High-Margin, High-Growth Shale Plays Make ConocoPhillips The Top Oil Major

| About: ConocoPhillips (COP)


Unlike its peers, ConocoPhillips has been able to grow its production base.

ConocoPhillips' shale operations are growing at a much faster rate than the rest of its assets, with BOE margins coming in much higher as well.

The Eagle Ford and the Bakken are leading the initial charge, but the Permian Basin offers plenty of upside.

Pioneer Natural Resources thinks it can more than double its reserve base in the Permian over the next three years.

Due to Pioneer's success, ConocoPhillips has a good chance of booking significant reserves in the region.

Unlike other oil majors, ConocoPhillips (NYSE:COP) was able to actually grow its production base last quarter. After factoring out its Libya operations, Conoco grew its output by 6.5% year-over-year (4% when adjusted for less downtime), as liquids production rose by 61,000 BOE/d, and natural gas output fell by 1,000 BOE/d.

As its liquids production rose, so did its margins. Conoco's cash margin rose from $28.58 per BOE to $31.78 per BOE, due in part to higher realized prices this quarter versus the second quarter of 2013. Even after adjusting for the higher price realizations, Conoco still boosted its cash margin per BOE to $29.28, meaning it is legitimately becoming a more effective company and doesn't need higher prices to grow its bottom line.

ConocoPhillips' plan is to boost its production and margins by 3% - 5% over the next several years, and so far everything seems to be going smoothly. To achieve both margin expansion and production growth, Conoco has been developing its position in various shale plays across America. Management has guided for Conoco to grow production from its unconventional American assets by 22% CAGR from 2013 - 2017, with the cash margins per BOE exceeding $40.

Plenty of liquids upside
Last quarter, Conoco grew its output from the Eagle Ford and Bakken/Three-Forks by 38% year-over-year. The high liquids content of the Eagle Ford (59% crude, 20% NGLs) and the Bakken/Three-Forks (83% crude, 6% NGLs), its two main shale plays, allows Conoco to generate strong cash margins. With over 4,800 potential drilling locations in these two plays, Conoco will be able to keep growing its production base beyond its 2017 time frame.

To keep the momentum going, ConocoPhillips is moving into new horizontal plays. In the Permian Basin, Conoco has 150,000 net acres in the Delaware Basin and 90,000 net acres in the Midland Basin, with plans to explore various parts of its acreage this year.

Stacked potential
The poster child of stacked potential is the Permian Basin. Pioneer Natural Resources (NYSE:PXD) sees 75 billion BOE in recoverable reserves in the region, which houses the Spraberry and Wolfcamp shale formations. On top of that, continued drilling in the area could open up intervals like the Atoka, Clearfork, and the Middle Spraberry.

Currently Conoco is still in the exploration phase, with 24 horizontal wells planned for 2014. A major benefit of being a relatively new player in the Permian is that Conoco can leverage the previous success of operators like Pioneer with little risk. Pioneer has already delineated and tested several horizons in the play, allowing it to book 432 million BOE in reserves across all three basins in the Permian. Management is guiding to add another 600 million BOE to Pioneer's Permian reserve base through 2016, so the fun is just getting started.

It wouldn't be unrealistic to assume that ConocoPhillips could book a substantial amount of reserves from its Permian Basin position over the next several years. After Conoco completes its exploration program, it can enter the development phase and start cranking out plenty of production growth.

Final thoughts
While oil majors like ExxonMobil and Chevron have seen their production bases erode away, ConocoPhillips has been able to significantly boost its output levels by betting a large chunk of its capex budget on America shale plays. Investing in shale generates high levels of growth and cash margins that exceed its company wide average. Combine higher margins with more production and you get much larger streams of cash flow, boosting the value of ConocoPhillips. The stock has gone up substantially this year, but after the recent pullback ConocoPhillips is a long term buy.

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