Conoco Phillips (COP) — Q4 2020 Earnings Call Transcript

Thank you, Senara. Hello, and welcome to our listeners today. First, I’ll introduce the members of the ConocoPhillips executive team who are on today's call. We have Ryan Lance, our Chairman and CEO; Bill Bullock, our Executive Vice President and Chief Financial Officer; Matt Fox, our Executive Vice President and Chief Operating Officer; Tim Leach, our Executive Vice President of Lower 48; Dominic Macklon, our Senior Vice President of Strategy, and Technology; and Nick Olds, our Senior Vice President of Global Operations. Ryan will open this call with some prepared remarks, and then the team will be available for your questions. Before I turn the call over to Ryan, excuse me a few reminders. The results we released this morning reflect 2020 results for ConocoPhillips only. We will not be discussing any Concho-specific results today. Beginning in the first quarter of 2021, results will reflect the combined ConocoPhillips Concho Company. We'll make some forward-looking statements this morning based on current expectations. Actual results could differ due to the factors described in today's press release and in our periodic SEC filings. We'll also refer to some non-GAAP financial measures today. Reconciliations to the nearest corresponding GAAP measure can be found in this morning's press release and on our website. Thanks, and now I'll turn the call over to Ryan.

Thank you, Ellen, and thanks to all our listeners for joining today's call. Lately, I've been reflecting on this time a year ago, we had just rolled out a groundbreaking multiyear plan for the company. The plan was anchored to a comprehensive philosophy and approach we've been espousing since 2016 that was aimed at reversing the failings of the E&P sector to create sustained value for shareholders through cycles. What was that business model? It was to reinvest about 70% of our cash flows into the lowest cost of supply resources to grow financial returns and free cash flow, return at least 30% of the cash flow to our owners, maintain a very strong balance sheet, and lead in ESG stewardship. Our multiyear plan gave the market a credible example of how this business model would work. Well, almost as soon as the ink dried on our multiyear plan, along came 2020. And for the entire year, nothing went as expected for any of us. But here's the thing—despite the most challenging year in the history of our sector, our business model worked, and the value proposition prevailed. We exercised available flexibility without forfeiting productive capacity. We high-graded our portfolio, executed our programs, and returned over 50% of our cash to our owners. Our balance sheet stayed strong, and we continued to up our game on ESG. In other words, our value proposition passed the test of 2020. This strengthened our conviction that we have the right model for this volatile sector. This conviction is what led us to acquire Concho in a transaction that will enhance our ability to deliver our proven value proposition. We've turned the difficult experience of 2020 into an opportunity to emerge as an even stronger, more investable company for our sector. Earlier today, we announced fourth quarter and full-year 2020 results for ConocoPhillips. Because the Concho transaction closed after year-end, the results we reported today represent standalone ConocoPhillips performance for 2020. However, beginning January 1, our 2021 results will reflect the combined company performance. I don't plan to review the results we announced this morning; I'll just describe some important highlights from last year. But this morning's results should give you all confidence that the underlying standalone ConocoPhillips business is running very well, thanks to the many efforts of our workforce. And I can assure you that the Concho Permian business is running well too, again thanks to our workforce in Midland. Our mindset as we start 2021 is all about doing the work and delivering the results that make us the best E&P company in the business. We've identified our key focus areas for 2021. Our top priority is to create the strongest competitor in the business from the combination of ConocoPhillips and Concho. The closing of the Concho transaction cleared the way for us to begin comprehensive integration and optimization efforts across every part of our business. We're just getting started post-closing, but we are already taking actions that will drive greater efficiency and capture best practices to ensure we perform at the highest level organizationally, technically, operationally, financially, and culturally. We have already identified the sources of capital and cost reductions to meet the $500 million target we set when the deal was announced. I can report that we will significantly outperform those initial expectations as we review our processes, share best practices, and organize for the new realities of the business. Let me put our revised savings expectations into perspective for you. Compared to pro forma 2019 adjusted operating costs of approximately $7 billion, we anticipate being at an annual run rate of approximately $6 billion in 2022, assuming a similar production level of roughly 1.5 million barrels a day equivalent. This billion-dollar reduction, about $400 million of that was driven by actions taken by both companies prior to the deal announcement, with the remaining savings to be realized through cost reductions implemented in conjunction with the transaction. This represents a major value upgrade for the company because it greatly enhances the competitiveness of our free cash flow generating capability, which is how we’ll win. We'll be implementing our cost reduction actions throughout 2021 and will provide updates on our progress along the way. The next priority is to execute the announced operating capital plan of $5.5 billion. This budget is comprised of sustaining capital of about $5.1 billion, with about $400 million