24/7 Wall St. reported Wednesday that Wells Fargo maintains its OUTPERFORM rating on ConocoPhillips (NYSE:COP) and raised its valuation range to $56 to $59 from the previous range of $52 to $56. The firm also altered its EPS estimates to −$2.84 and $1.99, from the previous estimates of −$2.87 and $2.27, in 2016 and 2017, respectively. Wells thinks ConocoPhillips possesses one of the lowest all-in cash operating breakeven levels in the sector. Let's take a look.
Over the last two years, COP has reduced its capital requirements by ~60% by completing oil sands and LNG mega-projects, increasing capital efficiencies, reducing the dividend, ringing out operating costs, and benefiting from deflation in capital and operating costs. As a result, the company says its breakeven price is less than $50 Brent for this year and beyond:
Source: 1/5/2017 Presentation At Goldman Sachs
The reason COP has such a low all-in cash operating breakeven point is because the company has a low-decline rate asset base. And this is where spending on the oil sands and Australian LNG export terminal will pay dividends: both of these assets will have an effective "0" decline rate for decades. As the following slide shows, Wood MacKenzie says that of all the domestic independent E&P companies, only one has a lower capital intensity than ConocoPhillips:
Note the list of companies in the comparison include shale heavyweights like Pioneer Natural Resources (NYSE:PXD), Continental Resources (NYSE:CLR), EOG Resources (NYSE:EOG) , and Occidental Petroleum (NYSE:OXY). I don't have access to the original Wood Mac October 2016 report, but if any of my followers or readers know who #1 is, I would appreciate a heads-up in the comment section.
As COP has executed its non-core asset divestitures over the past few years, and the company's exit from deepwater, its global footprint - in terms of the numbers of countries it is operating in - have been cut in half. Gone from the picture are countries like Russia, Kazakhstan, Algeria, Angola, Nigeria, Poland, Bangladesh, Greenland, and even Canadian provinces Nova Scotia and Newfoundland. What we have left are higher-return and more geopolitically safe countries to operate in.
Meantime, the company has reduced its dependence on North American natural gas, while raising its percentage of oil production and higher margin International gas. The trend is expected to continue moving forward.
But at the end-of-the day, the companies that are going to prosper in a lower-for-much-longer oil price scenario, are those with the lowest cost of supply. And that is precisely where COP shines:
Note that COP has 18 billion boe with a cost of supply under $50/bbl, and roughly half of that is <$40/bbl and about one third under $30/bbl. That is a really nice production profile with WTI currently at $52 and Brent at $55.
I mentioned before the "0" decline rates of COP's oil sands and LNG production. What that means is that the company can keep flat production for those assets with very little cap-ex. As the slide below shows, COP estimate its LNG and Oil Sands facility will require only $500 million per year in cap-ex to produce 5 billion boe over decades of operation:
In addition, note that COP has 20-year LNG offtake contracts for 8.6 MTPA. That is two decades of secure and signficant cash flow with a cos of less than $30/boe. For Oil Sands, Surmont is going to ramp up from less than 40,000 bpd in 2016, to close to 70,000 bpd by the end of 2018.
Next comes the companies conventional assets - most of it low-risk legacy assets like Alaskan crude, Norwegian natural gas, and Chinese oil. These will require ~$3 billion to produce 6 billion boe. At the top of the chart comes the company's large lower-48 conventional portfolio. These are short-cycle shale plays with relatively high decline rates, but which are also relatively cheap and quick to bring online. Assets in that class would be the company's leading acreage in the Eagle Ford as well as its Permian and Bakken leaseholds. These plays will start to get more capital directed toward them in a "lower for longer" oil price scenario.
Summary & Conclusion
ConocoPhillips has had a rough couple of years which has seen it exit deepwater, meet its large cap-ex commitments to finish up its Oil Sands and Australian LNG projects, cut the dividend, and reduce overall cap-ex. The company now is much leaner, has a much more focused global portfolio, and is excellently positioned for the future. COP is attractive as compared to many other shale oriented E&P firms. However, I still rate it a HOLD because I want to see how the company performs in the new price scenario. The Q4 EPS report (due out around the end of January) will give us a clue, but Q1 2017 will be much more interesting.
Meantime, much of COP's upside potential will be determined by its asset divestiture program. Considering the company is looking to sell non-core North American natural gas properties, the recent rise in the price of natural gas (see above) and NGLs like propane is a positive development. I expect natural gas and NGL pricing to continue working its way higher as LNG and LPG exports on the Gulf Coast pick up speed. Then the value of COP's lower-48 natural gas assets will become more apparent. Regardless, it will be nice to see COP back in the green in 2017. If COP can meet Wells Fargo's $1.99/share in net income for the year, it will be safe to say that COP is back!
Disclosure: I am/we are long COP. 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.
Additional disclosure: I am an engineer, not a CFA. The information and data presented in this article were obtained from company documents and/or sources believed to be reliable, but have not been independently verified. Therefore, the author cannot guarantee their accuracy. Please do your own research and contact a qualified investment advisor. I am not responsible for investment decisions you make.