Higher Gas Prices, Liquids Production From U.S. Onshore Assets To Boost ConocoPhilips’ Earnings

ConocoPhillips (NYSE:COP) is scheduled to announce its 2014 first quarter earnings on May 1. We expect the company’s earnings to receive a boost from higher natural gas prices in the U.S. Unusually cold winter in the U.S., which forced consumers to use more heat and electricity this year, drove a sharp increase in domestic natural gas prices. Spot henry hub prices were up more than 45% y-o-y during the first quarter due to a precipitous decline in natural gas inventories.

Benchmark crude oil prices have been slightly lower this year, but we expect the sharp increase in natural gas prices to more than offset this decline. Apart from higher commodity prices, ConocoPhillips 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 first quarter earnings 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.

We currently have a $76 price estimate for ConocoPhillips, which is almost in line with its current market price.

See Our Complete Analysis For ConocoPhillips

Better Volume Mix To Drive Thicker Margins

ConocoPhillips’ 2013 full-year cash margins improved by $2.91 per barrel of oil equivalent (BOE), which is equivalent to an increase of more than 11% y-o-y. This could partially be attributed to higher natural gas prices in the U.S., compared to 2012. However, even after adjusting for the difference in price realizations, the company’s cash margins improved by $2.35 per BOE, which implies more than 9% year-on-year growth. The key reason behind this spectacular margin improvement was better volume-mix, which we believe would also be the case during the first quarter. ^[1]

Last year, ConocoPhillips’ volume-mix improved on higher proportion of liquids as production growth mostly came from the liquids-rich unconventional plays in the Lower 48 states and oil sands in Canada. 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. ^[2]

ConocoPhillips’ 2013 full-year production from continuing operations grew by 30,000 BOE per day, net of field declines. Although not substantial, the growth in production came from the right areas, which boosted its operating margins. In North America, where natural gas prices are heavily depressed compared to international markets, the company’s natural gas production declined by 16,000 BOE per day, while liquids production from the Lower 48 and Canada increased by 49,000 and 21,000 BOE per day, respectively. This boosted ConocoPhillips’ 2013 cash margins by almost $3 to $28.55 per BOE. ^[1]

Going forward, the independent oil and gas explorer expects to boost its net hydrocarbon production rate from around 1.5 million BOE per day (MMBOED) in 2012 to 1.9 MMBOED by 2017. Since the 2012 base production is expected to decline to around 0.9 MMBOED by 2017 due to normal field declines, the company effectively plans to add new production of almost 1 MMBOED in a period of 5 years. ^[3]

The biggest contributor to this production ramp-up and margin expansion plan is expected to be its ongoing development of the U.S. onshore assets in the Lower 48 region. ConocoPhillips has been investing heavily in the segment. Last year, the company spent as much as $5.2 billion or ~34% of its total capital expenditure in the development of oil and gas reserves in the Lower 48 region, which is expected to contribute ~60% to its total planned incremental production from the development of existing projects and more than 36% to the total anticipated new production of 1 MMBOED. ^[3]

More importantly, liquids now represent over 50% of the total hydrocarbons produced from the Lower 48 region, compared to just over 45% at the end of 2012, and production has been growing steadily over the past few quarters. In 2013, crude oil production from the Lower 48 region grew by 24% y-o-y, while total hydrocarbon production from the region increased by just around 7%. Based on ConocoPhillips’ long-term plan and its progress so far against it, we believe that better volume-mix would drive further improvement in the company’s cash margins going forward.

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1. ConocoPhillips ​Fourth-Quarter Conference Call, conocophillips.com [↩] [↩]
2. 2013 10K Filing, sec.gov [↩]
3. Credit Suisse Energy Summit, conocophillips.com [↩] [↩]