Conoco Phillips (COP) — Q3 2017 Earnings Call Transcript

Thanks, Christine, and welcome to all of our call participants this morning. Today's presenters will be Don Wallette, our EVP of Finance, 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 deck. We will make some forward-looking statements during today's call that refer to estimates and plans. Actual results could differ due to the factors noted on this slide and also described in our periodic SEC filings. We will also refer to some non-GAAP financial measures in today's call. The purpose of these is to help facilitate comparisons across periods and between peers. Reconciliations of non-GAAP measures to the nearest corresponding GAAP measure can be found in this morning's press release and again on our website. Finally, this morning, we're going to limit during Q&A your questions to one and a follow up. And with that, I'm going to turn the meeting over to Don.

Thank you, Ellen, and good morning. I'll start on slide four with our key strategic financial and operational highlights for the third quarter. Starting on the left side of the chart with strategy, this quarter was another impactful one for our company. We've executed a number of transformational decisions to accelerate our differentiated, disciplined and returns-focused strategy. During the quarter, we closed the sales of our San Juan basin and Panhandle assets. We also continued progressing several other sales that should close in the fourth quarter or early next year. We expect to deliver greater than $16 billion of asset sales during 2017. In the third quarter, we paid down another $2.4 billion of debt, bringing our balance sheet debt to $21 billion. In the quarter, we received a credit rating upgrade and we are on track for the year-end debt balance to be under our target of $20 billion. We repurchased $1 billion of our shares during the quarter, which takes us to over $2 billion repurchased for the year, representing about a 3.5% reduction in outstanding shares year to date. We expect to buy back another $1 billion of shares in the fourth quarter. Between our dividend and the expected share buybacks, capital returned to shareholders would represent the equivalent of 60% to 70% of our operating cash flow in 2017. Moving to the middle column, our third quarter financial results extended the momentum we've built over the past year to achieve profitability and maintain cash flow neutrality in a $50 price environment. On an adjusted earnings basis, we were profitable for the second successive quarter, realizing a profit of about $200 million, or $0.16 a share. We generated $1.1 billion of cash from operations excluding working capital. I want to point out that operating cash flows this quarter were impacted by a choice we made to use a portion of our cash balances to accelerate funding of future pension obligations with a $600 million cash infusion. I'll cover this item in more detail in a few slides. Excluding the pension item, cash flow was right in line with our expectations and consistent with our published sensitivities. On a year-to-date basis, cash from operations is $4.5 billion, which exceeds CapEx and dividends by over $400 million despite the $600 million CFO reduction I just mentioned. As we've shown for more than a year now, our cash flows have more than covered our CapEx and dividends. We don't require a pathway or market help to get to cash neutrality. Adjusted operating costs were 15% lower year on year, as we continue to lower our breakeven price across the portfolio. Moving to our operational results on the right. We're meeting or exceeding all of our operational targets. Production excluding Libya for the quarter was 1.2 million BOE a day. Adjusting for dispositions, our underlying production on a per-debt adjusted share basis grew by 19% compared to the third quarter of last year. We successfully completed the last lenders' test at APLNG, which allowed us to release the final project financing loan guarantee. And we continue to execute our 2017 capital program scope at lower costs. As Al will cover in more detail, we're lowering our capital guidance for the year to $4.5 billion. That's a reduction of $500 million or 10% compared to our initial 2017 guidance. So to recap, this quarter's performance again reinforces the transformation we've made as a company. We're delivering on our priorities and continuing to build momentum. And while the outlook for commodity prices has improved recently, we remain committed to our disciplined, returns-focused strategy that creates shareholder value. If you turn to slide five, I'll walk through the third quarter financial results. With WTI averaging about $48 a barrel and Henry Hub about $3 an MCF, our average realized price was around $39 per BOE. Compared to the prior quarter, adjusted earnings improved slightly because of higher realizations and equity earnings, partly offset by disposition impacts. Compared to the year-ago quarter, adjusted earnings improved by over $1 billion, with the improvement driven by higher commodity prices, lower depreciation and exploration expenses and the impact of dispositions. Third quarter adjusted earnings by segment are shown on the lower right. The supplemental data on our website provides additional financial detail. If you turn to slide six, I'll cover our cash flows during the quarter. First, looking at the sources of cash shown in green, cash from operations was $1.1 billion, which as I mentioned, was impacted by our decision to make a $600 million cash contribution to our U.S. pension fund. As we continue to strengthen our financial position, we look across the balance sheet for opportunities to reduce long-term obligations. This payment represents an economic acceleration of future contributions which will also serve to reduce cash flow volatility and increase flexibility going forward. The other major source of cash during the quarter was asset sales, which generated $3 billion. The uses of cash, shown in red, were in line with expectations we provided during our last earnings call. We used $2.5 billion to retire debt and distributed $1.3 billion to shareholders through dividends and share buybacks. We ended the quarter with $9.6 billion of cash and short-term investments. If you turn to slide seven, I'll wrap up by covering year-to-date cash flows to emphasize our focus on free cash flow generation. This slide illustrates the disciplined approach we take to running the company. Starting with the first set of bars on the left, as I just said, year-to-date operating cash flows have more than exceeded spending on capital investments and dividend distributions. The second set of bars shows how cash proceeds from dispositions, our pre-funding our debt reduction and share repurchases. In addition to the roughly $14 billion of cash proceeds shown here, we also have $2 billion of equity in Cenovus, which will be converted to cash proceeds over time. So in summary, the business continues to run well. Now let me turn it over to Al to give you some color on the operations.

