $40.39 per barrel, compared to $55.61 per barrel for the same quarter of 2011. Production for the fourth quarter is expected to increase compared to the third quarter because of the completion of turnaround activity and the ongoing ramp up in major North American programs, notably in the Eagle Ford and oil sands. Full-year 2012 production is expected to be in the region of 1.570 million to 1.580 million BOE per day.

During the quarter, ConocoPhillips generated $3.9 billion in cash from continuing operations, excluding working capital. Cash provided by continuing operating activities was $3.5 billion, reflecting a $0.4 billion increase in working capital. The company also received $0.5 billion in proceeds from asset dispositions. The company financed a $3.7 billion capital program, paid out dividends of $0.8 billion and reduced debt by $2 billion.

Peer Comparison

Of the 43 stocks in the S&P 500 Energy Sector, the four largest have had similar performances so far in the third quarter, with Exxon Mobil (NYSE: XOM) up by 3%, Chevron (NYSE: CVX) up by 3%, Schlumberger (NYSE: SLB) up by 2%, and ConocoPhillips up by 6%. These four companies represent market capitalization of roughly $871 billion and account for over 60% of the market capitalization of this sector.  Schlumberger has shown reasonable growth this year (sales are up 16% year-to-date), while earnings per share (EPS) are up 25% from continuing operations. However, Schlumberger has seen a contraction in its price/earnings multiple. 

Chevron and Exxon Mobil, on the other hand, haven't shown much sales or production growth. A handful of E&P companies, like Cabot Oil & Gas (NYSE: COG) and EOG Resources, have done well. The reason appears to be the market rewarding growth in production, which is the best way to beat the impact of surging oil and gas production from the shale reserves in North America. Cabot has focused on the Marcellus play, while EOG has focused on several big shale areas like the Eagle Ford and the Bakken.

Both companies have been able to grow revenue (and earnings) substantially this year in spite of weak prices due to strong production.  It is clear that in the current environment, profitability will be driven by production growth and not by prices.  Moreover, the markets don't seem to be looking favorably towards companies who finance exploration through debt and companies are now forced to stay within the limitations of their own free cash flow generation. 


ConocoPhillips has only completed a few months of its reincarnation as a standalone upstream play, and there is still insufficient data to evaluate its future performance. ConocoPhillips is a strong and profitable company, but the jury is still out when it comes to recommending a buy at the moment. I would suggest a rating of neutral and to hold onto the stock for now.

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