Conoco Phillips (COP) — Q4 2016 Earnings Call Transcript

Thank you, Christine. Hello, everyone, and welcome to our fourth quarter and full year 2016 earnings call. Our speakers for today will be Ryan Lance, our Chairman and CEO; Don Wallette, our EVP of Finance and Commercial and our Chief Financial Officer; and Al Hirshberg, our EVP of Production, Drilling, and Projects. Our cautionary statement is shown on page two of today's presentation. We will make some forward-looking statements this morning during the call that refer to estimates or plans, and our actual results could differ due to many of the factors described on the slide as well as in our periodic SEC filings. We will also refer to some non-GAAP financial measures today, and that's to facilitate comparisons across periods and with our peers. Reconciliation to non-GAAP measures that most closely correspond to the GAAP measures can be found in this morning's press release and also on our website. And then finally, during this morning's Q&A we will limit questions to one and a follow-up. And now I'll turn the call over to Ryan.

Thank you, Ellen, and let me also welcome those joining the call today. Since our analyst and investor meeting in November we've received quite a lot of positive feedback on our disciplined returns-based value proposition, but I think we also heard that we needed to show you that we can deliver on this plan; in other words, we said it, but you need to see it. So that's the punchline of today's call. Since November we've taken several actions that offer a snapshot of our value proposition in action. In addition, our fourth quarter results underscore the inflection point we're at as a company. I'll build on these themes over a couple of slides and then I'll turn the call over to Don and to Al. So we turn to slide four, this is an updated version of our value proposition on a page that we showed you in November. We showed our principles on the left and our cash flow allocation priorities and targets in the middle column. Shown on the right are proof points that these priorities are activated and delivering. Let me step through them. In the fourth quarter we generated sufficient cash from operations to cover our capital expenditures and pay our dividend for the second quarter in a row, at an average of $45 to $50 Brent prices. As you know, our first call on cash flows is to invest capital to maintain our production and pay our existing dividend, and we're reiterating our 2017 CapEx plan of $5 billion which can achieve this priority. Our second priority is to grow the dividend. Earlier this week we announced a 6% increase in our quarterly dividend rate. The dividend is an important part of our commitment to return capital to our shareholders, and we believe this increase sends a strong signal that we intend to operate a dividend that is competitive, sustainable, and affordable through the cycles. In November we set a debt target of $20 billion by the end of 2019. We're making steady progress toward that goal; we reduced debt by $1.4 billion in the fourth quarter. We're committed to maintaining a strong investment grade balance sheet through the cycles, and our plan is to reduce debt as it matures but we're willing to reduce debt more quickly if we find ourselves with additional cash due to higher prices or earlier proceeds from our disposition plans. We stated a goal to pay 20% to 30% of our cash from operations to shareholders through dividend and share buybacks. In mid-November we began repurchasing shares under the initial $3 billion repurchase authorization. However, like our debt reduction target, we would be willing to put more money to this priority if cash is available and the value is compelling. Finally, we grew production by 3% on an adjusted basis, 2016 versus 2015, and we did this while spending only $4.9 billion in capital. We're on track to grow up to 2% on that same basis in 2017 when excluding the full year impact of our 2016 disposition plans. We're putting more money to shorter-cycle low-cost supply investments in the Lower 48. Growth will be balanced against our other priorities, and that's key to our disciplined approach. Our ongoing commitment to these priorities is that we can enable us to deliver more predictable and sustainable returns to shareholders no matter what the prices do. We believe these priorities are unique, and they are working; that's why it's a compelling time to invest in ConocoPhillips. Another reason is we're at a significant inflection point as an E&P company, and I'll describe that in more detail on the next slide. This slide describes that inflection point in three ways: transformation, acceleration, and differentiation. On the left, we've significantly transformed our company. The fourth quarter performance highlights the many changes we made to our business during the past two years which led us to cash flow neutrality in a $45 to $50 Brent environment. As we go forward you'll see sustainable improvements in both our cash flow and income drivers which will also drive improvements in free cash flow generation and in returns. Our margin should improve as we allocate more CapEx to high cycle, short cycle investments – high return, short cycle investments. We've guided to lower adjusted operating costs, exploration costs, and DD&A versus 2016, and we think these improvements are sustainable, and we're reducing our share count. These factors should provide strong momentum in 2017 and beyond. We're also accelerating our value proposition. Investors don't have to wait for a significant price move to the upside for our priorities to start kicking in. As I mentioned, since November we've increased the dividend, reduced our debt, initiated a share repurchase program, and shifted capital within our portfolio to higher marginal Lower 48 activity. We also expect to deliver $5 billion to $8 billion in asset sales that can fund additional debt reduction, buybacks or incremental growth. Our marketing processes are underway, and we'll provide updates throughout the year. Finally, what differentiates us compared to other E&P companies; we're managing the business for free cash flow, and we laid out clear priorities about how we'll allocate our free cash flow to generate strong returns. Our value proposition balances commitment with flexibility and balances reinvestment in the business with returning cash to owners. Our 20% to 30% payout of CFO is distinctive. We're focused on returns; not absolute growth. We intend to differentiate ourselves by maintaining discipline through the cycles and across all value drivers; we're not going to chase prices up and down. We believe our diversified low-cost supply portfolio is also an advantage. We have an 18 billion barrel resource base with an average cost of supply of less than $40 Brent that can drive future returns. We believe this inventory of high-quality investment opportunity is distinctive amongst our competitors. So transformation, acceleration, and differentiation; these are the themes I hope you take away from today's call. We're on a more disciplined and resilient future path, and that's good for all our stakeholders. Now let me turn the call over to Don and Al who will describe our 2016 performance and our outlook for 2017 in more detail.

