While the crude market is continuously down trending it is becoming increasingly difficult for oil companies to hold their head high. In our earlier article about ConocoPhillips (COP, Financial) we had stacked our hopes high on the company and had recommended adding positions at current levels which looks attractive even when the company is trending downwards for the simple reason that the southward movement is not due to intrinsic factors but is influenced and induced by heavy corrections in the crude prices.
Since then oil prices suffered a major correction, with WTI falling from the mid-$80s per BBL to the current $76 per BBL price level. However, in the face of heavy pressure due to falling crude prices globally, ConocoPhillips has held steady, in contrast to some of the other smaller E&P names.
Third-quarter 2014 results
ConocoPhillips reported its Q3 2014 results in the later half of October. Going by the reports EPS stood at $2.17, up by 9% from $2.00 last year. However adjusted EPS saw a dip, which excludes one-time items and discontinued operation, came in $1.29, down by 13% from $1.47 posted last year. But ConocoPhillips reported robust production growth, especially in the North American region, with total production averaging at 1.473 million BOE/Day excluding Libya operations. The company as expected remains firm in its operations to post 4% YoY adjusted production growth.
The main reason for the dip in EPS was due to weak price realization in the face of falling prices, down 7% to $64.78 per BOE, against $69.68 per BOE last year. As a result, cash margins took a hit and stood at $29.58 per BOE, compared to $29.83 per BOE of last year.
Position rethinking
ConocoPhillips also issued a future guidance to its 2014 outlook. The company expects to meet and exceed both its production and margin growth target of 3% to 5% in 2014. However, post the issuance of the management guidance, international oil prices have further nose-dived, making the lives of oil companies difficult globally; as a result, margins will have to take a hit due to the correction.
Through the whole of 2014, the production numbers from ongoing operations, excluding Libya, are expected to be approximately 1.525 to 1.535 million BOE/Day. For Q4, ConocoPhillips expected production to range from 1.546 to 1.575 million BOE/Day, which means lower gas volumes output from the APLNG, infrastructure roadblocks in the Malaysian region, and ethane rejections in the Lower 48 regions.
Impact of falling international oil prices on ConocoPhillips
Going by ConocoPhillips management’s net income sensitivity data, a $1/BBL fall in WTI prices would adversely impact net income by $35 million to $40 million, while a $1/BBL fall in Brent would plummet net income by $80 million to $85 million, while a $1/BBL fall in WCS would negatively impact net income by $30 million to $40 million.
ConocoPhillips' price estimates are based on $100 Brent, $90 WTI and $70 WCS, all per BBL.
The worst part is the prices have traveled farther downward against the company's estimates as follows, making things on the income side look worse.
- Brent is trading at $80 per BBL, $20 below ConocoPhillips's estimates
- WTI is trading at $76 per BBL, $14 below ConocoPhillips estimates
- WCS is trading at $60 per BBL, $10 below ConocoPhillips estimates
From the above data, if oil prices continue at their current levels without any further down trend, ConocoPhillips’ net income will also have to see a downside by almost $2.5 billion. But this holds true only if the global crude prices do not dip further for the complete year which seems highly unlikely owing to the weakness in the energy market. In 2013 ConocoPhillips had reported net income of $8 billion.
This means the downside in ConocoPhillips would stand at 32% from that of 2013. This looks rather bright for an oil company in the current state of matter and in comparison to other oil companies. The reason why ConocoPhillips would be successful at arresting the fall at 32% is due to its strong fundamentals and low cost of supply, resulting in relatively higher margins than its peers.
On the flip side, it is also possible that the oil prices start upscaling from here because if it stays at such low levels or dips further, the smaller E&P companies might find it difficult to survive, causing supply volumes to fall substantially, thus leveraging the position of ConocoPhillips.
Last word
For a matter of fact, even though the current price levels make oil and gas look rather shady, they are natural resources that have a time limit of existence and are well in demand even as prices are falling. These natural resources cannot be manufactured synthetically and are not about to see any potential replacement in the near future; hence after a point it has to rise owing to its limited volume and rising demands. As the living standards of more and more people rise, so will the needs for oil and natural gas.
A lot of people are of the opinion that, due to the heavy down trend in the oil sector, it would be a waste of money to invest in an oil company like ConocoPhillips, but the truth is that they are missing out on the fine points and the underlying truth of this sector. ConocoPhillips has been a strong company offering moderate but value growth to your investment over a longer period of time than the other sectors where the price movements are relatively faster, but this company adds depth to your portfolio and can play a pivotal role when the crude prices take an upswing which is inevitable over time. The 4% yield is just the icing on the cake. Hence we strongly recommend a hold and buy with the current dip in ConocoPhillips for a long-term benefit.