directed toward major capital projects, primarily in Alaska and ongoing appraisal activity. For this level of capital, we expect to produce about 1.5 million barrels of oil per day equivalent, which is roughly flat to 2020 pro forma production, adjusted for curtailments and asset sales. In this morning's supplemental material, we provided an operating capital plan by segment. We expect to spend about 55% of our capital in the Lower 48, with the remainder allocated across our diverse global programs. We set the capital budget at $5.5 billion for two principal reasons. First of all, the macro environment has firmed up recently; we're cautious about the trajectory and timing of a recovery. Demand recovery is taking longer, spare supply remains, and inventories remain elevated. It makes no sense to grow into this market environment, so we're choosing to stay at a sustaining level for the year. Second, we're committed to growing free cash flow, and we're setting up the company to be a significant free cash flow generator. That means maintaining capital discipline, but also driving program improvements that enhance uplift efficiency. We're driving free cash flow growth, not production growth. At $5.5 billion of capital in 2021, if current prices hold, we expect to generate significant additional free cash flow. In that situation, our dividend alone would not be sufficient to meet our target of returning greater than 30% of our CFO to our shareholders. You should not be surprised to see us reactivate buybacks as a channel, and we always like the idea of improving net debt. A third key priority for 2021 is engagement with our various stakeholders. This includes investors, regulators, government officials, partners, communities, and our workforce. We're undergoing a significant level of change, both internally as we integrate our companies, but also in the external environment. While we consider engagement part of ordinary business, there's no question this has taken on a new level of importance in today's environment, especially given the recent industry-related announcements coming from a new Biden administration. Let me take a moment to address our thoughts about the administration's recent pronouncements regarding a temporary moratorium on leasing and permitting on federal lands. I have to say we were not entirely surprised by the announcement. In fact, President Biden said during the campaign that he would issue a temporary moratorium on new leasing. As for the permitting moratorium, the administration has publicly indicated this is a temporary pause and that they will continue to issue permits. Obviously, we hope these temporary actions are resolved in a timely fashion, and we're watching the situation closely. Some of the recent executive actions targeting U.S. oil and gas production will have negative economic and environmental consequences for the American people. If the moratoriums become permanent, they will eliminate well-paying jobs primarily in rural America, slow economic recovery, negatively impact energy and national security, and increase our reliance on higher GHG for minerals. We certainly want to avoid these outcomes, so we stand ready to work with the Biden team, as we did successfully with the Obama-Biden administration, to find balanced solutions to address the issues. As for the questions regarding what a permitting moratorium could mean for ConocoPhillips specifically, let me take that head on. While we are certainly going to engage to protect our interests, ConocoPhillips has the flexibility, diversity, and depth of low-cost supply and low GHG resource to manage through this issue without materially impacting our plans. A final 2021 priority is to continue to improve our performance on another issue that is very important to our stakeholders, namely ESG. This is an area where we have a long-term demonstrated track record of commitment and performance. There is heightened interest across the entire industry on this topic. We continue to accept our responsibility for improving ESG and, in fact, embrace the opportunity to be an industry leader. Last year, we became the first U.S.-based upstream company to adopt a Paris-aligned climate risk strategy. We set internal emission reduction targets that are consistent with the goals of that agreement and are taking significant measures to monitor and reduce methane emissions across our operations. Additionally, we advocate for a well-designed price on carbon in the U.S. because we believe that's the most economically efficient and effective step that the U.S. can take to set the world on a sustainable path to long-term GHG emission reductions. While we work diligently to reduce emissions, we have established a low-carbon team within the company. That team is conducting in-depth studies of energy transition alternatives, monitoring trends, and evaluating the economics and viability of these alternatives for ConocoPhillips over time. Our board is engaged with the team and its work, and we are committed to continuing our analysis on this important topic. For now, we believe the highest value we can create for all our stakeholders is by being the best E&P company in the business. The world needs clean, low-cost barrels that are safely delivered by disciplined, free cash flow and returns-focused companies like ConocoPhillips. 2020 was indeed a challenging year. But the lessons and accomplishments we took from it put us in great stead, not only for 2021, but as a $75 billion enterprise value industry leader. We are in a unique position to help transform the perception and performance of our sector with a clear vision of what we need to do: deliver value from the Concho transaction, execute our 2021 operating plan, engage with our stakeholders, and continue to enhance our ESG leadership. We look forward to keeping you informed of that progress as we go throughout the year. Now, let me turn that back over to the operator, and we'll take your questions.

