ConocoPhillips (COP) Earnings Call Transcript & Summary

Good morning, and welcome to the ConocoPhillips Fourth Quarter 2019 Earnings Conference Call. My name is Zanera, and I'll be the operator for today's call. [Operator Instructions] Please note that this conference is being recorded. I will now turn the call over to Ms. Ellen DeSanctis. Ellen, you may begin.

Thanks, Zanera. Hello to our listeners, and welcome to today's call. With me in the room today are Ryan Lance, our Chairman and CEO; Don Wallette, our EVP and Chief Financial Officer; Matt Fox, our EVP and Chief Operating Officer; Bill Bullock, our President of the Asia Pacific, Middle East region; and Michael Hatfield, the President of our Alaska, Canada and Europe region, are also with us today. Dominic Macklon, President of our Lower 48 region, was unable to join today's call. Page 2 of the presentation deck contains our cautionary statement. We will make some forward-looking statements during this morning's call. Actual results could differ due to the factors described on this slide and also in our periodic filings with the SEC. We will also refer to some non-GAAP financial measures today. And reconciliations to the nearest corresponding GAAP measure can be found in this morning's press release and on our website. And with that, I'm going to turn the call over to Ryan.

Thanks, Ellen, and welcome again to all our listeners. Well, it's certainly early in the new year and this sector is already off to another volatile start. Volatility can certainly be tough on an industry or a company if you're not built for it. Well, we're built for it, with clear resilience to lower prices, full upside to higher prices and a shareholder-friendly framework that works through the cycles. All of our usual results and outlook details can be found in today's published materials, but we're going to keep our prepared remarks pretty short. Our main goal is to reinforce why ConocoPhillips offers an attractive way to invest in this cyclical business. That's the key theme as we reflect on 2019 and we look forward to the future. 2019 capped off a successful 3-year period in which we transformed our business model and significantly improve the underlying performance drivers across our entire business. Slide 3 summarizes those 2019 results that contributed to this transformation. In the financial column, we delivered strong earnings, and we generated cash from operations of $11.7 billion, delivering free cash flow of over $5 billion. Our balance sheet got stronger. We ended 2019 with over $8 billion of cash and short-term investments and lowered our asset retirement obligation by almost 30%, largely due to dispositions. And our North Star return on capital employed was 11%. We delivered on our volume projections for the year with roughly 5% underlying growth, including 22% growth from the Big 3 unconventionals. The rest of our portfolio delivered strong base performance, and we progress new projects and exploration opportunities across our regions. Our world-class portfolio keeps getting better. As part of our high grading efforts, we generated over $3 billion of disposition proceeds, and we have another $2 billion of announced dispositions that we expect to close in early 2020. But we're not just selling. We're also on the lookout for opportunities to add low cost of supply resources to the portfolio, like we did last year in the Lower 48, Alaska and internationally. And when reserves closed for the year, we replaced 117% of our production organically. 2019 was another outstanding year for delivering on our disciplined, shareholder-friendly strategy. We returned 43% of our CFO to our shareholders. That's essentially all of our free cash flow. We paid $1.5 billion in dividends, including a 30% increase in our quarterly dividend, and we repurchased $3.5 billion of shares. In today's announcement, you saw our board approved an increase of our existing repurchase authorization by $10 billion to a total of $25 billion. This demonstrates our commitment to executing a consistent long-term buyback program. Finally, our execution focus goes beyond just the numbers. We continue to take leadership role in environmental, social and governance matters through target setting, engagement, disclosure, advocacy and stakeholder alignment. We call this performance with purpose, and it's an imperative. So 2019 is over, and we're in the starting gates for a new year and a new decade. In November, we laid out a powerful 10-year plan that can deliver on all the elements we believe investors want from this sector: a disciplined strategy framework, consistent execution, strong free cash flow and compelling returns of and returns on capital. That's the path we set for ourselves in 2016. That's what we delivered in 2017, '18 and '19, and that's what we're ready to do again in 2020. We're focused on executing a strategy that we believe is right for the future of our industry and certainly right for ConocoPhillips and our investors. So with that, let's go to your questions.

[Operator Instructions] And our first question comes from Doug Leggate from Bank of America.

