Interesting Times For 2 Integrated Energy Names

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 |  Includes: COP, CVX, IMO, XOM
by: Investment Underground

by Kathleen Martin

We live in fascinating times when it comes to integrated petroleum products companies. The price of oil is high relative to last year, natural gas prices are low, refinery capacity is over limit, and environmental concerns impact the economies of both the upstream (exploration, development, and production of oil and gas assets) and downstream (refining of crude oil) endeavors of these companies. Today we're looking at Chevron (CVX) and ConocoPhillips (COP) and how they are faring in these interesting times.

Chevron's common shares trade around $105 and have a 52-week range of $112.28-$104.33. It has a price earnings multiple of 7.8 and earnings per share of $13.44. The dividend yield is 3.10%. The market capitalization is $207.09 billion. The company has total cash of $20.07 billion and total debt of $10.15 million. Its book value per share is $61.27. Of the 1.98 billion issued shares, 0.01% is held by insiders and 64.3% is owned by institutions, leaving retail investors holding approximately 35.69%. The number of shares short at March 15, 2012, was 23.04 million.

Chevron's fourth-quarter 2011 results showed sales and other operating revenues of $58 billion, up from $52 billion in the same quarter 2010. Net earnings were $5.1 billion, down from $5.3 billion in the fourth quarter 2010. Net earnings per share were $2.58, compared with $2.63 in the fourth quarter of 2010. Full-year earnings were $26.9 billion, or $13.44 per share, up 41% from $19 billion, or $9.48 per share in 2010.

The Chairman and CEO stated that "Chevron had an outstanding year financially due to a strong upstream portfolio and higher crude prices in 2011." In 2011, the company raised the dividend twice and increased cash available for the share repurchase program. The Jan. 27, 2012, news release outlined the fourth quarter with the company beginning construction in Australia at a liquefied natural gas project. Also, the company announced two additional natural gas discoveries in Australia. The company upped production of natural gas in the Gulf of Thailand to 330 million cubic feet per day. 2011 saw the company sell refining and marketing assets in the U.K. and Ireland, and Chevron sold its marketing and aviation businesses in Africa, the Caribbean and Latin America. $1.25 billion of its common stock was repurchased in the fourth quarter of 2011. Total cash of $20.1 at Dec. 31, 2011, was up $3 billion from Dec. 31, 2010. Total debt as of Dec. 31, 2011, was $10.2 billion, down $1.2 billion from year-end 2010.

Income from operations increased 10% from fourth-quarter 2010 to $242 million. Upstream earnings were $1.61 billion in the fourth-quarter 2011, up $675 million from the same period in 2010. The company achieved an average per barrel of crude oil and natural gas liquids of $101 in the fourth quarter of 2011. It was $76 per barrel a year ago. The average sales price of natural gas was $3.62 per thousand cubic feet in the fourth quarter of 2011, down from $3.65 in the previous year. The company's downstream (refining) operations in the U.S. lost $204 million in the fourth quarter 2011, compared with earnings of $475 million in the previous year's fourth quarter. The fourth-quarter 2010 was attributed to a $400 million net gain on the sale of ownership interest in a pipeline company.

All of these financial results reflect the CEO's statement. Whether or not the per-barrel cost of oil will remain at current prices or will increase remains to be seen. There is more speculation in the oil market than there is straight supply and demand. The dependence on the increased per-barrel price for revenue and income growth is not prudent. Increasing costs associated with the development, production, and refining of crude oil decrease its economies of scale with time. Natural gas is a logical alternative to a company in the fossil fuels market. Chevron is trying to build up assets that will enable it to continue to provide investors with capital appreciation and dividend yield. Holding onto legacy assets will be nothing but a huge capital drain on the company, providing the investors diminishing returns. While natural gas is low cost now, demand for clean burning energy sources that are easily accessed will continue to increase over time.

Chevron is divesting itself of aging refinery and infrastructure assets and investing in upstream assets, particularly natural gas. As the refinery business ages itself into this part of the century, Chevron is concentrating on more plentiful and less expensive natural gas assets that are abundant both domestically and abroad. Liquefying and transmission of natural gas faces its challenges from the environmental angle, but Chevron is a well seasoned player in the energy market and has the capital and the ability to attract all the necessary expertise to dominate in the natural gas space.

Turning to ConocoPhillips, shares of the company trade around $75.40, within a 52-week range of $58.65-$81.75. It has a price/earnings multiple of 8.40, and earnings per share of $8.97. The dividend yield is 3.50%. The market capitalization is $96.44 billion. The company has total cash of $6.36 billion and total debt of $26.94 billion. Its book value per share is $50.73. Of the 1.28 billion issued shares, 0.20% is held by insiders and 72% is owned by institutions, leaving retail investors holding approximately 27.8%. The number of shares short at March 15, 2012, was 23.37 million.

