ConocoPhillips' 10-Year Plan Ensures Growth and Shareholder Returns 

Strategist

Allen Good

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Differentiating itself from peers big and small, ConocoPhillips has laid out a 10-year plan for restrained investment, steady growth, improving returns, and, importantly, returning cash to shareholders. Its strategy makes Conoco a compelling option in the energy sector, given its commitment to capital restraint and clear policy on return of cash to shareholders. Its low-cost portfolio gives it high return investment options to grow in a rising price environment while its strong financial position keeps the dividend safe in a downcycle.

Central to its plan is a commitment to maintain capital spending at $11 billion on average annually while returning 30% of operating cash flow to shareholders per year through a three-tier capital return program consisting of buybacks, an ordinary annual dividend, and a variable component. Through high-grading and cost improvements, the company has reduced the oil price necessary to earn a 10% return on produced resource in its plan to under $40/barrel.

Its growth plan rests largely on its unconventional assets, specifically its Permian position, which became the company’s largest position with the acquisition of Concho Resources and later grew with the purchase of Shell’s Permian shale assets. It has since steadily improved its operational performance. Permian resources constitute the bulk of the planned produced resources in the 10-year plan, with production plateauing at around 1.2 mmboe/d by the end of the decade. 

While the company holds acreage in the Bakken and Eagle Ford, production will only be held flat during the next decade. Outside of the U.S. unconventional portfolio, volumes will steadily grow during the next decade with Alaska and Canada offsetting declines internationally. Growth in Canada will come from the Montney, where Conoco plans to leverage its unconventional experience. New volumes in Alaska will come from leveraging existing infrastructure to grow around legacy assets and later the recently approved Willow project. LNG volume growth will come from participation in two Qatar expansion projects while also sourcing volumes from Port Arthur LNG in the U.S.

Business Strategy & Outlook

We think ConocoPhillips has sufficiently improved its portfolio through cost reductions and divestitures, which combined with the addition of low-cost unconventional production growth warrants a narrow moat rating, as we now expect the company to deliver excess returns on capital at our midcycle oil price assumption of $60/barrel.

In the last few years, ConocoPhillips has reshaped its portfolio by selling higher-cost, lower-return assets including natural gas production in the U.S. and Canada and bitumen production in Canada. Meanwhile, it acquired high-quality Permian acreage with the purchase of Concho Resources and additional acreage in the Delaware basin in the Shell asset acquisition. In total, production has remained flat since 2014, but divested volumes were largely natural gas, leaving higher-margin crude oil production at 53% of the portfolio compared with 39% previously.

Meanwhile, the company has reduced its per-barrel operating costs nearly 30% from 2013 levels. Reductions were most pronounced in its conventional assets in Europe and Asia-Pacific/Middle East regions, where costs are down over 40%. These reductions are a critical driver of the improved portfolio as conventional production constitutes around 600 thousand barrels of oil equivalent per day, or about 40% of current production. Operating costs typically track movements in commodity prices, so based on our expectations for lower oil prices over the cycle as well as the introduction of new technological innovations, we’d expect ConocoPhillips to hold on to the cost improvements during the next five years. 

ConocoPhillips’ unconventional portfolio includes positions in the Eagle Ford, Permian, and Bakken that produced about 1.0 mmboe/d in 2022, or about one third of total production, an holds about 12,000 remaining well locations. Production will continue to increase as investment is primarily directed to Lower 48 development including assets acquired from Concho and Shell in recent years. 

In the Permian, it holds 659,000 net acres in the Delaware Basin and another 251,000 in the Midland Basin. The Permian will drive the company's volume growth with production rising to a plateau level of 1.2 mmboe/d by the end of the decade from a little over 700 mboe/d in 2022

Its Eagle Ford position, acquired at a low cost well before the shale boom, totals 199,000, essentially all in the higher-return oil or liquids window. In the Bakken, ConocoPhillips holds 560,000 acres. Volumes are unlikely to grow too much beyond current levels of about 315 mboe/d, but improvements in drilling times and other advancements means those levels can be preserved with half the number of rigs needed in 2016. Although the Permian tends to garner most of the headlines, ConocoPhillips’ Eagle Ford-dominated portfolio holds break-evens for new shale wells at $40/barrel and below. 

Rounding out ConocoPhillips’ portfolio are the liquefied natural gas assets, which produce about 220 mboe/d from projects in Qatar and Australia. While its Qatar assets rank as some of the best in the world, its Australia assets are more of a mixed bag. Like other LNG projects in Australia that were developed over the past decade, ConocoPhillips’ APLNG facility struggled with cost inflation that ultimately resulted in impairment charges when oil prices fell. However, with startup in 2016, the large capital requirements are behind it while the project benefits from relatively lower operating costs and proximity to Asian demand markets as well as a large resource base capable of producing at plateau levels for decades. It acquired another 10% of APLNG in early 2022 and is set to acquire another 2.49% interest.

LNG low-cost volume growth will come from awarded interests in Qatar's North Field East and North Field South expansion projects which once complete near the end of the decade should bring Conoco's LNG production close to 300 mboed. 

In culmination, we expect ConocoPhillips to deliver midcycle returns on invested capital of 10.4%, above its 8.4% estimated cost of capital and in line with other narrow-moat E&Ps we cover.

We have incorporated environmental, social, and governance risk into our moat evaluation, but most fall outside the 10-year narrow moat window or risk is not material or probable enough to cause material value destruction in the next 10 years. A carbon tax is likely to be implemented and will increase the price of end products to consumers, which will likely erode demand, though the impact on hydrocarbon demand remains more than a decade away. 

ConocoPhillips’ reported greenhouse gas intensity of 27 kg CO2e/boe (2021) is relatively high for its peer group due to its oil sands operations. However, it is investing to improve its emissions intensity and reduce methane leakage and flaring. Management aims to reduce emissions intensity by 50%-60% by 2030 compared with 2016 levels (previously 40%-50%) on both gross operated and net equity basis and set a target for zero routine flaring by 2025. Additionally, ConocoPhillips set a target in 2020 to have net zero carbon emissions by 2050. However, these targets only concern Scope 1 and 2 emissions, while 90% of the full lifecycle of emissions from oil and gas occur during combustion (Scope 3), which lies outside the company’s influence. 

Unlike peers, ConocoPhillips has shown little appetite for investing in low-carbon solutions or renewable energy generation.

Narrow

Economic Moat

ConocoPhillips

ConocoPhillips engages in the exploration, production, transportation and marketing of crude oil, bitumen, natural gas, natural gas liquids, and liquefied natural gas on a worldwide basis. It operates through the following geographical segments: Alaska, Lower 48, Canada, Europe, Middle East and North Africa, Asia Pacific, and Other International. The Alaska segment primarily explores for, produces, transports, and markets crude oil, natural gas, and natural gas liquids. The Lower 48 segment consists of operations in the U.S. and the Gulf of Mexico. The Canada segment consists of oil sands development in the Athabasca Region of northeastern Alberta and a liquids-rich unconventional play in western Canada. The Europe, Middle East and North Africa segment consists of operations and exploration activities in Norway, the United Kingdom and Libya. The Asia Pacific segment has explorations and product operations in China, Indonesia, Malaysia, and Australia. The Other International segment handles exploration activities in Columbia and Argentina. The company was founded in 1875 and is headquartered in Houston, TX.

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