Conoco-Phillips Spins Down to Rebound

By Peter Pham - November 1, 2012 | Tickers: APC, BP, CHK, COP, XOM, PSX | 0 Comments

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The Houston-based oil and natural gas company ConocoPhillips (NYSE: COP) released its third quarter earnings results, which saw revenues and earnings falling by 9.6% and 31.3% year-on-year, but adjusted profits managed to beat analysts’ expectations as the company spun off its refining and marketing units in April to create Phillips 66 (NYSE: PSX). The relatively bigger slide in profits, caused by the retreat in crude and natural gas prices, is evident in falling margins, which decreased from 15.7% year over year to the present 11.9%. The results do not include the performance of Phillips 66.

Conoco-Phillips was able to beat estimates due to increase in output from the expected 1.4 million bpd to 1.5 million bpd, due to the performance of the Bakken and Eagle Ford shale fields.  Also, output from China improved, while assets in Libya continue to come back on-line. However, the fact remains that its revenues, income, margins, and total production continue to slide (although some of the fall in production can be attributed to disposal of assets).  

ConocoPhillips’s dominant revenue-generating regions are still Alaska and Asia Pacific/Middle East, from where it earned 30% and 37%, respectively, of its revenues in the third quarter. However, overall production for liquids and gas has decreased in Alaska (15.3%) and Europe (22%), while it has remained fairly constant or increased in the remaining segments.

ConocoPhillips expects to generate a further $6-$8 billion in cash through 2013 as it continues disposing of what it feels are non-core assets. For the next couple of years, ConocoPhillips is planning to spend ~$16 billion annually in capital expenditures.  The company will continue to focus on its strategy of optimizing its portfolio by withdrawing from riskier and less profitable investments and moving towards more safer and less costly options. Just weeks before releasing the earnings report, Conoco-Phillips announced that it was withdrawing from exploration activities in two Peru blocks, citing its strategic objectives, while its 45% stake will be sold to a local firm. 

ConocoPhillips is the seventh largest U.S. natural gas supplier, a commodity whose prices have touched record lows and is expected to remain in the $4/MCF in the near future, or at least until the issues related to oversupply are sorted out. To offset this, ConocoPhillips has a simple plan: more reliance on crude, less on gas.

It has a relatively higher debt-asset ratio when compared to BP (NYSE: BP) or Exxon (NYSE: XOM), but it is not nearly as high as its much bigger rivals like Chesapeake Energy (NYSE: CHK) or Anadarko Petroleum Corp (NYSE: APC), who have relatively higher exposure to natural gas and have struggled as a result of the price collapse.

* Sep 2012 data             **June 2012 Data          ***H1 2012 data by Natural Gas Supply Association

Nonetheless, Chesapeake is still betting on its heavy exposure to natural gas as a path to explosive returns in the long term. In its third quarter, the contribution of natural gas towards the total volume was 46% (25% North American Nat Gas, 21% International Nat Gas). It should be noted that the company’s overall average selling price (ASP) for this commodity in all of its regions was just $4.60. Norway, Indonesia, the U.K. and Libya are the only regions that offer higher ASP’s than United States.

Other regions such as Canada, Australia, China and Vietnam have significantly lower ASPs, as compared to the U.S., that range from $1.13/MCF to $2.45/MCF. Therefore, out of most of the regional markets, the U.S. is relatively more attractive.However, between two to three years, the prices are expected to bounce back and would increase substantially, which would guarantee higher returns in the future.

In terms of returns on equity and yield, ConocoPhillips is much better positioned than the leaders in natural gas (APC and Chesapeake). The huge decline in ConocoPhillips’ stock was partly due to spinning off Phillips 66. However, all three companies (ConocoPhillips, Chesapeake and APC) are under a burden of debt and need to continue disposing assets and shuffling portfolios. ConocoPhillips is expecting an improvement in profits for the final quarter as it finishes upgrading some of its North American and oil sands facilities. The company is also planning to increase its exposure to oil, particularly in the Gulf of Mexico, where it is looking at 3 to 6 drillings annually.

This would be a significant change in the business’s operations because until now, it has only been a minor partner in three drilling activities in that region.  However, this is more of a long term prospect because actual production from the Gulf is not going to happen for another three to four years.

Despite the disposal of assets, the business is aiming for 3%-5% annual increase in production levels. The company has not identified any new discoveries; therefore I believe that production is going to start from the still underdeveloped projects in Australia, Canada, Malaysia, UK, and the North Sea, and this is where most of the capital expenditure is going to go. 

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