Hi, everybody. ConocoPhillips has emphasized cost-effective energy supply, ESG leadership, and competitive returns to shareholders, which has really been a prescient approach and one that most of your peers have ended up emulating over the past couple of years. While having a good head start is usually a good thing, a paradigm shift seems to be underway in energy with investor expectations for management teams changing too. My question is, what are some of the things that the management team is going to need to do to sustain its leadership position in this new environment to continue to be the best E&P company with these new realities, I think, is the way you phrased it a few minutes ago? So that's my question.

Thank you, Doug. First, congratulations on your retirement. Your contributions as a partner and thought leader in the industry have been remarkable, and you've often been right in your insights. Currently, there are significant external pressures on the industry due to the new administration. I want to emphasize three key areas that are vital for the success of an exploration and production company. First, we need to ensure competitive returns for our shareholders, and we must achieve this sustainably through various economic cycles. We are committed to this approach. Additionally, we must provide low greenhouse gas and affordable energy globally, which is crucial as we navigate this transition. It's important to recognize the role of oil and gas in this process, even if it's sometimes overlooked in the current discourse. Lastly, we need to approach this with sustainability as a priority, keeping environmental considerations at the forefront. It's essential that we avoid experimentation with the planet. We have long been advocates for managing our Scope 1 and Scope 2 emissions, aiming for a reduction in intensity by 2030, which aligns with our goals for 2050 and the Paris Agreement. Every company should concentrate on their Scope 1 and Scope 2 emissions. Regarding Scope 3 emissions, we support implementing a carbon price, as this is the most effective and economical way to address these issues and influence consumer behavior in a manner aligned with the Paris Agreement.

Thanks for that, Ryan. Also, to be fair, it's been really easy to have ConocoPhillips as my top idea in E&P since you became CEO in 2012, and you guys originated the model for success in this sector. It's obviously worked, and you stuck to it, so kudos to you and the team. Thank you for your leadership in the space, and the pleasure has been all mine. Thanks again.

Thank you, Doug. We'll miss you.

Good morning, team, and thanks for taking my questions. Ryan, you alluded to capital returns. As you look at 2021, at the $5.5 billion capital budget, where do you see the break-even to cover your dividend? I'm guessing the number is a lot lower than where the spot is right now, close to $58 Brent. How do you think about using a share buyback to take advantage of that excess cash flow, but also the dislocation? You've historically talked about the correlation between your stock and the price of oil, but that correlation has recently broken down. So how do you think about leveraging excess cash flow via buyback to take advantage of a dislocation to the extent you see one?

