ConocoPhillips Successfully Navigates New Colorado O&G Drilling Rules

About: ConocoPhillips (COP), Includes: EOG, PXD
by: Michael Fitzsimmons

ConocoPhillips and the city of Aurora have come to an agreement covering ~300 wells in Weld County, Colorado.

This is impressive, given the new O&G drilling rules as a result of the recently passed "Senate Bill 181".

While the Niobrara play in Colorado was a minor contributor to COP's production profile in 2018, it is yet another lever and growth catalyst for COP moving forward.

COP is undervalued and could easily end 2019 above $70/share for a 15% return in six months.

The Denver Business Journal reports the city council of Aurora, Colorado, has reached an agreement with ConocoPhillips (COP) covering about 300 wells the company's Burlington Resources subsidiary wants to drill on 45 sites in Weld County. This is a big accomplishment, considering the new Colorado Senate Bill 181, which lets cities and counties in Colorado have more control over local O&G drilling.

The agreement is largely the result of ConocoPhillips voluntarily holding 15 open-house meetings in Aurora to address local concerns before negotiating an agreement.

ConocoPhillips spokesperson Emma Ahmed said:

Stakeholder engagement is an integral part of our exploration and production activities. We identify stakeholders and engage with them in face-to-face to ensure that they understand out activities and that we consider their feedback.

The agreement includes measures to lessen surface impact (using pipelines instead of storage tanks, for example) as well as using electric drilling rigs to reduce noise pollution and continuous air-quality monitoring.

The Niobrara

According to COP's March 2019 "Lower-48 Fact Sheet", the company holds about 98,000 net acres in the southern Denver-Julesburg basin within the Niobrara play:

Source: ConocoPhillips Lower-48 Fact Sheet

While that is a nice sized leasehold in the play, it is a relatively small part of COP's massive 10.3 million net acres in its onshore Lower-48 Segment (most of which is already held by production). As shown by the graphic above, ConocoPhillips breaks its Lower-48 Segment into two distinct business units ("BU") - the Great Plains and the Gulf Coast. The Niobrara Shale play is in COP's Great Plains BU, and average daily production was a relatively minor 8,000 boe/d in 2018:

Source: ConocoPhillips Lower-48 Fact Sheet

However, with the agreement covering a future 300 wells, COP can clearly ramp up development in the Niobrara if it chooses to do so.

L-48 Shale Profitability

Judging by many of the comments I get on Seeking Alpha, it is clear that many investors continue to view the domestic shale industry as a "Ponzi scheme" fueled by cheap money.

But COP has figured it out. I say that because ConocoPhillips demonstrated excellent profitability in the L-48 Segment last year by delivering $2.22 billion in net income:

Source: Q4 2018 Supplemental Data

That success continued in Q1 this year when COP made $261 million of net income in the L-48 Segment. This is mainly the result of COP's focus on efficiency, its high-quality acreage, and the fact that COP sold off the majority of its low-margin dry-gas producing assets.

Q2 Estimates

As a result, the company is literally printing money in the current environment (Brent above $63/bbl and WTI above $57.bbl), considering it has a breakeven point of under $40/bbl WTI. That said, natural gas is plumbing 3-year lows below $2.40/MMBtu.

Current Q2 EPS estimates are relatively flat as compared to last year:

Source: Yahoo Finance

But that's OK, considering COP delivered $5.5 billion in free cash flow for full-year 2018.

Meantime, my followers can tell by the comparisons I made in recent articles of COP versus other leading L-48 shale players like EOG Resources (EOG) and Pioneer Resources (PXD) that ConocoPhillips appears significantly undervalued. That may be because there is more of a takeover premium built into those smaller companies.

That said, COP has excellent Brent-based production (in Alaska and globally) and, as a result, blows both EOG and PXD away when it comes to realized pricing:


Realized Pricing

(Full-year 2018)

ConocoPhillips $53.88/boe
EOG Resources $45.51/boe
Pioneer Resources $42.73/boe

Source: COP Q4 FY2018 EPS Report & Supplemental Data; EOG Q4 2018 EPS Report; PXD Q4 2018 EPS Report

Not hard to outperform when you have a $8-11 per boe realized pricing advantage! That, along with its investment grade balance sheet and credit rating, may be why Morningstar (3-star), S&P (Strong Buy), and Credit Suisse (Outperform), all currently have COP rated as "undervalued" and with price targets anywhere from $75 to $82 per share.

Summary & Conclusion

COP demonstrated it could deliver massive free cash flow last year ($5.5 billion, or over $4.50/share), but the market apparently wasn't impressed. Yet, COP continued delivering excellent results in Q1 and will likely deliver another impressive quarterly report on July 30th. At some point, COP will close the valuation gap as compared to peers EOG and PXD.

So, COP is significantly undervalued here and could easily end 2019 above $70/share. That would be more than 15% higher from here, in just 6 months.

Source: Yahoo Finance

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 the investment decisions you make.