Is ConocoPhillips A Safe Investment?

Nov.22.13 | About: ConocoPhillips (COP)

ConocoPhillips (COP) is turning its exploration and production program to areas where there is regional political stability and growth potential. It is focusing on major production growth from the U.S. onshore reserves such as Eagle Ford shale formation and Bakken shale formation. In these shale plays, ConocoPhillips has plans to generate long-term growth. These shale plays are among the major shale reserves located in the U.S. and are important from an investment point of view.

Re-entering Eagle Ford

ConocoPhillips is turning its focus to the development of the Eagle Ford shale formation where it has around 227,000 net acres with reserves of around 1.8 billion barrels of oil equivalent, or bboe. The company plans to spend a total of around $8 billion through 2017 to develop its acreage in the counties of La Salle, McMullen, Live Oak, Karnes, and DeWitt to increase the production from this region by around 130,000 barrels of oil equivalent per day, or boepd, in the same time span. The table below shows the type of petroleum deposits available where the company operates in these counties:


Type of petroleum deposit

La Salle

Oil, gas-condensate, wet gas, dry gas


Shale oil, gas-condensate, wet gas

Live Oak

Oil, natural gas liquids, or NGL, dry gas


Oil, shale gas, gas-condensate


Condensate, wet gas, dry gas

Click to enlarge

During the third quarter ending in September this year, ConocoPhillips reported an increase in the production from the Eagle Ford by 66% over the third quarter of last year to around 126,000 boepd. The company has identified more than 1,800 drilling locations in the development area, and it plans to drill around 140 wells in the region by the end of this year.

ConocoPhillips plans to increase the productivity of this area with the use of an efficient hydraulic fracturing process to extract tight oil. Tight oil is a type of oil that is available from low-permeable shale reservoirs. Permeability measures how easily the oil and natural gas can flow through the rocks. The greater the permeability the easier it is to extract oil and natural gas. In certain wells in the Eagle Ford shale formation, ConocoPhillips has been able to reach a production of around 1,000 barrels per day, or bpd. Historically the decline rates of production from a well in the Eagle Ford are 60% in the first year, 64% in the second year, 72% in the third year, and 46% in the fourth year. So, a high production leads to a longer productive life of a well.

In addition to productive wells, the petroleum reserves in the Eagle Ford formation are huge. According to the estimates by the EIA, tight oil production from the Eagle Ford is going to rise in the coming quarters. The following chart shows that tight oil production will continue to rise until 2020:

Source: EIA

The growth potential for oil production from the Eagle Ford shale formation is in line with ConocoPhillips' plans to increase production of oil from this region. Out of the company's total production of petroleum products from the Eagle Ford region, 20% consists of oil, which it plans to increase to 60%. I think that ConocoPhillips will be able to increase production from the Eagle Ford region in the coming quarters.

Another major producer of the Eagle Ford formation and a competitor to ConocoPhillips is Marathon Oil (MRO). The company has around 330,000 net acres in the Eagle Ford formation with around 80% operating interest. Marathon Oil plans to produce around 100,000 boepd from Eagle Ford by the end of this year. In addition to the production increase, the company is also focusing on efficient drilling. During the third quarter results, the company reported a decrease in the number of spud-to-spud days to 12 days, which is a 20% decrease over the spud-to-spud days last year. Spud-to-spud days are the time interval between the start of drilling of two wells. Marathon Oil is planning to increase crude production from Eagle Ford by around 700,000 bpd through 2020.

Is Bakken a slippery slope?

ConocoPhillips is focusing on increasing production from the Bakken formation, another project area in the U.S. onshore. The company plans to invest $4 billion in the Bakken formation until 2017 to increase the production by 45,000 boepd. ConocoPhillips has around 626,000 net acres in the Bakken formation with major operations in McKenzie and Dunn counties in North Dakota. The company's estimated more than 1,400 drilling locations in the area under its operation. According North Dakota Department of Mineral Resources, or DMR, a typical Bakken Well produces around 427 barrels of oil per day, or boepd, during the first year of its operation with a production life of around 45 years.

The Bakken shale formation holds a huge reserve of oil. According to the U.S. Geological Survey, the Bakken shale formation could generate production of around 4.3 billion barrels of oil. McKenzie and Dunn counties are some of the major producing areas in the Bakken formation and have high growth potential for oil production. These two counties produce around 40% of North Dakota's total oil production. The following graphs show the estimated oil production growth from these two counties:


Although the production potential from the Bakken formation is high, one factor that needs to be taken into consideration is the decline rates of the Bakken wells. This could be understood from comparing the number of wells added to the barrels of oil produced from the new wells. In the Bakken, in June 2011 an addition of 66 wells added 46,626 barrels per day, or bpd, while in June this year an addition of 140 wells added only 52,828 bpd. One reason of this decrease in additional production is that the production from older wells is declining faster than what newer wells could add. An increased number of wells led to comparatively fewer barrels per day, and this is a risk for ConocoPhillips. However, as shown in the production projection chart of McKenzie and Dunn counties, we believe that production decline of the reserves will take time to set in and will be after 2017, which is currently beyond the company's investment period in the Bakken.

Kodiak Oil and Gas (KOG), an independent oil and gas producer, has major acreage of around 196,000 net acres in the Williston Basin. The company's primary and important focus is the Bakken and Three Forks formation located in the Williston Basin, North Dakota. The company plans to produce around 30,000 boepd - 34,000 boepd from this region. During the third quarter of this year, the company was able to grow production by 50%, to around 35,400 boepd, over the production during second quarter this year.

Cash flow to moderate out





Cash flow from operations ($ billion)




Click to enlarge

Source: MarketWatch

As ConocoPhillips is increasing investments to develop in the major plays in the U.S., there is a continuous decrease in cash flow from operations over the three quarters of this year. I expect the cash flow will gain vigorously over the coming quarters as the operations in the Eagle Ford and Bakken start production. The improvement in production is going to increase the cash flow because of the company's improving cash margin over the quarters. ConocoPhillips' average cash margin was around $25.12 per barrel of oil equivalent, or boe, last year, which improved to around $28.84 per boe year to date, or YTD. The improvement in production and the improvement in cash margin will moderate the cash flow from operations in the coming quarters.

U.S. onshore projects have potential

ConocoPhillips' assets in the Eagle Ford formation provide high opportunity for growth in production, especially in the production of tight oil. As I have discussed, tight oil production still has growth potential before it tapers out. The company's asset in the Bakken also has high production potential. While the Bakken wells might show some initial declines, I expect the reserves in the Bakken will remain productive over the coming quarters. Currently, the company's price-to-sales, or P/S, ratio is around 1.52. With the increase in production from the Eagle Ford and Bakken formations, the P/S is expected to decrease in the coming quarters. The U.S. onshore projects of ConocoPhillips are expected to provide significant growth due to the quality of its assets, and it is a safe growth opportunity for its investors.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.