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ConocoPhillips has reinvented itself again, exiting deep-water exploration and betting on flexible US production

Four years ago, when ConocoPhillips spun off its downstream businesses, the logic was shareholder value. The transaction created Phillips 66, the new owner of the group’s refineries, pipelines and chemicals businesses – and the US’s largest refining company, with 14 refineries and throughput capacity of 2.2m barrels a day. And it left behind the world’s largest independent exploration and production firm by reserves and production. Chairman and chief executive Ryan Lance said the new-look E&P company’s “unmatched size, scope and capability” provided a platform for profitable growth, strong financial returns and a sector-leading dividend.

Lance hadn’t anticipated the depth and length of the oil-price collapse that would start a couple of years later: since mid-2014, ConocoPhillips has experienced the downside of not having a downstream business, feeling the full force of falling commodity prices. Last year, it made a net loss of $4.4bn, compared with earnings of $6.9bn in 2014. Its shares have fallen further and harder than those of the majors – by more than 50% since mid-2014. Over a similar period, Chevron’s shares have declined by about 30% and ExxonMobil’s by roughly 20%. Then, in February, ConocoPhillips cut its quarterly dividend by two-thirds – from $0.74 to $0.25 a share, blaming weak commodity prices and tightening credit markets. Hardly sector-leading.

None of that was in the plan. But ConocoPhillips has at least been decisive and resourceful in adjusting its vision to cope with the unexpected. Like many other oil companies, it has reduced capital and operating spending, as well as the size of its workforce – by almost a fifth in 2015. And it has assiduously sold off assets to generate cash.

The capital spending budget for 2016 is $6.4bn – down by 25% from the 2015 level and 63% lower than in 2014, largely because of reduced spending at its onshore US properties. Group operating costs are being trimmed by $0.7bn to $7bn. Last year, it raised $2bn from asset sales and, so far in 2016, has chalked up $300m of its full-year divestment target of $1bn. Meanwhile, the ignominious dividend cut at least demonstrated prudent reluctance to risk long-term financial stability on an improbable rally in commodity prices.

Fully in flux

Even more significant, ConocoPhillips has continued to shift strategy. Its biggest recent call is the decision to quit, post-2016, the costly business of deep-water exploration. That frees up extensive acreage for sale in the deep-water Gulf of Mexico. And, more importantly, it liberates an estimated $0.8bn in capital, much of which will be directed to “flexible” conventional and low-cost unconventional assets – where spending and rig use can be quickly reduced or increased in response to commodity-price fluctuations.

That means a greater focus on US shale, already a core part of a portfolio that includes coveted assets in the Permian, Eagle Ford and Bakken plays. In 2015, US onshore operations accounted for a third of the company’s worldwide liquids production and 36% of its gas output. But US shale will only grow in importance: about 30% of planned spending will be directed towards so-called flexible projects; and, geographically, ConocoPhillips is putting a strong emphasis on North America, which will absorb about two-thirds of available capital. Quality is an emphasis too: among large independents and integrated oil companies, ConocoPhillips already claims the lowest wellhead break-even point in unconventional drilling. And, in 2015, it reduced drilling days per unconventional well in the Eagle Ford and Bakken basins by about 25% compared with the 2014 level, says Matt Fox, head of E&P.

Even before those strategic changes begin to have the desired effect, however, the firm has plenty to keep the glass-half-full brigade happy. The diverse nature of ConocoPhillips’s portfolio, for instance, means it has been able to preserve production, in spite of deep cuts in spending. Excluding Libya, output from continuing operations amounted to 1.589bn barrels of oil equivalent a day in 2015 – a 57m boe/d increase from 1.532bn boe/d in 2014. This year, it hopes to cut operating costs by $1bn compared with 2014, while keeping production at about the same level as in 2015.

Investments in mega-projects – in liquefied natural gas and in Canada’s oil sands – should embellish the production numbers. In January, first LNG was exported from the Australia Pacific LNG (APLNG) project (ConocoPhillips 37.5%), in eastern Australia. Train two should enter service in the second half of the year, helping the two-train, coal-seam gas facility build up towards nameplate capacity of 9m tonnes a year of LNG. Encouragingly – notwithstanding low commodity prices and a recent write-down of part of the company’s APLNG investment – almost all of the plant’s capacity is already allocated to Chinese and Japanese buyers under long-term supply deals.

In the fourth quarter of 2015, meanwhile, the company started producing from Surmont-2, a 50:50 joint venture with Total in Canada’s oil sands. Progress towards gross capacity of 150,000 boe/d will also make a sizeable contribution to production this year. Ramp-ups at Foster Creek and Christina Lake projects – both part of a heavy-oil venture owned jointly with Canada’s Cenovus Energy – will add further to production.

Alaska is another important element of the portfolio – a region where ConocoPhillips says it has converted a declining production base into one promising stable production for a decade. Capital spending there will be down slightly compared with 2015, but that will not stop volume growth – thanks to the recent start-ups of the Alpine field’s 16,000 b/d CD5 project, and the 8,000 b/d Drill Site 2S project, as well as to development drilling at Prudhoe and Kuparuk. It is also still part of the Alaska LNG (AKLNG), a proposed LNG- export terminal in Nikiski on the Kenai Peninsula, which would receive gas from the North Slope through an 800-mile pipeline crossing Alaska.

The company is also continuing to invest in European assets, despite declines in capital spending and production. Production recently started at Eldfisk II (ConocoPhillips 35.11% and operator), which, along with Ekofisk South and other projects offshore Norway, will add 60,000 boe/d to the company’s production by 2017. New subsea tiebacks have boosted production in the UK North Sea and more start-ups are expected soon, including – this year – the gas and condensate Alder field (ConocoPhillips 26.3%); and, in 2018, the 120,000 b/d Clair Ridge field (ConocoPhillips 24%).

In Asia-Pacific, APLNG should boost production volumes by around 10% this year, despite significant capital-spending cuts in the region. Development drilling in “high-return” projects in Malaysia and China should keep the Asia-Pacific and Middle East segment growing for several years, the company says.

Those assets represent what is arguably in short supply across the portfolio: exposure to high-risk, high-return assets in non-OECD countries – and overreliance on stable, but less dynamic assets in OECD countries. Yet in the context of plummeting oil prices that stability has its own virtue. And there is there is plenty more to like about ConocoPhillips, including competitive positioning in US liquids production, an efficient divestment programme and critical mass. With reserves of 8.2bn boe at the end of 2015, it is substantially larger than its rivals among independents. Then there is the company’s record of adaptability: when times have got tough, it hasn’t ducked the hard choices. Eventually, that boldness should restore the creation of shareholder value.

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