Thanks, Don. I'll provide a brief overview of our third quarter operating highlights and our outlook for the rest of the year, including our updated capital guidance. Operationally, we had another strong quarter, despite some tough weather challenges here in Texas. As Don mentioned, production excluding Libya averaged 1.2 million barrels per day. Despite a 15,000 barrel per day reduction in the quarter due to Hurricane Harvey, better performance from our global portfolio allowed us to offset this loss and still exceed the midpoint of guidance by 12,000 barrels per day. Year on year, this represents an increase in underlying production of 1.4%. During the quarter, we ran 12 operated rigs in the Lower 48 Big Three unconventional assets, six in the Eagle Ford, four in the Bakken and two in the Delaware Basin. Our Big Three unconventional production was 211,000 barrels per day with 123,000 per day from Eagle Ford, 66,000 per day from the Bakken and 22,000 per day from the Delaware. This was about flat to the second quarter of 2017 but included the impact of Hurricane Harvey. Excluding this impact, production from the Big Three unconventionals would have been about 6% higher sequentially. In Canada, Surmont achieved a record daily production of 141,000 barrels a day gross during the quarter. The project continues to ramp up toward full capacity. In Australia, APLNG ran at 110% of nameplate and demonstrated 98% uptime. We've shipped 92 cargos through the end of the third quarter. In Alaska and Europe, we safely executed significant turnaround activities which now completes our major turnarounds for 2017. And finally, across the portfolio, we're making great progress on our conventional projects. In Alaska, we spud the first wells at 1H NEWS with first oil expected before year-end. Meanwhile, GMT1 is still on track for first oil by the end of 2018 with costs running well under budget. The Aasta Hansteen topsides left port in South Korea headed for Norway and this project is also on track for first production by late 2018. Work also continues on Clair Ridge and Bohai phase 3, both of which are on track for first production in 2018. Now, moving on to slide 10, I'll provide an update on our 2017 outlook. We're lowering our full year 2017 capital guidance for the second time this year. We now expect to spend $4.5 billion. We continue to do more for less. The updated capital guidance represents a 10% reduction from our original budget. Despite this CapEx reduction, we expect to exceed our original production guidance. This year, we now expect to deliver 3% underlying production growth, and that's 17% on a debt-adjusted share basis. On the left side of the slide, we list key fourth quarter and full year guidance metrics. Below the capital, you can see our fourth quarter production guidance is 1.195 million to 1.235 million barrels per day, and we've tightened the previous full year production range to between 1.350 million and 1.360 million barrels per day. Our remaining drivers are tracking closely with our guidance. So that's a quick recap of the quarter. As Don said, business is running well. We continue to look forward to providing an update of our future plans at our analyst and investor meeting on November 8. So I'll turn the call over now to Q&A.

Oh, hi. Good morning, everybody. Excuse me, I needed to clear my throat. Hi, everyone. So I'm not optimistic on getting too many forward-looking questions answered today, but I'm - I may give it a go so just one forward-looking and one about the quarter, if I may. $55 Brent all the way out in the strip from what we can tell now. You guys are obviously fairly levered to that. So it kind of changes the narrative a little bit about where your cash breakeven is for the portfolio and your choice between sustaining the buyback program perhaps beyond the disposal proceeds that you brought in versus reinvesting in the company. So I know you're going to get into this in a couple weeks, can you just frame for us what a $55 world, what does Conoco think about by way of growth versus continued debt-adjusted per share growth?

Well that, Doug, that almost sounds like you've written the title of one of our slides for the week after next for our Analyst Meeting, so I think you've teed it up perfectly. And we're going to answer it then, as you predicted.