Yes, Neil, maybe I can take the latter part of yours, and maybe Matt can chime in on break-evens and the first part of your question. Yes, you're right. Certainly, I know you guys can do the math and are doing the math pretty quickly these days. At current prices, if they hold, you shouldn't be surprised for us to be back in the market buying our shares at the kind of level we were at pre-transaction. We recognize our commitment is to deliver 30% back to shareholders, and we’re committed to doing that. We recognize that the ordinary dividend today and the market we're experiencing would be insufficient. So we recognize we’d have to take some of that free cash flow and return that to shareholders. That's certainly our commitment. I said in my opening remarks, and having a strong balance sheet is really important, so reducing our net debt is something of interest as well. So let me maybe ask Matt to chime in a little on the break-even numbers.

Yes, Neil. 2021 will be a little noisy in establishing that because of some one-off costs. When we get to 2022 in steady state mode, the break-even to cover the capital and for sustaining capital and the dividend will be somewhere around $40 a barrel, consistent with what was shown when we announced the transaction. That’s before we've considered some additional cost savings from capital reductions and margin improvements from commercial and supply chain, and so on. We're feeling very comfortable that we'll be consistent with that roughly $40 or a bit less once we enter 2022.

Okay, great. And then...

And I'd add, Neil, that—I’m sorry, Neil, I'd just add that we're taking the time to drive the efficiencies and free cash flow generating power through the transaction with Concho. We're just getting started with that. We've had two weeks since we got it closed. I think we have about a month of prices above $50 WTI as well. We're just getting started, and our focus is on trying to drive that as low as possible, and the teams are up for it.

That’s a follow-up for you, Ryan. It's been a couple of weeks since you’ve gotten your hands on the Concho steering wheel. Just your thoughts on what you're seeing so far. Is anything surprising to the upside? Anything surprising to the downside? Any quantification around the value creation that you've seen so far with the Concho assets?

No, thanks. I think I’d say we haven't seen a downside yet. We're just happy to have Tim and Will and Jack on the team and helping us get jump started in terms of what we're doing in the Permian Basin and building out the best practices, as Matt talked about. We're quite excited about the upside and the opportunity just to continue driving efficiencies, free cash flow generation, and get our assets on the Concho learning curve and continue to drive the value. This year of maintaining a sustaining level of capital gives us the chance to get the team really focused on driving those efficiencies and getting more out for every precious capital dollar that we're spending.

Hi, good morning, everyone. Thanks for taking my call. So...

Good morning, Jeanine.

Good morning. My first question is perhaps on the medium to longer-term. You'll be holding production flat this year, pro forma to 2020. Over the medium term, has your view on the mid-cycle price of $50 WTI changed relative to what underpins the 10-year plan? I know you indicated that you've passed the value proposition test of 2020. Is the plan to make their way back to that more than 3% production CAGR and substantial through-the-cycle share buybacks? Or have the macro and the Concho acquisition made you think a bit differently?

I'll start, then let Matt chime in a little bit as well. Long-term, Jeanine, our view of the mid-cycle price, if you think about it that way, over a long period of time hasn't really changed. We see some potential for demand destruction coming post-COVID that could be up to a couple million barrels a day. We also see some supply destruction as well. On balance, we'd have a long-term view that the mid-cycle price hasn't really changed. I can maybe turn to Matt; he can address the medium-term question you asked, which is directed over the next two, three, four years.

Yes, Jeanine. The guidance— in the short-term, we are facing price volatility as we work off inventories and we get use of best demand and supply. Our view is in the medium term, it's quite possible that we will spend some time above mid-cycle prices. Adding to this, there's some demand reduction. We know there's been significant supply reduction, particularly at year-end. U.S. current oil production was at 8.2 million barrels a day in December 2019, last year it was 7 million barrels a day. So, that's a significant drop. Once we enter 2022, we assume demand recovers and U.S. producer discipline holds, it’s reasonable our mid-cycle price could be above it for a few years but balanced underlined, mid-cycle for the longer-term adjusted EPS.

Okay, great.

