2023-12-16 00:34:55 ET
Summary
- The article discusses the current state of the oil market, highlighting the abundance of oil and gas supply and the resulting decline in prices.
- It mentions ConocoPhillips' exposure to low domestic gas prices and its strategy shift towards expanding LNG capacity to expand margins.
- The article also discusses ConocoPhillips' dividends and valuation, noting its recent increase in the organic dividend and the potential impact of lower oil & gas prices in the future.
Last year at this time, I warned oil perma-bulls that the tremendous returns generated by the leading oil companies was primarily the result of Russia's war-of-choice on Ukraine and the subsequent breaking of the global energy supply-chain. And that the invasion led to a spike in both oil & gas prices that was not sustainable given global supply/demand fundamentals. Indeed, this year has been a vastly different scenario, and we now find ourselves in an oil "contango" - where near-term prices are considerably lower than futures contracts. Contango encourages producers and traders to store oil today in order to sell it at a higher price down the road (see the article in yesterday's issue of Barron's: Oil Prices Just Flipped Into Contango ). Today, I'll discuss what all this means going forward for upstream producer ConocoPhillips (COP).
The Age Of Energy Abundance
Last December I warned energy investors that, despite the false narrative being propagated by many of the right-leaning politicians and oil perma-bulls that somehow President Biden would "kill U.S. oil & gas production", and that there was somehow a global shortage of oil, and that the price of oil would sky to as high as $150/bbl, that the exact opposite was the case: we now live in what I call an "Age of Energy Abundance" . The simple facts are that due to the technological disruption of shale (i.e. fracking combined with horizontal drilling) the United States is currently:
- The #1 petroleum producer on the planet.
- The #1 oil producer on the planet.
- The #1 LNG exporter on the planet (this happened last year, under Biden).
- We are literally swimming a massive supply of NGLs (i.e. propane/butane).
- A growing oil exporter.
Indeed, U.S. oil production is at an all-time high:
Combine U.S. oil production growth with abundant tar sands resources in Canada, growing production from Brazil, Exxon's ( XOM ) and Hess' ( HES ) - soon to be Chevron's ( CVX ) - discoveries and production ramp-up in Guyana, Johan Sverdrup's ramp-up off the coast of Norway, and as much as 5 million bpd of production being withheld from the global market by OPEC+, and, well, the world has got all the O&G it could possibly want. Indeed, many say if we burn even a fraction of all the proven reserves (let alone potential and possible reserves) we will quite likely burn-up the planet. But that is a topic for another day.
Meantime, on the supply-side, the IEA thinks oil demand growth will slow next year. The Paris-based organization said:
The increasingly apparent loss of oil-demand growth momentum reflects the deterioration in the macroeconomic climate -- in the wake of higher interest rates as well as the fading rebound from Covid-induced lows.
Prices
In the short-term, the O&G price action is what drives returns for energy investors:
As you can see from the chart above, the price of WTI is down more than 30% from its high after Putin's invasion of Ukraine. The chart below shows even a more drastic decline in the price of natural gas as Uber-cheap U.S. natural gas supply was ramped-up and turned into LNG to supply Europe that effectively broke Russia's gas supply stranglehold over the EU:
Of course, for ConocoPhillips, being one of the largest Permian leaseholders and producers, the price of WTI and NYMEX gas directly impact revenue, cash-flow, profits, and ultimately cash distributions to shareholders.
Despite a recent jump in the price of WTI after a multi-week downtrend, I advise investors not to chase it. It's a head-fake. I say that because much of the increase in WTI over the past few days has been, in my opinion, due to the significant decline in the U.S. dollar since Federal Reserve Chairman Powell's most recent "pivot" speech. As you know, global oil trade is still predominately settled in U.S. dollars (and, despite countries like Russia, Saudi Arabia, and China wanting to change that, rising U.S. oil exports are helping to support the status quo), so a falling U.S. dollar generally means a rising oil price, which is exactly what we have seen:
Going Forward
COP has addressed its exposure to very-low domestic gas prices by strategically pivoting cap-ex from expanding its Permian production capacity (via M&A) to expanding its LNG capacity (see COP Shifts Focus To LNG ).
COP is also maintaining capital discipline. Cap-ex for 2023 will likely come in at a range of ~$11 billion, resulting in an Q4 production increase of only ~4% yoy (but with L-48 production rising 7%). However, that includes COP's acquisition of the 50% of the Surmont oil sands JV from Total in October - adding to COP's long-cycle assets versus short-cycle shale.