The company reported 2011 fourth-quarter earnings of $2.7 billion, earnings per share of $2.02, and a 3% repurchase of outstanding common shares. Earnings in the fourth quarter of 2010 were $1.93 billion. Earnings for the year 2011 were $12.157 billion, or $8.76 per share, compared to $8.825 billion, or $5.92 per share in 2010. Exploration and production saw 1,597 billion barrels of oil for the year vs. 1,279 billion barrels in 2010. The U.S. accounted for $805 billion and international accounted for $1,544 billion in the fourth quarter 2011, vs. U.S. earnings of $619 billion and $1,235 billion from international earnings in the same period of 2010. Realized per-barrel crude oil prices in the fourth quarter 2011 were $96.42, vs. $78.96 in the fourth quarter 2010. Natural gas proceeds were $5.19 per thousand cubic feet in the fourth quarter 2011, up from $4.95 thousand cubic feet in the fourth quarter 2010. The company expended $14 billion in capital expenditures, $11.1 billion in share repurchases, and $3.6 billion in dividends for the full year 2011. The company received $10.7 billion in proceeds from asset dispositions and $9.5 billion from selling its shares in Lukoil, and expects it will receive $5 billion to $10 billion in assets sales in 2012. It also paid down $6 billion in debt in 2011. The company expended $15 billion in share repurchases in from 2010 to 2012. It expects to repurchase between $5 billion and $10 billion in common shares in 2012. The company increased the dividend by 32% during 2010 to 2011.

ConocoPhillips will continue to divest its downstream assets in 2012 and will look to establish itself in the upstream business, mostly in natural gas. As with Chevron, ConocoPhillips is looking to maximize shareholder value and decrease the risk and costs associated with the crude oil refinery business. ConocoPhillips recently announced that it suspended a proposed $16 billion gas pipeline because natural gas prices are at a 10-year low. The proposed route would have natural gas transmitted from northern Canada to the U.S.

ConocoPhillips' partners in the project were Exxon Mobil (XOM), Royal Dutch Shell (RSD.A) and Imperial Oil (IMO). The first-quarter 2012 earnings will show a one-time charge of about $525 million in relation to this suspension. As a consolation prize for the failed pipeline bid, ConnocoPhillips also recently announced that holders of ConocoPhillips shares will receive two Phillips 66 common shares for each ConocoPhillips common share held at April 16, 2012. This is part of an approved downstream business spinoff to separate the company from ConocoPhilips, which will retain the upstream business of Phillips 66. Phillips will be a separate company with no ownership interest from ConocoPhillips in ownership. This is a good move on ConocoPhillips' part to foster shareholder loyalty and reward investors with not only dividends, but also ownership in the shares of a public company invested in the refinery business.

Downstream (refineries) businesses in the U.S. have had to face the specter of decreasing demand in the U.S., aging, single purpose facilities, and increasing environmental regulation. Many integrated oil companies have decided that the refining business no longer makes economic sense. Consequently, some have chosen to divest the downstream assets and invest in upstream activities, where margins are better because of higher commodity prices and they can acquire upstream assets at prices that suit their business strategies.

Chevron received $730 million for the Pembroke refinery in the U.K. and $325 million for the Murphy s Meraux refinery on the U.S. Gulf Coast. Refineries are incredibly costly to build and to maintain; the environmental concerns weigh heavily on the cost basis for these assets and they are not renewable. Locations of refineries are a major factor for companies as the location is governed by the sourcing and logistics in the transmission of the crude oil, expansion possibilities, environmental, and competition pressures. Refineries located in densely populated areas such as the East Coast of the U.S. are subject to a high level of environmental compliance. Many refineries located in densely populated areas are older facilities, and are not equipped to handle the refining of different types of crude oil. Refiners in densely populated areas rely on Brent-priced crude. Wide spreads between Brent crude prices and West Texas Intermediate prices, competition, and exports from overseas have put some East Coast refineries in the position of having to exit the business.

It is a buyer's market for refining assets. The acquiring companies are able to purchase the assets for low dollar costs and have enough capital left over to upgrade the facilities in terms of capacity, ability to handle different types of crude and to environmental specifications. Refineries in the U.S. that are not located in the East tend to be larger, more flexible and are more likely linked to operators who are using the refineries for wholly owned upstream assets. These refineries are able to source less expensive domestic crude. Overseas refiners sold in 2011 giving Asian operators presence in Europe at favorable prices. Some European refineries have been repurposed to terminals because of the diminishing price economies from falling demand and fewer sourcing options, such as the loss of crude from Libya. The loss of crude from Libya was a demonstrable setback Atlantic Basin refineries. China and India still face growing demand for fuels which is driving Asian companies to look for additional refinery assets in the U.S. as well as in Europe.

Producers in the refinery business will continue to face challenges in 2012, with political unrest in Iran a having significant impact on these companies during the year. Refiners that have chemical operations will be able to offer more products and can have flexibility in offering different products that can mitigate some of the market demand risks -- particularly in the U.S. for where natural gas is in large supply.

While it may be a signal of the end of the oil refinery business as it has been seen in the past, it is a harbinger of good things to come for the much maligned and underappreciated and abundant natural gas assets these two companies own. Natural gas is a clean-burning energy source but like oil, it requires transmission and refining and/or liquefying and therefore the industry will face challenges of economies based mostly on environmental factors. ConocoPhillips has just taken the first of series of disappointments, which may continue for some time until there is more value to the underlying commodity. Both of these companies are faring well in a high cost of the commodity environment, and are rewarding shareholders with dividend increases and with spun off assets.

Both companies are long-term players and have faced challenges in the oil refining business. Chevron is more attractive from a debt-to-cash standpoint. ConocoPhillips is trading nearer its book value and is providing added incentive in the share distribution of Phillips 66 shares to keep investors happy, but its debt situation and failed pipeline partnership will impact the shares in the short term. I think that there will be continued challenges on the demand side for oil and on the supply side for natural gas. I think both of these companies have enough experience and capital to continue to reward shareholders for their patience.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.