ConocoPhillips 2Q Earnings: Lower Oil Prices To Significantly Eat Into Profits

ConocoPhillips (NYSE:COP) is scheduled to announce its 2015 second-quarter earnings on July 30. ^[1] We expect lower crude oil prices to weigh significantly on the company’s financial results. Benchmark crude oil prices have fallen sharply over the past 12 months on rising supplies amid slower demand growth. The average Brent crude oil spot price declined by more than $48 per barrel, or almost 44% year-on-year, during the second quarter. This is expected to result in thinner operating margins on ConocoPhillips’ spot crude oil sales.  However, higher liquids production, primarily driven by the development of tight hydrocarbon reserves in the U.S., is expected to partially offset the impact of lower oil prices on the company’s second-quarter results. During the earnings conference call, we will be looking for an update on the company’s operating strategy under the changed crude oil price environment. ^[2]

ConocoPhillips is the world’s largest independent exploration and production company by proved reserves and annual production. Its daily net hydrocarbon production from continuing operations, excluding Libya, averaged 1,532 thousand barrels of oil equivalent (MBOED) last year, and it had proved oil and gas reserves of around 8.91 billion barrels of oil equivalent (BOE) at the end of 2014. Headquartered in Houston, Texas, the company has operations in 27 countries, generating annual sales revenue of more than $52 billion. We currently have a $59 per share price estimate for ConocoPhillips, which is more than 15% above its current market price.

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Lower Commodity Prices To Eat Into The Profits

According to the latest Analyst Update presentation posted by ConocoPhillips, a $1 per barrel fall in the annual weighted average price of Brent or Alaskan North Slope crude oil stream, reduces its total full-year net income by approximately $80-90 million. Lower WTI and WCS crude oil prices also weigh on the company’s net income, albeit much less heavily as it derives a far smaller share of its crude oil net income from these streams. Therefore, we can expect the company’s second-quarter oil and gas exploration and production earnings to be around $1.77 billion less than the year-ago quarter, just because of the decline in oil prices. Lower average Henry Hub natural gas prices in the U.S. will further eat into the company’s net income for the three-month period ending June 30, 2015. Overall, we expect lower price realizations to result in a decline of approximately $1.96 billion or $1.59 per share in ConocoPhillips’ second quarter net income, compared to the year-ago quarter. To give some perspective, the company’s total net income, excluding non-controlling interests, stood at $2.08 billion in 2Q 2014. ^[3]

Lower 48 Development To Drive Production Growth

ConocoPhillips expects to deliver around 2-3% year-on-year growth in net hydrocarbon production for 2015, despite the sharp cut in capital investments in new projects, largely driven by the recent decline in oil prices. A large majority of this growth is expected to come from the ongoing development of its onshore assets in the Lower 48 states of the U.S., where the company has made some great progress recently. ConocoPhillips’ crude oil production from the Lower 48 states has grown from around 117 thousand barrels per day (MBD) in 1Q 2012 to 198 MBD in 1Q 2015, a growth of almost 70%. During the first quarter, almost 43% of the total net year-on-year production growth of around 82 MBOED came from its operations in the Lower 48 states, where the company is focusing on the development of its acreage in the Eagle Ford and the Bakken/Three Forks shale plays. Production from the Lower 48 states at 542 MBOED was up by around 6.9% y-o-y. ^[4]

We expect the Lower 48 region to have primarily driven production growth for ConocoPhillips during the second quarter as well, since the company has decided to double down on the development of its tight hydrocarbon reserves in the U.S. The company recently said that this strategy will make it more agile and help in navigating through the expected volatility in crude oil prices in a more efficient way since the capital requirements of shale oil development are far more flexible than the longer-term deepwater and LNG projects. ConocoPhillips plans to reduce its annual capital spending budget over the 3-year period ending 2017 to just $11.5 billion, down more than 28% from the previous target of $16 billion. However, it will increase the spending on the development of unconventional reserves in the U.S. by almost 50%, while cutting back on more longer-term, capital-intensive projects by 45%. ^[3]

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1. Press Release, conocophillips.com [↩]
2. ConocoPhillips 2014 10-K Filing, sec.gov [↩]
3. Investor Update, conocophillips.com [↩] [↩]
4. ConocoPhillips First-Quarter 2015 Earnings Call Presentation, conocophillips.com [↩]