ConocoPhillips’ 4Q’16 Earnings To Show Strong Improvement Driven By Oil Price Recovery And Cost Control Measures

Much like its peers, ConocoPhillips (NYSE:COP), one of the largest independent oil and gas companies, had a tough time weathering the commodity downturn in 2016. However, the recovery in commodity prices in the second half of the year, backed by the production cut proposed by the Organization of Petroleum Exporting Countries (OPEC), is likely to drive the company’s strong financial performance for the December quarter as well as for the full year 2016. The market expects the Houston-based company to post a drastic improvement in its top-line as well as bottom-line for the fourth quarter on 2nd February 2017((ConocoPhillips To Announce December Quarter 2016 Results, 12th January 2017, www.conocophillips.com)). However, after Chevron (NYSE:CVX), one of the largest integrated energy companies, missed its consensus expectations for the quarter last week, we believe that the market has over-estimated the impact of the rebound in commodity prices in the last three months. Accordingly, we expect that while ConocoPhillips will experience a notable improvement in its earnings, it is likely to miss the analyst earnings estimate for the latest quarter.

Key Trends Witnessed By ConocoPhillips In 4Q’16

In the fourth quarter of 2016, the OPEC and some Non-OPEC members announced an arrangement under which they plan to reduce their cumulative oil production by 1.8 Mbpd over the next few quarters. As a result, commodity prices bounced back sharply during the quarter. The WTI crude oil prices increased more than 10% to $49.21 per barrel in the December quarter, while the Henry Hub natural gas prices went up by more than 30% in the same period, ending the quarter at $3.71 per Mcf. With the recovery in commodity prices, ConocoPhillips is expects to witness a steep rise in its price realizations that will lift the company’s revenues for the quarter.

Data Source: US Energy Information Administration (EIA)

Further, ConocoPhillips is expected to record an output in the range of 1,555-1,595 thousand barrels of oil per day (KBOED) in the fourth quarter, and 1,535-1,545 KBOED for the full year 2016 (including the impact for dispositions). Since the oil and gas player has a strong track record of beating its production guidance over the last 17 quarters, we expect the trend to continue in the current earnings as well. Thus, higher production, coupled with better price realizations, will enable the company to report a notable rise in its top-line.

In terms of costs, the exploration and production company has undertaken stringent measures to bring down its break-even price, and has managed to bring it down by more than 60% over the last two years. As a result of these initiatives, we anticipate the company’s operating income and margin to show a significant improvement for the quarter. Going forward, ConocoPhillips estimates its operating expenses to decline further to $6 billion for 2017, 9% lower than the costs in 2016.

ConocoPhillips’ Production Guidance

On the financial side, ConocoPhillips continued to optimize its existing portfolio by divesting its non-core and/or non-strategic assets, and raised approximately $1.3 billion from the completion of these deals((ConocoPhillips Provides 2016 Asset Disposition Update, 14th December 2016, www.conocophillips.com)). The company plans to utilize these proceeds to reduce its debt obligations, and repurchase its shares to enhance its balance sheet and in turn its shareholder returns. In fact, the independent oil and gas company aims to divest assets worth $5-$8 billion between 2017 and 2018, mainly to reduce its exposure in the North American natural gas market.

In terms of capital spending, the company restricted its expenditure to $5.2 billion for 2016, as opposed to its initial estimate of $5.7 billion at the beginning of the year. Despite the improving outlook for the commodity markets, the US-based company will regulate its capital budget at $5 billion for 2017, subject to the recovery in oil prices.

Separately, ConocoPhillips started the year 2017 on a high note by announcing a breakthrough oil discovery in the Alaska region((ConocoPhillips Announces Willow Discovery In National Petroleum Reserve, 13th January 2017, www.conocophillips.com)). The initial drilling tests in the region suggest that the northeast portion of the National Petroleum Reserve of Alaska (NPRA) has a recoverable resource potential in excess of 300 million barrels of oil. ConocoPhillips holds a working interest of 78% in the discovery, while Anadarko Petroleum owns the remaining 22% share. The seismic evaluations of the discovery will begin soon, and the first commercial production of this discovery is likely to come on stream by 2023, subject to appraisal results and the choice of development scenario. It is expected that the discovery could produce up to 100,000 BOPD over the next five to six years. As the outlook for the commodity markets has improved, the discovery will augment ConocoPhillips’ long term production growth, and help enable the company to recover from the downturn.

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