ConocoPhillips’ 2Q’17 Earnings To Improve On The Back Of Solid Cost Savings

ConocoPhillips (NYSE:COP), one of the largest independent oil and gas companies, is expected to report its June quarter 2017 financial results on 27th July 2017((ConocoPhillips To Announce Its June Quarter Results, 6th July 2017, www.conocophillips.com)). Since the rally in commodity prices eased out in the second quarter due to growing US oil production and inventories, the market expects the US-based company’s price realizations to be weaker than the previous quarter, leading to a decline in the top line on a sequential basis. That said, the oil and gas producer’s efforts to reduce its break-even costs by improving its operational efficiency is likely to boost its profitability in the current quarter. Further, the company continued to sell its non-core and low margin assets in order to enhance its capital structure and improve shareholder returns.

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Key Highlights of 2Q’17

• The surge in commodity prices, particularly crude oil, due to the implementation of OPEC production cuts came to a halt as the US oil production and inventory levels rose sharply in the second quarter. As a result, the WTI crude oil prices dropped from an average of $52 per barrel in the first quarter of 2017 to $48 per barrel in the latest quarter. Consequently, we expect the E&P company’s price realization for the quarter to be lower than that of the previous quarter, impacting its June quarter revenues.

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

• After divesting its major oil sand assets in Canada in 1Q’17 for a sum of $13.3 billion, ConocoPhillips sold its San Juan Basin assets and Barnett assets in the second quarter to further shrink its exposure to North American gas markets. While the proceeds from these deals will allow the company to restructure its balance sheet to be better prepared for the ongoing downturn, excess divestment of assets could hamper the company’s fundamental value in the long term.
• That said, ConocoPhillips has been working towards reducing its break-even oil price by shedding its low-margin assets, and focusing on low-cost oil plays. At present, the company holds a resource base of 14 billion barrels of oil equivalent (BBOE), with an average cost of supply of approximately $35 per barrel, as opposed to $40 per barrel prior to these deals. This means that even if the commodity prices stagnate at last year levels, the oil and gas company will make higher profits on a year-on-year basis, since it has managed to bring down its operating costs notably.

• Post the recent asset sales, ConocoPhillips has increased its share repurchase program from $3 billion to $6 billion, to be completed by 2019. The decision allows the company to optimize its capital structure, and augment its earnings per share in a weak and uncertain oil price environment. Further, the company has announced a quarterly dividend of 26.50 cents per share for the quarter, hinting at improving cash flows.
• Lastly, the management expects to utilize the excess cash from the asset sales to repay $7 billion of debt in 2017, and maintain a net debt position of $15 billion at the end of the year. In fact, both S&P and Moody’s have improved their rating outlook for the company on the news of debt reduction and higher share buyback. Also, lower debt obligations will shrink the company’s interest expense on an annual basis and will boost its bottom line, even when commodity prices continue to be depressed.

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