ConocoPhillips Price Revised To $68.50 Per Share On Lower Capital Expenditures, Slower Production Growth

ConocoPhillips (NYSE:COP) recently announced its 2014 fourth quarter earnings. As expected, lower crude oil prices more than offset the impact of higher volumes and better sales volume-mix. The company’s earnings per share (EPS) adjusted for non-operating items declined by more than 57% to just $0.60. In addition to lower price realizations, primarily due to the recent decline in oil prices, the company’s earnings were also impacted by higher dry hole expenses and other operating costs and increased depreciation and depletion expense, driven by the growth in production. In response to the changed crude oil price environment, ConocoPhillips announced plans to further cut its capital spending budget to just $11.5 billion this year. ^[1]

ConocoPhillips is the world’s largest independent exploration and production company by proved reserves and annual production. Its net hydrocarbon production from continuing operations averaged 1,532 thousand barrels of oil equivalent per day (MBOED) in 2014, and it had proved reserves of around 8.9 billion barrels of oil equivalent (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. Based on the recent earnings announcement, we have revised our price estimate for ConocoPhillips to $68.50/share, which is almost 14.6x our 2015 full-year adjusted diluted EPS estimate for the company.

Below, we provide a quick update on some of the key factors driving the change in our price estimate.

See Our Complete Analysis For ConocoPhillips

Lower Capital Expenditures

Since the independent oil and gas companies do not have downstream operations, they are relatively more exposed to the volatility in global crude oil prices, compared to the integrated players like Exxon Mobil (NYSE:XOM). This is also reflected in the fact that the S&P Oil and Gas Exploration and Production Select Industry Index (SPSIOP) has declined by almost 45% since the WTI crude oil prices peaked at around $100 per barrel in June, while the NYSE Arca Oil & Gas Index (XOI), which includes both integrated and independent players, has declined by just 25% over the same period. This is because, unlike the integrated players, these companies do not have a relatively stable stream of cash flows from refining and chemical production operations. This means that in a commodity down cycle, such as this one, these companies see a sharp decline in their operating cash flows, which lowers their capacity to invest in future production growth. Therefore, capital expenditure (which is the biggest single cash expense item in this business and the primary driver for future production and earnings growth) plans of independent exploration and production companies are far more dependent on the short to medium term outlook for global crude oil prices.

ConocoPhillips announced its 2015 capital expenditure plan in December last year. The company revealed that it plans to cut capital spending by around 20% this year to $13.5 billion due to the recent decline in oil prices. However, with the fourth quarter earnings announcement, it further cut its  2015 capital spending budget to just $11.5 billion. During the earnings call presentation, the company’s officials announced that most of the spending cut is targeted towards the development of unconventional hydrocarbon reserves in the Lower 48 states. It currently plans to reduce the number of rigs deployed in the Lower 48 states by over 60%, compared to last year, so that it is just able to maintain the land possession and meet its long-term rig commitments. Based on the announcement, we have adjusted our net capital expenditure forecast for ConocoPhillips and its impact on the company’s production growth. ^[2]

Slower Production Growth

Last year, ConocoPhillips’ net hydrocarbon production from continuing operations increased slightly more than 4% over 2013. A large majority of this growth came from the increased development of its onshore assets in the Lower 48 states. The company’s average daily net hydrocarbon production (adjusted for downtime-related variance) increased by 61 MBOED last year, almost 69% of which came from the Lower 48 states, where the company significantly ramped up the development of its acreage in the Eagle Ford and the Bakken/Three Forks shale plays. Production from the Lower 48 states at 533 MBOED was up by around 8.6% y-o-y for the full year. However, given the cut in capital spending budget for Lower 48 development, we expect production growth from the region to slow down significantly this year. We therefore expect the company’s crude oil production growth to be just around 2% this year. In addition, lower capital spending also means lesser risky exploration and potential deferral of key long-term development projects. We have therefore also revised down our long-term forecast for ConocoPhillips’ crude oil production growth. ^[3]

View Interactive Institutional Research (Powered by Trefis):

Global Large Cap | U.S. Mid & Small Cap | European Large & Mid Cap

More Trefis Research

1. ConocoPhillips Reports Fourth-Quarter and Full-Year 2014 Results; Strong Reserve Replacement; Further Reduces 2015 Capital, conocophillips.com [↩]
2. ConocoPhillips Q4 2014 Earnings Call Presentation, conocophillips.com [↩]
3. Fourth-Quarter 2014 Detailed Supplemental Information, conocophillips.com [↩]