We're pretty committed to the 30% return of cash back to shareholders; we believe that's the right model for this industry. We're committed to doing that.

Okay. My follow-up digs into Neil's question. Conoco's cash return model is extremely differentiated. Not a lot of companies can return capital the way you can. When you mention the potential for the buyback to resume, would we be anchoring around the billion dollars announced in 4Q 2020, which got canceled, or is it more kind of the 2019 expectations?

You can do the math with these prices and calculate the CFO that we generate. Our commitment is to return 30%. So, it's more similar to what we were doing before the transaction.

Hi, thanks for taking the question. First one here would just be on the outer year look at capital spending. I know you're going to give us an update here in March when you disclose the transaction. But I guess in more directional nature, do you have any color about how you think about the moving pieces looking out? I noticed that you do have some spending allocated for Willow as well. Should we be anticipating that ramping up in 2022 and beyond at this point?

We expect to come back in March and certainly toward the latter part of the year to describe our longer-term plans. We have thoughts and ideas around optimal plateau levels of spend for the assets. We're watching how quickly supply and demand gets rebalanced in global markets, but expect that there will be some ramp-up to optimized levels, both at company and asset levels. I can have Nick describe a little about what we're doing today on the Willow asset.

Phil, this is Nick. Just to take you back a bit to Q4 2020, we crossed through two major milestones around permitting. For Willow, we got the record of decision by the BLM in October. The Army Corps of Engineers 404 permit allows us to put gravel for roads and pads. We plan to advance engineering through our FEED. We took feed at the end of December, that's a major decision gate within the company. Advancing front-end engineering and design, and part of the scope for 2021 is also small civil construction to put gravel and start the road system for Willow, targeting a final investment decision later this year. We're watching it closely, and if things move to the right because of this current administration, we have a lot of flexibility around how fast we ramp-up at Willow.

Thank you, Nick. A follow-up question to Neil's question on break-even. Understood on the 2022 kind of normalizing at $40–$41. I presume that includes the incremental synergies discussed. But for the transient factors for 2021, could you provide further color? Are there other things referring to LNG distributions and lag effects? Yes, Dominic; lead the integration efforts and can describe some of those transaction costs and the synergies.

Phil, there are severance costs related to duplicate labor. There are also fees associated with that. Once we get through this year with those costs, our focus is on the cost structure. We expect to exceed our targeted $500 million savings for capital and operating costs. The expected savings have increased from $350 million to $600 million. We're focused on efficiencies across D&C spending and economies of scale, and we expect that $750 million to increase as we continue our efforts throughout the year.

Thank you, and hello, everybody. Earlier today, one of your U.S. peers slashed their building growth forecasts by almost 40%. On their conference call, there wasn't a single question asking about that revision. It seems like the market has swung the pendulum. I wonder if you can reflect on the trend you're seeing in efficiency, cost, and supply? The market seems to believe that this business can be turned into one that generates free cash flow.

I'll start, Alastair, then maybe let Tim chime in. What drove our decision around the transaction was looking for the lowest cost of supply resources. When we look at the performance within our company, now getting a deeper look at Concho, we're pleased and seeing continued efficiencies and free cash flow growth. Maybe Tim can add some color.

Pleased to be here. The program we're executing is generating the best economics I’ve seen during most of my career. It's exciting to have the inventory and the opportunity to improve it, making it more capital efficient, enhancing free cash flow and driving down costs in the already low-supply area.

Do you think the industry in 2020 has managed to bring the cost of supply down further in the Permian? Or is it difficult to tell?

Certainly, there was declining capital costs and enhanced efficiencies from better-designed wells. So yes, I do think the cost of supply came down dramatically in 2020.

Ryan, I wanted to ask about your cost of supply. Are you thinking of an overall portfolio shake-up in coming years, or does everything in there really make sense? How do you think about international LNG opportunities at this point?