I appreciate the opportunity for a lengthy Q&A session. So I've just got a couple, and then I'll let someone else jump on. I guess, first of all, there's a number of headlines have been circulating for quite a while now around Alaska tax, and that's obviously a little different from the last time you presented to us back in November. So I'm just wondering if you can offer your perspective as to how you think -- what you think is going on there, how do you think that plays out, whether they get signatures and what the implications could be as to how you respond to that. And my second one is really on the production outlook for 2020. Obviously, the Malaysia pipeline issue appears to be back on the table again. So I'm just wondering if you could walk us through the cadence of how we should expect production to evolve through the year. I'll leave it there.

Yes. Thanks, Doug. This is Michael. I'll answer the first question about the Alaska tax. So you asked where we are in this process. The division of elections in Alaska is currently certifying signatures now. They were gathered as part of the initiative for this November ballot. We anticipate that the initiative will be part of the ballot. So they're in the process of certifying those now. Now as we showed in November, we're currently planning to invest about $25 billion of capital over the next 10 years in Alaska. These investments will increase the state's production and mitigate the current decline through tax. In fact, in 2020 alone, our net capital and OpEx spend in Alaska is expected to be roughly $3.4 billion. On a gross basis, in 2020, total industry capital and OpEx spend in Alaska is expected to be about $6 billion. Now if there's a negative change in the fiscal regime, our investment plans will change. But we've been in Alaska for over 40 years. We know Alaskans understand the industry. It's the lifeblood of the state's economy. We believe Alaskans will understand that short-term revenue gain is a risky and fleeting proposition if it comes at the cost of billions of dollars of investment over the coming years. We've had ballot measure challenges over the past few years that would have negatively impacted our business and Alaska's economy. After understanding the issues, Alaska voters have voted no on all of them. Now we're part of an industry group that will provide information to voters about the benefits of the current fiscal regime, the benefits that it has on jobs, investment, oil production and long-term revenue to the state. So the bottom line is we're working hard to ensure Alaskans understand the significant benefits that investment by this industry brings to the people and the state of Alaska under the current fiscal structure.

So as things stand right now, no change in your current plans, more of a wait-and-see-type situation?

That's correct. So in terms of our current plans, we're waiting to see. We're executing on our current plans, but we are gearing up to help Alaskans understand our view of the benefits that the current fiscal structure brings to the state and the people.

Okay. And on the production cadence?

Yes. Doug, this is Matt. The -- I can give you an update on that. The -- so the most significant update in our production guidance, as you mentioned, was associated with the KBB production in Malaysia. As you know, most of KBB's gas is sold through the third-party Sabah-Sarawak pipeline to the Malaysia LNG plant and it's exported from that plant. So in normal operating conditions for 2020, we do anticipate about 20,000 barrels a day being exported through MLNG via the Sabah-Sarawak pipeline. But right at the beginning of the year, there was a significant operational issue with the pipeline. So our expectation for the year, given that we don't operate that, our expectation is that might not be repeated at all through the year. So that's what we're assuming at the moment. Then we're hopeful that we may get access to some domestic gas offtake. But the magnitude of that and how long it might last is uncertain. So that's the vast majority of the adjustment to guidance. We also had some puts and takes across the business units. And we also adjusted our expectation for timing of dispositions, but the new range of 1,230 to 1,270, best guess at the moment of what we should expect for this year. And that's about a 4% growth on an underlying basis.

Okay. Matt, I don't want to press the topic. But are there any particular dips in the quarterly cadence as we go through the year?

Well, obviously, we have turnarounds as we go into the middle of the year. We have one in the first quarter at Qatar, and then we have usual turnarounds in Alaska and elsewhere as we go through the second and third quarter. So it's a similar profile to previous years.

Our next question comes from Doug Terreson from Evercore ISI.

So Ryan, you guys are one of the few, if not the only big oil or E&P with higher rather than lower normalized returns on capital in recent years. And while your stock has been a top performer in S&P Energy 3 years in a row for this reason, in my view, your cash position is building, it's strong. You have better valuation in your equity than a lot of peers. And so you're basically better positioned than your peers for strategic activity. At the same time, you guys outlined a pretty compelling multiyear investment plan in November, which suggested that you can attain your returns profile even without meaningful strategic action. So my question is, with the ongoing decline in upstream values that we've seen in public and private E&P, one, have strategic actions become more appealing to you guys? Are they more compelling? And what effect on return on capital employed is needed for you guys to move forward in this area? So 2 questions.