Thank you, Ryan. I'll begin on slide seven with adjusted earnings. This quarter Brent averaged about $50 a barrel, and Henry Hub about $3 in MCF, resulting in an average realized price of just under $33 per barrel. We reported an adjusted loss of $318 million or $0.26 a share. Year-over-year, adjusted earnings improved about $800 million. We benefited from a 15% improvement in realized prices and a reduction in exploration expenses. Sequentially, adjusted earnings improved about $500 million. Approximately $300 million of the benefit came from improved realizations, and $200 million from lower depreciation expenses. Depreciation expense in the fourth quarter was lower, and this was primarily a result of performance-related reserve revisions and the addition of new reserves. Fourth quarter adjusted earnings by segment are shown in the lower right side of the slide. Each of our producing segments showed improvement, and three of the five producing segments were profitable in the quarter. The supplemental data on our website provides additional segment financial detail. 2017 guidance is also provided in the appendix of the deck, and I want to comment on two expense items that are significant reductions from prior years: depreciation and exploration expense. We expect lower depreciation to continue in 2017. Our guidance for the year is $8 billion versus $9.1 billion in 2016. This may seem a little counterintuitive given the reserve revisions we announced this morning, however about 90% of the revisions were PUDs, undeveloped reserves, which have minimal impact on our depreciable asset base. Additionally, 2017 depreciation will benefit from the performance-related reserve increases we saw in the fourth quarter, and finally our consolidated volumes will be a little lower in 2017 but offset by higher equity affiliate volumes. Exploration expense guidance for 2017 is $200 million versus approximately $700 million in 2016, reflecting the wind down of our deepwater activity. If you turn to slide eight, I'll cover cash flow for the fourth quarter. There's a full year of cash flow waterfall in the appendix but we wanted to highlight the fourth quarter as a better reflection of the current environment and to demonstrate the inflection point message that Ryan emphasized earlier. As you can see, we continue to make progress on our cash allocation priorities. Again, this quarter we generated sufficient cash from operations to more than cover our capital spending and dividend. We started the quarter with $4.3 billion in cash and short-term investments. During the fourth quarter, we generated $1.75 billion from operating activities excluding operating working capital. Working capital was a $200 million use of cash in the quarter. Proceeds from asset sales generated $900 million. We retired $1.25 billion debt maturity and accelerated the repayment of our term loan by $150 million for a total debt reduction in the quarter of $1.4 billion. Capital spending was $1 billion. We initiated our share buybacks mid-quarter and, along with dividends, returns to shareholders totaled a little over $400 million, and we ended the quarter with $3.7 billion in cash and short-term investments. One final comment, as I mentioned last quarter, at Brent prices around $50 a barrel, we would expect to generate about $6.5 billion of operating cash flow on an annual basis. Based on the midpoint of our production guidance, that's still a good marker for 2017. We're going to be keeping a close eye on this just like you. That concludes my comments. Now I'll turn the call over to Al for his comments on operations.