Yes, I'd thought I'd give it a go, but anyway, it sounds optimistic. So thank you for that. My quarterly question is really a simple one. The U.S. is exporting this week again close to 2 million barrels a day of oil. It seems to us that we're now starting to see some real linkage, I guess, between certain parts of the Lower 48 and Brent pricing, so more of a Brent minus than a WTI plus kind of number. So I'm just curious, is that what you're seeing? Do you think it's sustainable, and if so, maybe you could help us with how you think that would impact the relative investment decisions for the Eagle Ford as we go forward? I'll leave it there. Thank you.

Yes, Doug, this is Don. I can comment a little bit on that. When you look at our U.S. production in total, we're pretty heavily weighted towards the Brent side and not so much exposed to WTI, and a large part of that is because our Alaska North Slope, which is the largest portion of our U.S. really trades similar to Brent. Probably what's not recognized well enough is our Eagle Ford production that you alluded to, about half of that production is marketed on an LLS component basis and as you know, LLS and Brent have had a pretty strong relationship. So we're not seeing the same impacts of the widening differentials that you might expect there. I do expect going forward that those relationships, they have maintained in the past, so I don't see why they would break down in the future. As far as exports themselves, we've been pretty active in the export, I'd say, in the first and second quarters this year and going back to last year, but we're seeing demand pretty strong domestically now. And so I think in the third quarter, I don't believe we had any waterborne cargos going outside the country. We did have some going inland or within the country. But we're seeing markets improve here in the U.S., and as I mentioned, we're pretty exposed to Brent relative to WTI.

Just to be clear, Don, so if export capacity is obviously up, can you envisage 100% of the Eagle Ford being marketed on a Brent basis or no?

Well, I think 100% would be an awful lot. I don't know what dynamic would have to cause that. Today, and in the third quarter, we didn't see the advantage, the arbitrage advantage in exporting relative to the strength that we were seeing domestically. I think there will be times when you see – I mean, if you go back last year, we had a good bit going outside the country, but 100% is probably something that we wouldn't be expecting.

Okay. I appreciate the answers guys. I'll see you in a couple weeks. Thank you.

Thanks, Doug.

Okay.

Hey, guys. Good morning.

Hey, Paul.

Don, just curious that for APLNG I presume we're now in a positive cash flow position, and I believe you must be building a cash cushion in the joint venture. So if the price stays here, when do you think the partner will start to receive the cash dividend payout from that? I mean, in some way that your cash flow from operation in this quarter not only impact by the $600 million of the pension contribution but also impacted by the not distributing the cash from the APLNG. Is that correct?

Well, we do have, I mean you're right, Paul, we do have cash that's building up in APLNG as we've said before, the cash, the net cash flow breakeven there in fact is somewhere in the $45 to $50 Brent range. And so, yeah, we have been building cash within the joint venture. And if prices stay where they are for the rest of the year, it's quite possible that we could see a fourth quarter distribution from APLNG, and then we would expect that to correspond to prices next year as well.

Yes. So that's an active area of discussion in the joint venture right now, Paul. And we of course want to make sure we maintain enough cash build going into next year to cover loan payments as they schedule out next year. But even with that, at these kinds of prices, you're absolutely right that we're building excess cash and we'll be in a discussion about distribution timing. But no decision has been taken on that yet at this point.

And now since that I have you here, the $4.5 billion of the revised CapEx for this year, that would suggest that fourth quarter would jump to $1.4 billion. You've been doing about $1 billion a quarter. What may be the effect behind why we that see that jump by 40%?

Yes. So we did $1.1 billion this quarter.

And also – you can also talk about that, whether $4.5 billion is really what you consider is now your new sustainable CapEx requirement.

Well, that latter question we'll cover in two weeks. But it was $1.1 billion this past quarter, and we're forecasting between $1.3 billion and $1.4 billion in the fourth quarter to get to that $4.5 billion number. And the key drivers to that increase, we have been on a fairly steady increase through the year in the Lower 48 on overall activity, and so there is still some more build in actual CapEx spend, and that's 3Q to 4Q in the Lower 48. And that's actually exacerbated a little bit by the Harvey effect, because there was some money that didn't get spent in the third quarter due to Harvey and just some work that you weren't doing because we were down for that for a period of time. But we also have increases quarter to quarter in Bohai Bay as that phase 3 project, as that continues to ramp. We expect that spending to be up. And also, our drilling programs in Alaska and Europe are both going to be up, we expect third quarter to fourth quarter. And so those are the key pieces.

Thank you.