Well, thanks, Doug. Yes, I think we believe we're on the right track with what we're doing in terms of what you describe our return profile focused on shareholder distributions, focused on free cash flow generation and a hyper focus on our return on capital employed. As I said, 2019 was 11%. That is our guiding North Star as we think about how we're executing the business. We have built a little bit of cash on the balance sheet. We believe we need it for the volatility we're experiencing in the marketplace. Just look at the month of January alone; early in the month, I think people were thinking it was headed to $70 a barrel, and now people are thinking it might be going to $40 a barrel. So that's the kind of volatility we see in this business, and we're keeping a balance sheet so we can execute our consistent programs, pay our capital, pay -- fund the dividend, pay our buybacks back to our shareholders. So we're executing that consistent program. We believe in it, and that's what we set up to do. And that's what we described to everybody in November that it's not just a 1- or a 2-year plan. This is a plan that's got a lot of legs and it can go on for the next decade. We have the portfolio and the people to execute on that plan. Now we have been in the bolt-on acquisition game. We've had some assets that I described in my opening remarks, and we keep on the lookout for some of those kinds of opportunities. But we also, I think, laid out a pretty consistent framework at our analyst meeting in November about how we think about those [Audio Gap]

As a consequence of that, we've resumed our legal enforcement actions. Of course, we're not the only creditor out there. It's a competitive marketplace. And so I think you'll understand that I can't go into any details at all about what those enforcement actions entail. But as you saw from us in 2018, you can expect us to vigorously pursue all legal remedies that we have available to us.

And we appreciate that. The follow-up question is just around some of the demand issues in Asia. And I was hoping, Matt and Ryan, you could put into context how we should be thinking about some of that demand weakness in the context of other demand checks that you've seen. And just how does it affect the way you think about your business, if at all?

Yes. And Neil, you're talking about demand for oil as opposed to, say, LNG?

Both would be interesting, actually.

Both. Yes. So we do see some -- I mean we're factoring in some demand loss in the first quarter of this year. And that translates into some reduction in demand as we go through the course of the full year. I think our estimate's still, as we look at the markets and look at the global economies, we're still projecting something on the order of 1 million barrels a day of demand growth as we go through 2020. Now that's probably down 100,000 barrels or 100,000 to 200,000 barrels a day because of the current issues that we're facing with the coronavirus in China. So we do see some impact to that. It will flow through to the storage side of the equation. So we'll see some building storage, we believe, in the U.S. and in the non-OPEC countries around the world as well. So that will put, obviously, some pressure on prices. We see inventory draws, though, coming later in the year. And we still see pretty good supply growth in terms of total liquids coming out of the U.S. that probably eats up most of the demand growth that we see coming from around. So it's going to be another volatile year, and that's what we've been preaching for, for the last 3 to 4 years because it's a well-supplied world and any small changes in demand or changes in what OPEC or others might do for the supply side will create that volatility that we've seen in spades here in January as well. We do see some weakness in the spot LNG market. It's had some pretty warm winters around the world. So demand has been -- demand growth, we still see over the long term in the LNG markets, but we've seen softness in the LNG side. And of course, you know how that lags in terms of how it manifests itself in our cash flows for the company. So -- but we still are long-term belief in the growth in the LNG market and still participating in that channel of the business.

Our next question comes from Phil Gresh from JPMorgan.

A couple of quick questions. First, just looking at the quarter, in the Lower 48, we saw some declines in the oil production quarter-over-quarter, NGLs and gas were up, I presume that was mostly mix effects. And the Big 3 was with Bakken and the Eagle Ford down. But just any thoughts you could share around that as well as we look out to 2020 and your guidance for 410,000 barrels a day there. Just any color you could provide around rig count and production cadence specifically for the Big 3?

Yes. Phil, it's Matt here. The -- yes, so I think you probably saw our numbers for the production individually for the Big 3. In aggregate, it was relatively flat. There was a -- Eagle Ford was down a little bit just because of the timing of framework we're bringing wells on, and there was growth in the Permian, and the Permian production is a bit gassier than the Eagle Ford production. So that's why there was that slight mix shift. In terms of the activity, the -- we averaged 12.5 rigs in the last year across the Big 3: 7 in Eagle Ford, 3 in Bakken and 2.5 in the Permian. And that was -- those were supported by 6 fractures. You'll have seen in our capital that as we go into 2020, it's pretty much the same level of activity in aggregate to the same capital cost for the Lower 48 last year.

