ConocoPhillips Earnings Preview: Higher Production, Thicker Margins Expected

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ConocoPhillips (NYSE:COP) is scheduled to announce its 2014 second quarter earnings on July 31. We expect the company’s earnings to receive a boost from higher commodity prices in the U.S., which accounts for more than 46% of its total oil equivalent hydrocarbon production. Spot Henry Hub prices were up more than 15% y-o-y during the second quarter, primarily due to lower natural gas inventories compared to last year. This could be attributed to the unusually cold winter in the U.S., which forced consumers to use more heat and electricity this year. On the other hand, average West Texas Intermediate (WTI) crude oil prices were almost 9% higher year-on-year during the second quarter so that will have a positive impact on revenues from spot sales of crude oil.

Apart from higher commodity prices, ConocoPhillips’ second quarter earnings would also benefit from better sales volume mix compared to last year. This is primarily because we expect the ongoing development of liquids-rich assets in the Lower 48 states to boost its hydrocarbon production the most. During the earnings conference call, we will be looking for an update on ConocoPhillips’ new project development, which is aimed at growing its hydrocarbon production rate in the long run.

ConocoPhillips is the world’s largest independent exploration and production company by proved reserves and annual production. Its daily hydrocarbon production averaged at around 1,530 thousand barrels of oil equivalent (MBOED) during the first quarter of this year, and it had proved reserves of around 8.9 billion BOE at the end of last year. Headquartered in Houston, Texas, the company has operations in 27 countries, generating annual sales revenue of more than $60 billion. We currently have a $85/share price estimate for ConocoPhillips, which is around 12.9x our 2014 full-year adjusted diluted EPS estimate for the company. [1]

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Higher Production

ConocoPhillips expects to boost its net hydrocarbon production rate from around 1.5 million BOE per day (MMBOED) in 2013 to 1.9 MMBOED by 2017. Since the company’s 2013 base production is expected to decline to around 1.1 MMBOED by 2017 due to normal field declines, it effectively plans to add new production of almost 0.8 MMBOED in a period of 4 years. A large majority of this new production (~50%) is expected to come from the ongoing development of its onshore assets in the Lower 48 states. We expect the ongoing development of the company’s acreage in the Eagle Ford and the Bakken shale plays to account for most of the hydrocarbon production growth during the second quarter. [2]

The Eagle Ford shale is now the largest tight oil play in the U.S. by EIA estimates. Its proved crude oil reserves of 3.4 billion barrels are greater than those of the Bakken Formation of North Dakota. ConocoPhillips plans to invest $3 billion annually in the development of its acreage in the Eagle Ford play and expects to more than double the rate of production from around 119,000 BOE per day in 2013 to over 250,000 BOE per day by 2017. In the previous quarter, the company’s average production rate from the Eagle Ford jumped over 38.5% y-o-y to 140,000 BOE per day. [2]

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. According to latest EIA estimates, the Bakken tight oil play holds 3.2 billion barrels of technically and economically recoverable crude oil. ConocoPhillips plans to invest roughly $1 billion annually in the development of its acreage in the Bakken play and expects to ramp up production rate from around 33,000 BOE per day in 2013 to over 68,000 BOE per day by 2017. In the first quarter of this year, the company’s average production rate from the Bakken stood at 43,000 BOE per day, which was over 48% higher than the previous year. [2]

Thicker Margins

The growth in ConocoPhillips’ Lower 48 production is also expected to boost its second quarter operating margins because of continuous improvements in drilling and completion cost efficiencies and better volume-mix. Over the past 4 years, the company has been able to achieve drilling and completion cost efficiency improvements of 37% and 41%, respectively in the development of its acreage in the Eagle Ford tight oil play. Most of this efficiency improvement can be attributed to the increased use of multi-pad well drilling. ConocoPhillips plans to further reduce its average total cost per well by using multi-well pad drilling technique in 75% of all the wells drilled in the Eagle Ford play this year. [2]

In addition to cost efficiency improvements, ConocoPhillips’ operating margins are also expected to expand because of the improvement in its sales volume-mix. During the first quarter of this year, ConocoPhillips’ hydrocarbon production from continuing operations grew by 41 MBOED, net of field declines. More importantly, most of this growth came from the right areas, which boosted its operating margins. In North America, where natural gas prices are still depressed by international standards, the company’s natural gas production declined by 14 MBOED, while liquids production from the Lower 48 states and Canada increased by 50 and 11 MBOED, respectively. This boosted ConocoPhillips’ price-adjusted cash margins by almost $3.5 to $30.24 per BOE. We expect ConocoPhillips’ cash margins to continue to expand in the short to medium term on the continued ramp up of its liquids-rich onshore assets in the U.S. [2]

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. [1]

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Notes:
  1. ConocoPhillips SEC Filings, sec.gov [] []
  2. Investor Update, conocophillips.com [] [] [] [] []