ConocoPhillips’ 3Q Earnings Hit By Weak Oil Prices

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ConocoPhillips

ConocoPhillips (NYSE:COP), the world’s largest independent exploration and production company by proved reserves and annual production, witnessed a rough third quarter as the price realizations continued to remain weak due to plummeting commodity prices. The company, that reported its September quarter results last week [1], posted a drastic drop in its earnings both sequentially and annually despite its cost cutting initiatives during the quarter. In the light of a challenging outlook of the commodity market, the US-based company has revised its capital spending for the rest of the year and is likely to restrict spending even in the next year. Thus, assuming weak oil prices even in the next quarter, we expect ConocoPhillips’ earnings to remain depressed, while the company’s cost control measures will somewhat ease out the pressure on the bottom line. In this note, we discuss the key highlights of the company’s third quarter earnings release and its outlook going forward.

COP-WTI prices

Source: Google Finance; US Energy Information Administration (EIA)

Higher Production and Lower Operating Costs Dampen The Effect Of Lower Price Realizations

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Due to the slower-than-expected recovery in commodity prices, large oil and gas companies, including ConocoPhillips, continue to see a sharp drop in their price realizations in the September quarter. The company’s realized prices declined 16% sequentially and 49% on a year-over-year basis. However, despite this, the company’s third quarter production stood at 1.55 million barrels of oil equivalent (BOE) per day, 4% higher on a year-on-year basis. This higher production was driven by better-than-expected production results from Alaska, Canada, US shale plays, and the Middle East. These higher volumes enabled the company to partially offset the impact of lower price realizations and post third quarter revenue of $7.5 billion, 13% down on a sequential basis.

COP-prod

Source: ConocoPhillips Form 8-K, 29th October 2015

Further, ConocoPhillips has been proactively reducing its operating costs by cutting down its workforce and improving the efficiency of its existing operations. This led to a drop of 18% in the company’s operating costs (adjusted) in the latest quarter, which eased out the pressure of lower realizations on the company’s margins to some extent. However, the company recorded a net loss of $1.1 billion, or $0.87 per share due to one-time charges for impairment of assets, restructuring charges, and penalty fees for terminating a contract for a deepwater rig in the Gulf of Mexico. On an adjusted basis, the company lost $466 million, or $0.38 per share, which compares to a profit of $1.29 per share earned in the same quarter last year.

COP-price

Source: ConocoPhillips Form 8-K, 29th October 2015

Milestone Achieved In 3Q

During the September quarter, ConocoPhillips achieved its first oil production from Surmont Phase 2, an oil sands project in Alberta. The company expects to ramp up the project through 2017. In addition, the company successfully completed the downstream mechanical runs at its Australia Pacific Liquefied Natural Gas (APLNG) project. ConocoPhillips holds a 37.5% stake in the project, along with Origin Energy (37.5%) and Sinopec (25%). The company has brought six major projects online so far in this year and expects the first cargo from the project by the end of this year. These major achievements will provide a capital flexibility of about $2 billion to the company for the next year, which the company could use to reinvest in its existing projects or wait for better opportunities.

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Strategic Decision – Exiting Deepwater Exploration by 2017

In July of this year, ConocoPhillips had announced its plans to curtail its spending in the deepwater Gulf of Mexico. However, in the latest earnings release, the company expressed its intent to exit exploration activities in its deepwater fields by 2017 and dispose its non-core offshore leases over time. This would reduce the company’s capital by $800 million, which it expects to use for exploration activities in other fields in 2016.

Besides, ConocoPhillips aims to sell its North Cook Inlet Field in Alaska and one-third interest in the Beluga River Field. The company is also proceeding with the sale of its non-core gas assets in the Lower 48 and Canada. On an average, the company plans to divest its non-core assets to free up capital of $1 billion to $2 billion annually. However, the company will provide more details about the sale of its non-core assets in North America next month.

Guidance For 4Q

ConocoPhillips expects its 4Q production to be in the range of 1.59 to 1.63 million BOE per day, which will allow the company to exceed its full-year production guidance of 1.56 – 1.60 million BOE per day for 2015. The independent E&P company plans to continue with its 13-rig program in the Lower 48, much like the second quarter of this year. It has six rigs deployed in the Eagle Ford Shale, four in the Bakken Shale, and three in the Permian Basin. With the current rig levels in the Eagle Ford and Bakken, the company forecasts a decline of 3-5% in its unconventional production over the next year. The company will provide more color on the capital spending and rig count for 2016 on 10th December 2015. Further, given a bleak outlook for the commodity markets, the company has reduced its capital spending guidance to $10.2 billion, down from its prior guidance of $11 billion. Due to efficiency improvements, and service cost deflation, the company estimates its operating cost to be approximately $8.2 billion for the full year 2015, $700 million lower than its earlier expectations.

Conclusion

While ConocoPhillips is increasing its capital flexibility, lowering its cost structure, and selling its non-core assets to weather the current downturn, we expect to see a decline in its earnings over the next couple of quarters due to a challenging outlook for the commodity prices.

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Notes:
  1. ConocoPhillips Announces 3Q Results, 29th October 2015 []