Thanks, Don. We've had another strong operational quarter. Production came in at the top end of guidance and, again, we beat guidance for both capital and adjusted operating costs. I'll begin with a review of our preliminary 2016 reserves. Final reserve details will be published in our 10-K in late February. So on slide 10 you'll see that we started the year with 8.2 billion barrels of reserves. We produced 0.6 billion barrels and had additions of 0.5 billion barrels, excluding market factors. So on that basis, our replacement from additions was 81%; that's an 81% replacement of production from additions in a year when we spent less than $5 billion in capital and sanctioned no major projects. Our addition of 482 million barrels results in an adjusted F&D cost of about $10 a barrel. Market factors reduced our year end reserves by approximately 1.6 billion barrels, and the oil sands represented over 70% of that reduction. About 90% of the reduction was PUDs. Of course, these resources have not gone away. Remember, these reserves were on the books in 2015 when the average Brent price was similar to today's price, so we expect to rebook reserves if current prices hold. The 18 billion barrels of resources with an average cost of supply less than $40 a barrel that we discussed at our recent analyst meeting are also unaffected by these market-driven reserve changes. More details will be available in our 10-K filing. If you turn to slide 11 I'll cover some highlights from our Lower 48 and Canada segments. In the Lower 48, our production in the fourth quarter was 458,000 barrels per day. Once you adjust for asset sales, that's an underlying decrease of about 9% compared to our fourth quarter production last year, primarily driven by our reduced activity levels in the unconventionals. Production from unconventionals in the fourth quarter was 226,000 barrels per day, a decrease of about 14% compared to our fourth quarter production last year. Underlying declines were in line with expectations, but we also had some impact from winter weather in the Bakken that's behind us now. We began ramping up unconventional rig activity in the fourth quarter and are currently running 10 development rigs. Moving to Canada, our production in the fourth quarter was 321,000 barrels per day. Once you adjust for asset sales, that's an underlying increase of about 17% compared to our fourth quarter production last year. The increased production in Canada is coming from our oil sands production ramp-up. For the quarter, we averaged 213,000 barrels per day; this is a new record for us. We've been pleased with the project execution in this segment, and we expect Surmont to continue to ramp up during the year. As I had mentioned during our Analyst Meeting, we added another 30,000 net acres to our liquids-rich Montney unconventional play in the fourth quarter, and we also had encouraging results from our Montney appraisal program last quarter. If you turn to slide 12 I'll cover Alaska, and Europe and North Africa. In Alaska, our production in the fourth quarter was 187,000 barrels per day. Once you adjust for asset sales, that's essentially flat compared to our fourth quarter production last year. Only a few years ago this segment was in decline, and we've now turned the corner. Alaska continues to be a very productive area for us with access to medium cycle projects with competitive cost of supply. We concluded Phase 1 of Drill Site 2S in the fourth quarter. Drill Site 2S is another example where our experienced Alaska project team delivered ahead of schedule, and under budget. In addition, we recently announced an important and exciting discovery in Alaska. In 2016, we successfully drilled and tested two exploration wells on the Willow discovery in the greater Mooses Tooth Unit with encouraging results. Initial technical estimates indicate the discovery could have recoverable resource potential in excess of 300 million barrels of oil. Appraisal of the discovery commenced in January 2017 with the acquisition of 3-D Seismic. As a follow-up to the discovery, we acquired significant new acreage in the December 2016 lease sale to allow us to follow up on the discovery. In 2017, we will also continue to progress development of the GMT1 and 1H NEWS projects. In Europe, our production in the fourth quarter was 221,000 barrels per day; that's an underlying increase of 1% compared to our fourth quarter production last year. We've been able to deliver low-cost supply projects that will add production in Europe. We brought Alder on stream in November, and it's continuing to ramp up. For 2017 we will be continuing to progress Clair Ridge, Aasta Hansteen, and development of the Greater Ekofisk Area. If you turn to slide 13 I'll cover APME and Other International. In APME our production in the fourth quarter was 400,000 barrels per day. Once you adjust for asset sales, that's an underlying increase of 15% compared to our fourth quarter production last year. During the year we've achieved key milestones with first production at Malikai, Bohai wellhead platform J, and APLNG train two, which marked the completion of the six-year megaproject. For 2017 the focus is making sure we reap the full year production benefit of APLNG, KBB, and Malikai. We will also be progressing Bayu-Undan infill wells and appraising Barossa as a backfill option for Darwin LNG. Our Other International segment is focused on the exploration and appraisal of unconventional reservoir potential. In 2016 we drilled two exploration wells in Chile. In 2017 we'll continue to focus on exploration and appraisal of both Chile and Colombia. So let's move to slide 14. Our 2017 operating priorities remain unchanged from what we outlined at our Analyst Meeting in November. That's production of flat to 2% growth compared to 2016 production, excluding the full year impact of dispositions in Libya, for $5 billion of capital and $6 billion of adjusted operating costs. We expect first quarter production to be between 1,540 and 1,580 thousand barrels per day, and expect to have our typical profile through the year with second quarter and third quarter turnarounds. We will also continue to implement our more-focused exploration program. And finally, as Ryan mentioned, we're making progress on our planned $5 billion to $8 billion of asset sales. We have active processes underway, and we'll update you throughout the year. So operationally, everything is on track for 2017. And now we'll turn the call over for Q&A.

