Burgess COMMENTARY

Peter Burgess

Conoco's Tough Decision Praised By Analysts, Sold By Investors

ConocoPhillips' management team began the company's 4Q15 conference call with refreshing, though sobering, realism. Right off the bat, CEO Ryan Lance pointed to the challenges the company in particular, and the O&G industry in general, is facing amid the 70% fall in oil prices since mid-2014. As a result of the challenging price environment, COP has decided to cut its dividend to 25 cents per share, compared with the previous quarterly dividend of 74 cents per share. The dividend is payable on March 1, 2016 to stockholders of record at the close of business on February 16, 2016.

Some of the analysts on Thursday morning's call praised company management for making the tough call to cut the dividend, one of whom cited what he called COP's 'really detailed and thoughtful economic analysis process.' Another questioner said, 'I actually want to compliment management and the firm for making the right choices when the market condition changed. And I actually think that it will improve your long-term competitive position.'

However, in midday trading following news of the dividend cut and a 4Q15 loss, COP's stock was down 7.69% ($2.97) to $35.66. This is a massive move for an equity of this size and it equates to about $3.5bn in lost market value in a single trading day.

enter image description hereChart Source: Bloomberg

'A Tough Decision, But The Right One'

'Today we announced one of our toughest decisions, but we believe it's the right one...We're not willing to risk a strong balance sheet in the hope for a quick fix to prices,' Ryan Lance, ConocoPhillips CEO, said on Thursday's call.

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Jeff Sheets, EVP of Finance, explained the reasoning behind the decision. The fall of oil prices since mid-2014, but most particularly the 'depth of the drop over the last 8 weeks to 2 months,' were the most significant factors. This, combined with the conversations COP has been having over the last month with ratings agencies, prompted the company to make the 'difficult decision to reduce the dividend.'

'The dividend has been, and will continue to be, a top priority. We still intend to provide a competitive dividend, while significantly lowering the breakeven price for the company and substantially reducing the level of borrowing in 2016. Our actions also position us to deliver strong absolute and relative performance as prices recover,' CEO Lance added.

The World Has Changed

'Just a few months ago, we thought the market would rebalance by the second half of 2016, now it looks like that could stretch into 2017,' Lance said on the call.

During the Q&A portion of the call, he expounded on that statement, 'We weren't anticipating a drop from $50 down to $30 like we've seen in the last 7-8 months. We expected to see inventories to start flattening out by now but they've continued to build...This leads to our concern that lower prices would extend throughout 2016 and we wouldn't see a rebound till 2017.'

enter image description hereRyan Lance

Lance has been consistent in his realism. One year ago in the 4Q14 conference call he said, 'There's a lot of debate right now about the duration of the current low oil prices...But we're assuming that they will stay low for 2015 and we're taking decisive actions accordingly.' In February 2015 he said 'We now believe it is prudent to position the company for lower, more volatile prices for the foreseeable future. In July's 2Q15 call, Lance said COP is positioning itself 'for a period of lower, more volatile prices.' Finally, in the 3Q15 call he said, “We are accelerating actions to position our company for low and volatile prices, while improving the underlying performance of the business.'

Discussing the current market environment, COP sees continued deterioration in the near-term price outlook, a protracted supply/demand imbalance, and growing concerns about world economic and oil demand growth. Consequently, ratings agencies have lowered long-term price outlooks, significant industry credit downgrades have already occurred and more are expected, and there's shrinking debt capacity within ratings across the industry.

Capex Reduction, 2016 Production Flat

COP lowered its guidance for 2016 Capex by 41% compared to 2014- from $7.7 billion to $6.4 billion, primarily driven by reduced activity in the Lower 48. And guidance for 2016 operating costs has been reduced from $7.7 billion to $7.0 billion.

Consistent with the capital reductions, COP revised its full-year 2016 production guidance to be essentially flat with 2015 production of 1,525 M/boepd, which excludes 64 M/boepd for the full-year impact of completed dispositions. 1Q16 production guidance is 1,540 to 1,580 M/boepd. On the call, company management referred to its phased exit from deepwater GOM exploration announced last year. As deepwater exploration has higher resource risk and a longer-cycle time, COP judged that an onshore shift is prudent given current market realities and the company's short- and medium-term strategy.

Matthew Fox, EVP, E&P said the company will remain focused on those areas it can control amid a difficult year. 'It looks like 2016 may be an even more challenging year for the industry than we have experienced in 2015, but we remain focused on what we can control: delivering best in class operational and safety performance. And we're ready to ramp up the development of our diverse, flexible, low cost of supply resource base when prices recover.'

The slide below from Thursday's conference call summarizes COP's operational priorities for this year:

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'The actions we have announced will improve net cash flow by $4.4 billion in 2016. The decision to reduce the dividend was a difficult one. The dividend has been, and will continue to be, a top priority,' Lance said.