In the Permian, COP is obviously a major player after its acquisition of Concho Resources and Shell's assets. That said, it has three major competitors in the play: obviously, both Exxon and Chevron have large-scale leaseholds and both are guiding to production growth of 1 million bpd (or more). Occidental ( OXY ), with its recent announcement to buy CrownRock , is also a major player and also has the potential to increase its Permian production to 1 million bpd. Meantime, M&A in the Permian Basin has been so pervasive and extensive that RBN Energy recently reported that there are arguably only two large private companies left in the play: Mewbourne Oil and Endeavor Energy Resources (see Chasing the Crown: Our Take On OXY's $12 Billion Acquisition of CrownRock ).
That being the case, COP's decision to diversify and expand into global LNG and funding projects like Alaska's Willow make abundant sense in my opinion.
Dividends & Valuation
In Q3, COP generated $2.9 billion of free-cash-flow, but earnings were down across all operating segments:
As you can see in the graphic from the Q3 presentation , on a yoy basis, the average realized price/boe dropped ~25%: from $83 to $60. This is exactly why I warned investors about the fact that, in contrast to the false narratives being spun by many politicians and oil executives talking their book, there was substantial global O&G productive capacity to meet demand.
I was glad to see that COP significantly cut-back on its over-emphasis on stock buybacks over dividends directly into the pockets of shareholders. For Q3, the company allocated $1.3 billion to both "buckets" (i.e. 50/50).
On the Q3 conference call , COP announced:
"And today, as Ryan said, we announced an increase to our organic dividend of 14% to $0.58 per share ... Before shifting to guidance, I do want to take a quick moment to update about our VROC. Beginning in 2024, we will be aligning both the announcement timing and subsequent payment of our VROC with our ordinary dividend. Therefore, you can expect us to provide details on our first quarter VROC payment on the fourth quarter call in February.
So, now the "regular" annual dividend is $2.32/share, corresponding to the dividend most financial websites report (including Seeking Alpha), along with the misleading yield based solely on that regular payment (2.0%). Of course the actual yield should also take into account the variable dividend declarations, which are shown below:
As you can see in the graphic, the last four variable dividends (three $0.60/share payments, and a $0.70 payment), in aggregate, equate to an additional $2.50/share. Combined, with the previous regular dividend of $0.51/share, give a TTM yield of 3.95%. That said, investors should expect lower variable dividends in 2024 given the broad pull-back in O&G prices.
COP currently trades with a TTM P/E=12.5x and a forward P/E=12.9x . Both of which appear to be rational and, combined with the dividend (actual and potential variable) - and in my opinion - do not suggest either a buy or a sell.
Risks
Downside risks include more global over-supply and project execution risks on Willow in Alaska, which is a relatively ambitious project in a harsh environment.
Upside risks include geopolitical instability in the Middle East and, in general, and most unfortunately, just more wars.
Summary & Conclusion
This year in the oil patch can be characterized by one in which the false narrative spun by right-leaning politicians simply did not materialize. In fact, it was the exact opposite: there is an abundant supply of oil and gas and prices fell quite dramatically. Today, I have a HOLD on COP as the current stock price is rational given the supply/demand fundamentals and with a slight geopolitical premium already built in.
I'll end with a 5-year chart of the total returns of the U.S. "big-3" O&G companies as compared to the total returns of the broad market averages as represented by the ( VOO ), ( QQQ ), and ( DIA ) ETFs:
As you can see, and other than the Nasdaq-100, ConocoPhillips significantly beat both Exxon and Chevron (see ConocoPhillips: Beating Its Big Brothers Exxon & Chevron ) as well as both the S&P500 and DJIA. That said, I do not expect COP to outperform the S&P500 over the coming 5-years. That's because we live in an "Age of Energy Abundance" with strong O&G productive capacity as we head into the "New Era of Electrification & EVs". In fact, without Putin's war on Ukraine, the chart above would quite likely have looked a lot like the previous 10-years, or what I refer to as "the lost decade", when Exxon actually delivered a negative total return by pushing way too hard on the growth string into an already over-supplied market (see How Tiny Engine #1 Was Able To Turn Exxon Around ), i.e. the very misguided "drill baby drill" mantra.
For further details see:
ConocoPhillips In 'The Age Of Energy Abundance'