Good morning to you guys. The first question I have for you is around the dividend raise. So earlier this week you raised your dividend by 5% to 6%. Is that a good proxy for what we should expect going forward post-2017 as well? And then, Ryan, can you just talk about the buyback program and how you weigh that versus dividend growth on a go-forward basis?

Yeah. Thanks, Neil. Yeah, certainly a couple of days ago we announced a 6% increase to the dividend, so what we're doing – no, it's driven by the fact that we've reached cash flow neutrality in the company; we're generating free cash flow. What we describe to our investors it was important, our second priority to grow the dividend; felt that was important to do, we'd reached that milestone. As we look at the market, we see some recovery in the market. We continue to, as Al said, operate really well and we'll continue to generate free cash flow as we go forward. So recognizing that priority, we're going to – we'll be growing our dividend, and that's our intention to do that. We're augmenting that right now with share repurchase as we generate the free cash flow, so I kind of view those together. We're going to target our 20% to 30% return to shareholders. I think we're at the upper end of that right now with respect to both the dividend and the share repurchase. We'll balance those two as we go forward. We're going to set the fixed dividend, make sure it's affordable and make sure it's sustainable through the cycles. So that's kind of how we're thinking about the fixed portion of our return to the shareholders combined with the flexible part through share repurchases. By the way, on the share repurchase piece, too, Neil, I'll just remind people we got started in mid-November after the Analyst Meeting, so that represented only kind of a half a quarter in terms of our – the amount we're trying to buy back over the course of the year.

Appreciate that, Ryan. And a follow-up on just the asset sale program, the $5 billion to $8 billion. When do you expect to be able to provide us an update on San Juan which seems to be the one that's most progressed? And can you just comment on early market appetite for North American natural gas assets?

Yeah. I think we're seeing a lot of interest. These are pretty high-quality assets, so we expect a lot of interest and in fact we're getting that through the data room right now. We expect to get bids in and have some decisions probably over the next couple of months with respect to San Juan.