ConocoPhillips: Watch Closely

| About: ConocoPhillips (COP)


Lower impairments and larger revenues will narrow losses for the second quarter.

Higher average price for the quarter will result in better cash flows.

Cost cutting measures are still underway and the operating expenses will further go down.

Global economy is growing at a slower but steadier pace.

Oil prices have stagnated around $45 per barrel after a strong run over the last four months. This has resulted in a pull back in a number of upstream stocks. One of these is ConocoPhillips (NYSE:COP), which I believe is a good pick for the long-term investors. My optimism about most oil and gas companies stems from the expected recovery in the oil price over the next twelve months. It is expected that 2017 will be the year of equilibrium for global oil demand and supply, which will cause the prices to stabilize.

In the meantime, ConocoPhillips has been taking necessary steps to tackle this cyclical issue. Capital expenditures have been reduced and the operating expenses have also been slashed. The company is looking to let another 1,000 employees go in order to further reduce the operating expenses. Total number of layoffs will reach 3,400 after this decision. This will have a significant impact on the operating expenses and the cash position will be strengthened. There are a few other factors that one needs to take into account.

First, the impairments will likely not be part of the results when the second quarter earnings come out. Oil and gas prices during the first quarter of the year were at record low - crude price went below $30 per barrel. However, during the second quarter, the oil and gas prices have experienced a strong surge and at one point oil price went above $50 per barrel. This should result in higher average realized price for the period and the revenues should get a boost. At the same time, higher prices mean the revaluation of the properties will likely not result in substantial impairments. Although impairments are non-cash expenses, it does spook investors and the overall loss puts pressure on the stock price.

The business is in a good shape fundamentally. Total cash is just under $5 billion and the credit lines are still largely unused, which means that the liquidity is strong and the company should not face any problem. Despite having one of the worst quarters when it comes to commodity prices, ConocoPhillips was able to generate more than $400 million in operating cash flows; smaller companies would be recording negative operating cash flows. As I am expecting the company to have a better average realized price for both oil and gas, operating cash flows will be better for the second quarter. Average price for natural gas was $2.09 in the first quarter, while the Henry Hub price for the month of June was $2.59 - ConocoPhillips will surely have better sales and cash flows sequentially.

Current downturn in the oil prices is coming from the fears about increasing inventories. Mostly, the trading is happening on the data coming from the U.S. Department of Energy, as explained in this Reuters article. However, most traders are ignoring that EIA and other major outlets are expecting the demand and supply to achieve a balance in 2017, despite the ongoing slowdown in the global economy.

The story of global economy is also an interest one. As this research shows that the economy might be slower but has never been steadier. The volatility in most economies has decreased over the last few years, and the economies are growing at a smoother pace. Are we going to see a new pattern in global economic growth? May be. The trend is changing. If the global economy is going to grow at a slower more predictable pace then that means the income is also going to be steadier and we might not see a spike in demand for oil. However, it should also be noted that the slump in oil prices was mainly from the supply side as the U.S. production increased massively. The demand side has slowed slightly but the larger impact has come from the supply side.

Source: Bloomberg

This chart shows that the volatility during the last three years has been lower compared to the 2004-07 period. Brazil, Russia and Japan have experienced greater volatility in the past three years, but for most of the other countries, the volatility has been lower.

ConocoPhillips' decision to get out of the deepwater projects will result in substantial cost savings as the deepwater projects eat into cash at a lot faster rate than the onshore projects. The company can go in and exploit these reserves once the oil prices reach a level which makes these reserves economically feasible. In the meantime, onshore projects will bear more fruits.

Oil price will stay under pressure in the short term as the traders have taken hold of the market completely and the trading is being done on the data alone. However, I remain optimistic that the balance will be achieved over the next 12-18 months and the prices will start to go up. Oil and gas producers are becoming extremely attractive due to this recent pullback and investors should keep a keen eye on ConocoPhillips.

Disclosure: I/we 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.

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