ConocoPhillips: Why the Dividend Will Be Back

At the beginning of February, ConocoPhillips (COP) investors had to take a massive dividend cut of almost 66% due to a period of sustained weakness in the oil patch. The cut might not have looked surprising at first as Conoco had burnt almost half of its operating cash flow since the summer of 2014 when the downturn began. Over the same time span, the company’s leverage had also increased by a sizable margin, indicating that it was being forced to service a high level of debt that created a negative impact on the cash flow profile.

Considering that Conoco has 1.23 billion shares outstanding and had an annual dividend rate of $2.96 per share before the cut, its annual dividend outlay was coming to $3.64 billion.
In a tepid oil pricing environment that has decimated Conoco’s cash position, this dividend seemed like a luxury so Conoco pulled the trigger and slashed it. But, this was more of a precautionary measure as Conoco was well-placed to keep the dividend intact due to its cost-reduction moves, as discussed below.

Why Conoco could have kept the dividend intact

As mentioned above, Conoco’s dividend outlay would have come in at $3.6 billion this year if it hadn’t slashed the yield. Now, Conoco’s cash flow is declining, but the company is quite capable of making up for the decline in the cash flow from other areas. For instance, this year, Conoco will reduce its capital spending by almost $2.5 billion as compared to 2015. In comparison, in 2014, Conoco’s capital expenses were $9 billion higher than the 2016 forecast.

What’s surprising is that despite cutting its capital expenses by almost 25% this year, the company will be able to maintain its production profile and grow output in the range of 1%-3%. Concurrently, Conoco is confident of reducing its operating costs by $500 million as compared to last year on the back of an improvement in drilling and completion efficiencies.

For instance, Conoco has been able to bring down its drilling and completion costs by 20%-30% in areas such as the Eagle Ford, the Permian, and the Bakken by optimizing well spacings. Additionally, the deployment of better completion techniques such as cemented liner and plug-n-perf as compared to open hole slide and sleeve completions is allowing it to keep costs under control.

A combination of lower capital expenses and cost savings worth $3 billion would have allowed Conoco to maintain its dividend. Now, the clinching move that would have helped Conoco keep its yield intact was its focus on non-core asset sales. In the first nine months of 2015, Conoco sold assets worth $600 million. Now, it has definitive agreements worth $1.7 billion in place to dispose more assets that are expected to be closed by the end of the ongoing quarter. Around 80% of these assets produce natural gas, so Conoco’s oil production profile will remain intact despite the asset sale.

All in all, Conoco’s total cost savings this year would have come in at over $5 billion, including potential asset sales and savings from lower capital expenses. This would have been enough to keep the dividend intact. Moreover, the recent improvement in oil prices is another reason why Conoco could have kept the dividend intact.

Oil prices are getting better

Oil prices have improved of late. Brent crude has reclaimed $40 levels after dropping to less than $28 a barrel in January. This improvement in oil prices has been driven by positive developments in the oil market as producers, both OPEC and non-OPEC, looking to take proactive steps to support pricing.

As reported by Bloomberg:

“Saudi Arabia and Russia, the world’s biggest crude oil producers, joined Venezuela and Qatar in an agreement to freeze output in an effort to revive prices from a 12-year low.”

Thus, OPEC is now seriously considering lending support to crude oil prices, and this has played a key role in oil’s rally of late. Additionally, non-OPEC production is expected to go down by 0.7 million barrels per day this year after increasing 1.3 million barrels per day last year. In my opinion, a contraction in oil supply is quite likely as investments in oil and gas infrastructure are slated to go down by $320 billion this year after a $250 billion decline last year.

Thus, there are certain positives emerging in the oil and gas space and this is good news for oil companies such as Conoco as better oil pricing will bring some relief to the balance sheet and cash flow.


Considering the improvement in oil prices and also the fact that ConocoPhillips has done enough to reduce costs and maintain production this year, I won’t be surprised if it is able to reinstate the dividend going forward. So, investors should not lose hope as things will get better for ConocoPhillips in the long run.
Published on Mar 15, 2016
By Yaggyaseni Mittra

Copyrighted 2016. Content published with author's permission.

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