It just so happens that I turned on the TV and I listened in on the CNBC show on Wednesday, November 8, just as the CEO of ConocoPhillips (COP), Ryan Lance, was being interviewed. The TV anchor asked him what the breakeven oil price is for Conoco. CEO responded, somewhat misleadingly, that his company can meet its obligations with oil averaging $40/barrel or lower. In other words, he did not directly address upstream break-even costs. That is not the same as being able to profitably produce oil at $40/barrel or lower. I know from experience, having covered many oil & gas producers in the past few years, that most companies have been having a hard time turning an operating profit from their upstream activities. It has been the downstream sector that has been keeping many companies, including the ones I am invested in, such as Suncor (SU), Shell (RDS.A), or Chevron (CVX) afloat during these hard times the oil & gas industry has faced for the past two years or so. I was therefore intrigued when Conoco’s CEO claimed on television that his company can make ends meet with oil under $40/barrel. I think it is worth taking a closer look at its operations in order to figure out just what he meant with his claim.
One of the first places we should look at in regards to Conoco’s profitability is the quarterly results it has been recording in relation to oil prices.
As we can see, Conoco’s quarterly operating results are hardly indicative of a company that is able to break even within the current oil price environment. Despite the fact that since the second quarter of 2016 oil prices have been firmly above $40/barrel, it in fact reported more losses than profits. We should also keep in mind that this is on its upstream and downstream activities combined. There is evidently a lot of volatility in terms of profits and losses from quarter to quarter due to one-time factors, the multi-quarter average, which is an average loss of over $900 million/quarter since Q2, 2016.
While Shell reports its operating results based on sectors of the industry, where it shows that for the first time in a long time, it managed to show an operating profit on its upstream operations as I pointed out in a recent article, as its upstream sector recorded a slight net profit, Conoco unfortunately does not provide us with such data, focusing instead on regional results. The general trend however when looking at most oil majors is that of a general lack of profitability in the upstream sector since 2015, with current oil price levels seemingly being the threshold for most of them to break even. The quarterly results that Conoco has been posting through this current oil price environment seem to suggest that it may in fact have an overall inferior profitability profile compared with the likes of Shell or Suncor. Therefore, it is very unlikely in my view that its upstream operations may have a breakeven in the $40/barrel oil price range. That would in effect mean that its downstream operations are very unprofitable, which I doubt it is in fact the case.
Conoco’s regional results do in fact shed light on certain aspects in relation to some of the comments made by its CEO. For instance, he claimed that the shale industry is overall well adapted to the current oil price environment and will be ready to increase production massively as the price of oil goes above $60/barrel. While he may be partially right in regards to higher prices once more triggering a shale drilling boom, which will temporarily lift production in the US, that might in fact put the brakes on the current oil price recovery next year, I do not share his optimism in regards to overall profitability. It should be noted that according to its own results, since the first quarter of 2016 till the latest quarter, it never managed to report an operating profit for the US lower 48 states. While I cannot say with definite certainty that it is due to its shale operations, I do think there is a definite correlation. It is something that we can also commonly see with other companies that report their results based on regional performance, such as Chevron. It reported a loss of $26 million on its US upstream activities, with its overall global upstream segment showing a profit due to its international operations. In the case of Chevron, we get not only US specific data but also a breakdown in terms upstream-downstream, giving us a better sense of just what is the average profitability of Chevron’s diverse upstream projects in the US.
I wanted to highlight the difference between Conoco’s CEO comments on CNBC and some of the realities on the ground when put to a bit of extra scrutiny, not only because it helps clarify Conoco’s situation in regards to its profitability prospects but also because some of his comments were in regards to the overall global oil industry and the global oil market. In this regard, he seems to be overly optimistic on shale profitability, while I have to admit, there is a real chance that oil prices going over $60/barrel do have the potential to unleash a new wave of shale drilling, even though recent evidence may suggest that investors may no longer be as eager to reward companies for production gains. After a whole decade of more money going into shale than coming out, it seems that the market is increasingly looking for profits and many companies may focus their efforts on delivering on that, rather than continuing to chase production growth in response to higher oil & gas prices.
Delivering on profits within shale plays may be getting harder if we look at data reference points such as the EIA’s drilling productivity report, which shows that in the past half a year or so, most of the main shale oil fields have seen a stagnation or even decline in productivity per rig. This while oil services costs have been firming, meaning that there is no longer any valid argument to be made for continued gains in shale profitability. In fact, we probably saw the reverse happen this year, with production costs rising. The expectation that the current oil price increase is likely to trigger another shale boom may therefore be somewhat misguided.
The fact that Mr. Lance believes that the increase in oil prices we are seeing currently should be reason to start drilling more intensely tells us a lot about Conoco’s future within this context. While I have no doubt that many companies will decide to be more restrained in reacting to the current oil price increase by dramatically increasing drilling, I also have no doubt that many companies will do that, which could in fact impact oil prices in the shorter term by at the very least creating a drag on the current advance in prices. If we are to take Mr. Lance to his word, then it seems that Conoco may be one of the companies that will be more aggressive in the pursuit of production growth. Given its operating results as well as the general market mood, it may not necessarily play out in Conoco’s favor, especially if Mr. Lance is right and oil prices are set to stay lower and be more volatile going forward.
Disclosure: I am/we are long SU, RDS.A, CVX.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.