By Mark Bern CPA CFA
ConocoPhillips (NYSE:COP) recently split into two companies, Phillips 66 (NYSE:PSX) (refining, transportation, chemicals, marketing and midstream assets) and ConocoPhillips E&P (which will retain the COP symbol and focus on exploration and production of oil and gas). Between the two separate companies shareholders expect to receive a greater dividend yield than while the two were still one company. The idea is to unlock the additional value of the two units by separating the assets and the different businesses. The integrated structure was no longer achieving advantages from being together as the oil and gas from the E&P unit was not necessarily flowing through the midstream assets to the downstream assets. When the synergy breaks down neither the needs nor the benefits of integration accrue to the whole, while assets allocations for capital investments tend to be made more complicated. The greater potential long-term returns come from the E&P unit while maintenance, upgrades and expansion of the mid and downstream assets cannot be overlooked. A tension exists in integrated oil for the two completely different businesses which can cause swings from one unit to the other. Such is the potential origin of catastrophe in this business. Personally, I think the break up is a great move. It allows each unit to concentrate their focus and available resources where the best returns can be made without the temptation to short shrift one area in favor of another. I believe the risk to shareholders is decreased by the move. I'd like to see more such moves in the integrated oil business by COP's peers.
Secondly, the even more recently announced intention of COP to sell its assets in Nigeria will also reduce risk and make available more cash to the E&P unit for investment where returns can be more predictable and economic stability reigns. There are many opportunities right here in the U.S. where COP can (and I expect will) redeploy its capital. There are also other opportunities to our immediate north in Canada. COP holds nearly 1 million acres of land in the oil sands region. Recoverable oil deposits in the bitumen on this acreage is estimated at more the 15 billion barrels of oil. Natural Gas production is also on the rise. Even though natural gas prices are still falling in the U.S., prices are still high in Asia and Europe. The earthquake and tsunami in Japan have led to the closing of nuclear power plants in Japan and a resulting surge in demand for liquid natural gas (LNG) for electricity production. The processing and distribution of LNG hold significant future potential for COP from both its holdings in North America and Australia.
I believe the move out of Nigeria with reduce risk and provide capital for future growth. The shares bucked the trend Tuesday and moved higher by 1.8 percent. Yet at $54.31 per share and a dividend yield of 5 percent has, in my opinion, significant long-term total return potential. I also believe that owners of shares prior to the split will do well to hold on to both issues for the time being.