Higher Risk For ConocoPhillips: Production Cuts Or Oil Price Volatility?

by Trefis Team
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In April, ConocoPhillips (NYSE: COP) announced a 30% production cut for June primarily due to declining energy demand and low benchmark prices. While the stock has gained nearly 80% since the lows observed on March 23, Trefis believes that ConocoPhillips’ stock faces a higher risk from declining production volumes than oil price volatility. Apart from direct operating costs, the company incurs a significant amount of depreciation and depletion charges to maintain well and equipment productivity. Therefore, margins are expected to slide due to higher maintenance expenditure as production volumes rise. In this article, we discuss the impact of declining production volumes on ConocoPhillips’ earnings in 2020. Also, our interactive dashboard What Factors Drove -16% Change in ConocoPhillips’ Stock between 2017 and now? provides the key numbers driving the stock price change over the last three years.

As prices remain stable, revenues are expected to contract with production volumes

In 2019, ConocoPhillips generated $36 billion in total revenues with 1,348 MBPD (thousand barrels per day) of average net production. As WTI benchmark prices are likely to remain under $40 per barrel from OPEC+ production cuts and voluntary curtailments by American oil producers, the company’s revenues are expected to decline with shrinking production volumes. At a 30% volume reduction, ConocoPhillips’ Revenues are expected to contract by 43% to $20 billion in 2020. However, if the volume reduction continues in Q3 and annual production contracts by 50%, revenues could fall to $16 billion.

Net margins to slide from higher depreciation and interest costs

Production, depreciation, and tax expenses account for 85% of the company’s total operating costs (excluding purchased commodities from external sources). While production costs vary across geographies, the company needs to regularly invest in new wells, processing infrastructure, transportation vessels, and other supporting assets to maintain an optimum production level. In 2019, ConocoPhillips incurred $6 billion of depreciation cost and invested a similar amount in property, plant, and equipment. Despite the targeted 35% reduction in capital expenses for 2020, we expect the company to incur higher maintenance costs during the latter half of the year. With $7.7 billion of available cash and short-term investments, the company is likely to expand its long-term debt with $6 billion of revolver credit. Thus, the $300 million of additional interest expense is expected to be a drag on near-term investor returns. Notably, the added interest burden of $300 million is comparable to $375 million of the average quarterly dividend payout in 2019.

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