ConocoPhillips’ (NYSE:COP) 2013 full-year cash margins improved by $2.91 per barrel of oil equivalent (BOE), which is equivalent to an increase of more than 11% y-o-y. This could partially be attributed to higher natural gas prices in the U.S., compared to 2012. However, even after adjusting for the difference in price realizations, the company’s cash margins improved by $2.35 per BOE, which implies more than 9% year-on-year growth.  The key trend behind this spectacular margin expansion has been the company’s improving volume-mix, which we believe is expected to continue for a while. In this article, we take a closer look at why that might be the case.
We currently have a $75 price estimate for ConocoPhillips, which is around 15% above its current market price.
What Happened Last Year?
Last year, ConocoPhillips’ volume-mix improved on higher proportion of liquids as production growth mostly came from the liquids-rich unconventional plays in the Lower 48 and oil sands in Canada. Higher liquids production boosts operating margins for oil companies as they earn more revenues per barrel of oil equivalent (BOE) on selling liquids rather than natural gas. ConocoPhillips sold liquids at an average price of over $85 per barrel last year, while the company realized average price of just around $37 per BOE of natural gas. 
ConocoPhillips’ 2013 full-year production from continuing operations grew by 30,000 BOE per day, net of field declines. Although not substantial, the growth in production came from the right areas, which boosted its operating margins. In North America, where natural gas prices are heavily depressed compared to international markets, the company’s natural gas production declined by 16,000 BOE per day, while liquids production from the Lower 48 and Canada increased by 49,000 and 21,000 BOE per day, respectively. This boosted ConocoPhillips’ 2013 cash margins by almost $3 to $28.55 per BOE. 
Why It Might Continue?
We believe that ConocoPhillips’ cash margins will continue to expand in the coming years as well on further improvement in the volume-mix. The company expects to boost its net hydrocarbon production volume from around 1.5 million BOE per day (MMBOED) in 2012 to 1.9 MMBOED by 2017. Since the 2012 base production is expected to decline to around 0.9 MMBOED by 2017 due to normal field declines, the company effectively plans to add new production of almost 1 MMBOED in a period of 5 years. It plans to achieve this through the development of existing projects and new project start-ups. Moreover, It also expects liquids, which primarily include crude oil, oil sands, liquefied natural gas (LNG), and natural gas liquids (NGLs), to comprise almost 95% of this incremental volume. Since liquids are generally more profitable than natural gas, ConocoPhillips’ cash margins would continue to expand in the coming years. 
Now, the biggest contributor to the company’s production ramp-up and margin expansion plan would be its ongoing development of the U.S. onshore assets in the Lower 48 region. The region is expected to contribute ~60% to its total planned incremental production from the development of existing projects and more than 36% to the total anticipated new production of 1 MMBOED. Lets take a closer look at the company’s activities in the region. 
ConocoPhillips holds 13.8 million net acres of onshore conventional and unconventional acreage in the Lower 48. The company’s unconventional holdings total 2.5 million net acres and include approximately 626,000 net acres in the Bakken; 227,000 net acres in the Eagle Ford; 194,000 net acres in Permian; 130,000 net acres in Niobrara; 900,000 net acres in the San Juan Basin; and nearly 430,000 net acres in other unconventional exploration plays. Currently, ConocoPhillips’ activities in this region are mostly centered on continued optimization and development of existing and emerging assets, with a particular focus on areas with higher liquids production. 
- Bakken: The Bakken Shale Play is located in Eastern Montana and Western North Dakota, as well as parts of Saskatchewan and Manitoba in the Williston Basin. Oil was initially discovered in the Bakken play in 1951, but was not commercial on a large scale until the past ten years. The advent of modern horizontal drilling and hydraulic fracturing helped make Bakken oil production economic. ConocoPhillips plans to invest roughly $4 billion in the development of its acreage in the Bakken play and expects to ramp-up production rate from around 24,000 BOE per day in 2012 to over 55,000 BOE per day by 2017. In the fourth quarter of 2013, the company’s average production rate from the Bakken stood at 39,000 BOE per day, which was over 63% higher than the previous year. 
- Eagle Ford: The Eagle Ford shale formation in South Texas runs from the US-Mexico border north of Laredo in a narrow band extending northeast for several hundred miles to just north of Houston. The EIA estimates proved oil reserves in the play to be around 1.25 billion barrels of oil and 8.4 trillion cubic feet of gas. ConocoPhillips plans to invest roughly $8 billion in the development of its acreage in the Eagle Ford play and expects to almost double the rate of production from around 65,000 BOE per day in 2012 to over 130,000 BOE per day by 2017. In the previous quarter, the company’s average production rate from the Eagle Ford jumped over 42% y-o-y to 126,000 BOE per day. 
- Permian: The Permian region, in western Texas and extending into southeastern New Mexico, has been one of North America’s major oil and natural gas producing regions for nearly a century. It accounts for about two-thirds of crude oil production in Texas and nearly 15 percent of that of the entire U.S. ConocoPhillips plans to invest roughly $3 billion in the development of its acreage in the Permian play and expects to increase its production rate from around 45,000 BOE per day in 2012 to over 70,000 BOE per day by 2017. According to our estimates, the company’s production rate from the Permian Basin averaged around 53,000 BOE per day during the fourth quarter of 2013. So, the company is well on its way to achieve its target by 2017. 
More importantly, liquids now represent over 50% of the total hydrocarbons produced from the Lower 48 region, compared to just over 45% at the end of 2012, and production has been growing steadily over the last few quarters. In 2013, crude oil production from the Lower 48 region grew by 24% y-o-y, while total hydrocarbon production from the region increased by just around 7%. Based on ConocoPhillips’ long-term plan and its progress so far against it, we are compelled to believe that the company’s cash margins might continue to expand going forward.Notes: