ConocoPhillips: All-In On Oil Makes A Risky Investment

seekingalpha2021-11-29

Summary Strong oil prices bolstered COP's third quarter, but its failure to lock in the high prices just as it writes a massive check will weigh on future results. COP faces significant challenges as...

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patrickLai
2021-11-29
patrickLai
Good news
US_watchlist
2021-11-29
US_watchlist
Please like and comment. Thanks

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Other notable highlights included:\n\nCash flow from operations of $4.8B ($4.1B w/o working capital) exceeded capex of $1.3B, generating substantial free cash flow. Management plans to return much of the extra cash to shareholders in the form of dividends and share buybacks ($4B year-to-date) rather than reinvest it in projects. This indicates a bullish strategy largely pegged on strength of oil prices - an iffy strategy if recent volatility in commodity price is any indicator.\nThe company had $10.9B in cash & short-term investments at the end of the third quarter. This will be greatly reduced once COP closes on itsacquisition of Shell's Permianassets for $9.5B in cash later this year.\nAlong with the aforementioned purchase of Shell's Permian assets, COP announced more stringent greenhouse gas emission intensity targets, but limited its targets to Scope 1 & Scope 2. Management refrained from any commitments to measure/limit Scope 3 emissions, despite apledge by its shareholdersto do so.\nCOP raised its quarterly dividend 7% to $0.46/share, which constitutes a 2.5% dividend yield.\nThe company generated $0.2B from asset sales YTD - mostly in the Lower 48 - as a start to its ambitious $4b-$5b total target through 2022. While management noted interest in some of its marketed packages, whether or not they will close remains to be seen.\n\nLack of Hedges = Major Risk\nAs management stated during theQ3 call, COP is 'all in' on oil - the company has not locked in any of its production, despite recent strength of oil prices. While this strategy allowed it to generate handsome returns when oil prices were high, it also exposes COP to significant downside risk once they decline.\nData byYCharts\nA $10/bbl decline in crude prices would reduce the company's projected cash flows by at least $1B. And given Friday's$10/bbl decline, this scenario is not too farfetched, nor would the accompanying volatility be viewed favorably by investors.\nSource: ConocoPhillips Q3 Earnings Presentation\nPermian Inflation & Fracking Might Cause Issues\nIn September this year, COP announced a $9.5B all-cash acquisition ofShell's Permian assets. The hefty price tag implies a valuation of $48k/flowing barrel of output (~175k boe/d at the time of the announcement) or $42k/acre (225k net acres in the Delaware Basin). On a per acre basis, this is more than double the price that COP paid for its $9.7Bacquisition of CXO(Concho Resources) in October of last year, even before factoring in expected synergies and all-equity nature of the latter transaction.\nThe transaction might cause issues for COP for several reasons, in my view:\n\nThe deal is projected to close by YE'21, reducing COP's cash balance to just $700M (before any FCF generated during Q4). This comes just as oil prices are under increasing pressure due to anew COVID-19 strainand President Biden's decision torelease oil from the SPR(Strategic Petroleum Reserve) in an effort to balance the market and bring down prices. Given COP's zero-hedge strategy, it could experience a significant drop in cash flows just as it has to write a substantial check.\nCOP announced more stringent (Scope 1 & Scope 2) emission targets along with its Shell assets acquisition. Meanwhile, Shell put these assets for sale following aDutch court rulingordering the company to reduce emissions. How COP plans to reduce emissions while developing US shale assets that require fracking - in ways that RDS failed to do - remains to be seen.\nInflation has been a major point of concern for analysts and investors alike, and COP's management admitted on the Q3 call that the Permian is taking the brunt of it. While its scale and size should somewhat mitigate these risks, COP plans to reconsider its Permian development plans if \"inflation is expected to get out of hand.\" This is significant as - following the CXO and Shell's assets acquisitions - COP is one of the region's largest players. If it is forced to alter plans in response to inflation, it will likely be a major overhang on the stock, in my view. In addition, this would likely make any Permian asset sale much more difficult to complete at a favorable price, hampering the company's $4B-$5B asset sales target.\n\nAlaska Project Delay Costs to Add Up\nEarlier this year, afederal judge blockedthe planned development of COP's Willow oil project in Alaska, citing issues with its environmental analysis. The 100k bbl/d field should be developed nonetheless, given its importance to the region and widespread support, but start-up is likely to be pushed back by at least a few years, and could increase the project's already sizable $6B budget.\nBased on my analysis of the Willow oil project below, a 3-year delay, even w/o any additional spending requirements, would have a ~$2.50/share impact on COP's overall valuation. An additional $1B of capital spending would further reduce the field's net value to COP by ~$0.25/share.\nWillow Oil Development Valuation Net to COP (original plan):\nSource: ConocoPhillips, Alaska Department of Revenue, Author Estimates\nWillow Oil Development Valuation Net to COP (with a 3-year delay):\nSource: ConocoPhillips, Alaska Department of Revenue, Author Estimates\nIs the Divvy Enough to Please Investors?\nFollowing the Shell assets deal closing, COP's total output is projected to reach 1.7M boe/d, making it the world's largest independent E&P. As the company grows in size, its stock should increasingly be compared to that of the majors (CVX,TTE,RDS.A,RDS.B,BP). However, COP's dividend yield of 2.5% cannot compare to Chevron's 4.7% or Total's 4.6%. Therefore, COP runs the risk of scaring away investors looking for production growth customary for an E&P, but falls short of attracting those interested in the majors for their substantial dividend yields. This could, in my view, create some overhang on the stock.\nData byYCharts\nConclusion & Recommendation\nI believe that COP is facing significant challenges down the road as it looks to maintain production growth and a steady dividend payout in face of uncertain commodity prices, inflationary pressures and a rising tide of environmentally-friendly regulations. The company's 'all-in' bet on oil prices just as it is about to sign a check for 93% of its cash balance is a risky proposition for investors, and ongoing uncertainty about the development of one of its major projects in Alaska also likely to weigh on the stock. If one wants to bet on oil prices, there are plenty of WTI & Brent benchmarked ETFs available. Plus, safer alternatives among the energy majors that offer nearly double the dividend yield and clean energy options to support cash flow growth during/after the transition. In short, it might be a good investment for the short-term, but the long-term conclusion is to stay away from COP.","kind":null,"is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"0","news_tag":"","news_rank":0,"symbols":[],"gpt_button":1},"commentList":[{"id":600533953,"gmtCreate":1638170092656,"gmtModify":1638170150128,"author":{"id":"3585604372962377","authorId":"3585604372962377","name":"patrickLai","avatar":"https://static.tigerbbs.com/baedd77ad7c3a28da1ae2ecc8b2e88aa","vip":1,"crmLevel":2,"crmLevelSwitch":0,"idStr":"3585604372962377","authorIdStr":"3585604372962377"},"htmlText":"Good news","listText":"Good news","text":"Good news","images":[],"top":1,"highlighted":1,"essential":1,"paper":1,"likeSize":2,"commentSize":0,"repostSize":0,"link":"https://laohu8.com/post/600533953","repostId":1173164765,"repostType":4,"isVote":1,"likeStatus":false,"favoriteStatus":false,"reportStatus":false,"tweetType":1,"langContent":"CN"},{"id":600539467,"gmtCreate":1638170065165,"gmtModify":1638170066365,"author":{"id":"3581244873474125","authorId":"3581244873474125","name":"US_watchlist","avatar":"https://static.tigerbbs.com/c45e6bbe1cefb0fecde067a20b3c788f","vip":1,"crmLevel":2,"crmLevelSwitch":0,"idStr":"3581244873474125","authorIdStr":"3581244873474125"},"htmlText":"Please like and comment. Thanks","listText":"Please like and comment. Thanks","text":"Please like and comment. Thanks","images":[],"top":1,"highlighted":1,"essential":1,"paper":1,"likeSize":1,"commentSize":0,"repostSize":0,"link":"https://laohu8.com/post/600539467","repostId":1173164765,"repostType":4,"isVote":1,"likeStatus":false,"favoriteStatus":false,"reportStatus":false,"tweetType":1,"langContent":"CN"}],"isCommentEnd":false,"newsSizeData":{"likeSize":15,"commentSize":2,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":false,"deviceId":"web-server-community-laohu8-v3","version":"4.29.1","shortVersion":"4.29.1","platform":"web","vendor":"web","appName":"laohu8","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/1173164765"}