We've made a lot of portfolio changes since forming the company in 2012. Overall, we're pleased with our resource base and cost of supply of major assets. We'll keep those that can compete for capital and divest those that cannot. We stand by our focus on maintaining low-cost supply and sustainability. Regarding LNG projects, we value the market in Asia and the need for gas globally. We're interested in competing in Qatar for another train. If it fits our investment profile around cost of supply, we'd like to participate in that. These projects help lower capital intensity and enhance the overall portfolio.

Do you anticipate that you'll have some visibility to make your longer-term directions at some point? When do you expect to have a firm direction by the administration?

We're watching the next 60 days closely. We need to ensure easements across public lands are probated. If that gets hung up, we'll adjust our plans. We're starting to see permits getting approved now. We're following closely to see if this is short-lived, and we expect things to get back to business as usual.

When you look at the synergies you're looking to capture, could you discuss how much of that is included with what your commercial teams can do with the Concho assets?

The $750 million in synergies mentioned does not include commercial uplift for realizing price benefits or supply chain enhancements. We're looking for significant uplift from those as well.

Your mention of the studies of energy transition alternatives raises my thought; there seems to be a financial lens on that, does this compete for capital against other options in the portfolio? How do you frame those in terms of financial and strategic objectives?

The low-carbon team focuses on opportunities relevant to our core business and competencies, like carbon capture and reducing the emissions intensity of our operations. We're committed to our Paris-aligned climate risk strategy while achieving affordable energy and returns.

Ryan, I’m wondering if the consolidation opportunity in your mind is over? Are you still looking for additional opportunities as we move into a recovery phase?

Our focus is on integrating these two companies. That's our focus right now. M&A isn't down in this business; you should continue to drive costs down and find the best resources. It's certainly not on the radar now, as we focus on driving the best results from the Concho transaction.

My follow-up is on capital allocation, thinking of Federal land exposure affecting capital. How do you plan to prioritize capital allocation moving forward?

We’re evaluating production levels based on market environment decisions. We've demonstrated our ability to remove assets that don't compete for capital. We're focused on low-cost supply resources, balancing local and global markets.

There is clearly operating risk in having an E&P portfolio just in the U.S. Does that shape your view of investments over the next five years to try and get some diversification?

While we have a significant footprint in North America, we consider uncertainties around administrations as well. We value diversification, but it needs to be low-cost supply. Dominic said we reduced our allocation to new venture exploration from $300 million to $150 million, and we're considering monetizing assets that don't compete in the portfolio.

Could you provide any color on relative capital allocation within the $3.1 billion you've planned for the Lower 48?

No, we haven't split anything out regarding the $3.1 billion; it's allocated for the whole Lower 48. We’ll provide updates as we progress.

We had four successful exploration wells in Norway. The Warka and Slagugle discoveries are quite significant. Warka is a gas condensate discovery with an estimated 50 to 190 million barrels equivalent, and the Slagugle discovery is between 75 and 200 million barrels of oil. We're optimistic about the low-cost supplies, likely subsea tiebacks.

If I look back to your last Analyst Day, you talked about growth exceeding 3%. I understand it's too early to set a target, but with current commodity prices, could you grow at mid to high single-digit rates?

I don't think growth is a target. Growth will be an output of our plans. We're focusing on delivering 30% cash return to shareholders and maintaining a strong balance sheet.

If we are above your mid-cycle price, could you expect to return more cash to shareholders? Is there a chance that number could be in the 45% or even 50% range?

You can look at our history. Strengthening the balance sheet is also a priority as we consider cash returns.

Hello, this is Ellen; we're close to the top of the hour. So we'll take our last question, please.

Thanks for sneaking me in. Regarding synergies around $750 million, will we be able to quantify the benefits from marketing and supply chain in March? Or will it be too early for that?

We aim to provide more guidance in March. We realize it's essential for your models. Updates on synergies will be part of our future guidance as they persist through the course of the year.

Thank you, Senara, and thank you to everyone for your time today, and of course for your interest in ConocoPhillips. Please stay safe. Senara, I'll pass it back to you for the wrap-up comment.