VALUATION HIGHLIGHTS

1. Crude Oil constitutes 74% of the Trefis price estimate for ConocoPhillips's stock.
2. Natural Gas constitute 18% of the Trefis price estimate for ConocoPhillips's stock.

WHAT HAS CHANGED?

COP Saw A Strong Q3

In the third quarter, ConocoPhillips' net income nearly doubled to $4.5 billion, or $3.55 per share, from $2.4 billion, or $1.78 per share, in the year-earlier quarter. In addition, its Q3 production jumped 13.5% to 1.75 million barrels of oil equivalent (boe) per day from 1.54 million boe/day in the same period last year. The company's Q3 total average realized price rose 46% to $83.07/boe from $56.92/boe realized in the year-ago quarter.

Note: ConocoPhillips' FY'21 ended on December 31, 2021. Q3 FY'22 refers to the quarter that ended on September 30, 2022.

Guidance

Going forward, COP forecasts Q4 production of 1.74 million to 1.8 million boe/day and maintains its full-year expected production at 1.74 million boe/day. With respect to current inflationary impacts, the company increased its FY 2022 operating capital guidance to $8.1 billion compared with prior guidance of $7.8 billion, and adjusted operating cost to $7.7 billion from $7.5 billion previously.

Volatility In Energy Markets

The shares of ConocoPhillips have touched highs of $120 in the early months of 2022, assisted by skyrocketing benchmark oil & gas prices and rising transportation demand. In 2021, the company reported 1.04 MMBPD of liquid products, which is almost 1% of the global crude oil output. While the geopolitical uncertainty due to the Russia-Ukraine war has led to spikes in benchmark oil prices, rising inflation has jeopardized global economic growth and triggered measures such as new energy security alliances.

In 2021, the company's crude oil, natural gas, natural gas liquids, and other products contributed 51%, 37%, 4%, and 8% of total revenues, respectively. With revenues to be pushed by rising capital investments in oil & gas assets, the company announced a net-zero (only scope 1 and scope 2) roadmap by prioritizing opportunities in CCUS (carbon capture, utilization & storage) and hydrogen.

COP's revenues depend on benchmark oil prices, causing variability in profitability ratios. The Brent benchmark increased from $54 in 2017 to $71 in 2018, remained slightly lower at $63 in 2019, and declined to $41 in 2020. COP reported an operating cash flow margin of 22%, 33%, 30%, and 25% in 2017, 2018, 2019, and 2020, respectively. Considering the company's aggressive capital allocation strategy and rising production in the U.S., Trefis believes that the stock is a good bet in the oil & gas industry.

POTENTIAL UPSIDE & DOWNSIDE TO TREFIS PRICE

Below are the key drivers for ConocoPhillips, which present opportunities for upside or downside to the current Trefis price estimate for ConocoPhillips.

• Crude Oil Price: ConocoPhillips' stock price is highly sensitive to crude oil prices as the company derives more than 60% of its total value, by our estimates, from the sale of crude oil. We believe that the recent surge in oil prices could sustain over the near-term amid slow easing of curtailed output the OPEC and non-OPEC allies and geopolitical tensions. According to our estimates, annual average crude oil prices (Brent) could average at around $98 per barrel this year and decline to around $78 per barrel by 2025. However, if oil prices remain high for longer than what we currently expect and increase only to around $120 per barrel by the end of our forecast period, there could be almost a 20% upside to our current price estimate for ConocoPhillips.


• Price of Natural Gas: In 2010, approximately 1% of natural gas production came from shale sources. By 2014, this figure had increased to nearly 25%. Technological improvements have helped improve the ability of companies to discover these new resources. As a result of new discoveries of shale gas, there has been a decoupling between the prices of crude oil and natural gas.
  However, the oil slump that began in 2014 resulted in a sharp drop in natural gas prices. Thus, the company's natural gas price realization declined from $6 per mcf in 2014 to $3.80 per mcf in 2015 and further to $3 per mcf in 2016. Natural gas prices recovered to $3.90 per mcf in 2017 as oil prices recovered. In 2021, COP reported $6/mcf of natural gas prices due to global shortages. We expect natural gas prices to increase to $9 in 2022 and then decline gradually to stabilize around $8 over the next couple of years. However, if demand picks up further and prices rise above $9 per mcf, there could be an upside of about 10% to our price estimate.

BUSINESS SUMMARY

ConocoPhillips is the world's largest independent exploration and production company, based on proven reserves and production of liquids and natural gas. After the spin-off of its midstream and downstream businesses into an independent company (Phillips 66), ConocoPhillips has become a pure-play exploration & production company. The company conducts exploration activities in 19 countries and supplements its income with equity stakes in other oil & gas and chemical companies. About 56% of its production consists of liquids, and about 44% consists of natural gas. Of the 56% that are liquids, roughly half is tied to Brent or international prices. The remaining 11% of liquids is tied to North American crude markers, NGL, or bitumen prices. On the natural gas side, comprising about 44% of its portfolio, roughly 45% consists of international gas. Price differentials between Brent and West Texas Intermediate (WTI), a widely used North American crude marker, have been narrowing of late. This has reduced the disparity in realized prices for crude oil in domestic and international markets. Price realized by the company on the domestic and international sale of natural gas is also different.

SOURCES OF VALUE

Crude oil exploration and production is the most valuable segment for ConocoPhillips for the following reasons:

Large base of proven reserves

The amount of proven hydrocarbon reserves is an extremely critical metric for any oil and gas exploration and production company. It directly impacts the company's production growth outlook, as it represents the total quantity of technically and economically recoverable oil and gas reserves owned by the company at a given point in time. ConocoPhillips' total proved hydrocarbon reserves stood at 6.10 billion barrels of oil equivalent at the end of 2021. This implies that the company holds enough reserves to be able to produce oil and gas for more than seven years at current production rates.

More importantly, ConocoPhillips has reported a greater than 100% reserve replacement ratio for the last five years. This shows that the company has been able to grow its reserve base through a successful exploration program consistently. Its average reserve replacement ratio for the last three years (excluding asset disposition) has been over 155%.

Enviable acreage position in the Lower 48 states

ConocoPhillips holds 10.8 million (as of 2021) net acres of onshore conventional and unconventional acreage in the Lower 48 states. The company's unconventional holdings total 1.8 million net acres and include approximately 560,000 net acres in the Bakken, 200,000 net acres in the Eagle Ford, 920,000 net acres in Permian, and nearly 293,000 net acres in other unconventional exploration plays. Currently, ConocoPhillips' activities in this region are mostly centered on the continued optimization and development of existing and emerging assets, with a particular focus on areas with higher liquid production.

KEY TRENDS

Improving volume-mix

ConocoPhillips' price-adjusted cash operating margins have also been helped over the past few years by the continuous improvement in its sales volume mix, which is primarily being driven by the development of its assets in the Lower 48 states. Liquids (crude oil and natural gas liquids) now represent 61% (as of 2021) of the total hydrocarbons produced by ConocoPhillips from the Lower 48 states, compared to just over 45% at the end of 2012, and their production has been growing rapidly over the last few years.

Peak oil

It is estimated that a large part of the world's oil reserves has already been discovered. Recent statistics have indicated that global consumption has been outpacing reserve additions. Peak oil is a commonly used term to describe the point at which world oil output will reach a maximum and decline afterward.

However, many institutions, such as the International Energy Agency (IEA), believe that peak oil will not occur for another 25 years at the very least. Many governments across the world are promoting alternative energy measures to ensure that the supply and demand for energy will be met at all times to come.