Okay. Great. Second question for Don. The cash flows in the quarter looked a little bit light there. I think there is another bucket that had some headwinds. If you could just elaborate what might have been in that bucket? And just generally, how we think about cash flow for 2020, if there are any moving pieces we should think about, whether it's distributions or other things. You already talked about PDVSA, but anything else we should think about?

Yes, Phil, I can point to a few items that may help explain the cash flow in the quarter. The way we look at it, we take our ratable guidance items along with the cash flow sensitivities that we publish. And if you do that and nothing else, you come up with an estimate of about $2.9 billion CFO, and I think a lot of analysts came in at a number similar to that, whereas our actual results were about $2.7 billion. So to start, LNG realizations, we're about $100 million lower than what our sensitivities would have predicted because we don't incorporate the 3-month lag to Brent pricing. Brent was up about $1 quarter-on-quarter, but JCC fell $5. And so that's what's causing that impact. In addition to that, our adjustable controllable costs for the year came in at $6.14 billion versus our guidance of $6.1 billion. So that's $40 million or about $0.03 a share on that, and that came through the SG&A. And the items on -- and you all have noticed that SG&A was up quarter-on-quarter, and what drove that increase was basically 2 things about equally split: the mark-to-market on compensation because of the good quarter that the stock enjoyed in the fourth quarter; and the other was due to an accrual that was made related to employee-based incentive compensation. So those were kind of unusual items. And we also made a pension contribution to the U.S. qualified plan that was probably about $50 million higher than what our typical quarterly run rate was. And so I think if you look at those items -- and even though we don't -- we try to encourage people not to include the PDVSA $90 million payment, we know that some do. And so that may have been a contributing factor for some folks. As far as 2020, I think we've been pretty clear about what our distribution plans are, $3 billion of buybacks. Nothing has changed on that. Our dividend rate is what our dividend rate is, until we consider adjusting it probably toward the end of the year. So that won't have much impact. As far as CFO, you've got some new sensitivities that have been updated for 2020 in the appendix of the materials that we published today. And I would say as far as a benchmark and expectation on CFO at, say, current prices, around $50 WTI, we would expect about $8.5 billion to $9 billion of CFO.

Okay. Great. That's very helpful. Just one clarification. With the proceeds from distributions of $2 billion, I assume that's gross. Is there a net amount that you might have for that?

I don't know that I can provide you a net on that. I know our Australia headline -- Australia-West headline number there is about $1.4 billion, and we would expect cash proceeds to be about $1.1 billion based on our expectation of closing at the end of this quarter. And then Niobrara, the proceeds on that are going to be close to $400,000 about $380,000. But I haven't seen the estimates on cash on that. But I would expect it would be close to the proceeds. And then the remainder is just smaller assets that we'll do to round off to the $2 billion.

Our next question comes from Roger Read from Wells Fargo.

I think that was probably the shortest management introduction I've been on a call in at least the last several years, so congrats on that. A couple questions. A couple questions to follow-up on, one on Neil's question about the demand issues in Asia and maybe more specifically on LNG there. There have been some reports that some of the buyers in China made a clear force majeure, and that's kind of a just-in-time market. So I get that if they're not getting offtake, they're going to run into other issues. So I was curious, direct exposure to China as you think about it. And then the second question on the LNG front. Just an update of where we are with the cutter expansion and everything.

Roger, it's Bill Bullock. I'll take this one. First, we've heard similar concerns raised in the market about force majeure into Asia. But to date, we haven't had any force majeure declarations. So we are continuing to watch the market and see. If we do, we'll be addressing those with spot sales or domestic sales in the market and managing appropriately. So nothing to date, but we have heard similar concerns. With respect to Qatar, we continue to be very interested in Qatar. We continue to believe we're well placed. Qatar is a great location with -- serves the global market with low-cost supply resources. And it's a strategic location that works well for both Europe and Asia. We are still in the process. That process is being managed by Qatar Petroleum, and they're in control of that pace, and we're moving along at pace as they provide. Really can't say any more on that at this time. What I can say is that we're very hopeful the opportunity is going to be a competitive cost of supply addition to our portfolio. And as we laid out in November, it needs to be a competitive cost of supply to be an attractive addition. So that's kind of where we're at for Qatar.

Just a quick follow-up. Is there any reason to think anything material has changed in the project since kind of late last summer when it picked up and certainly the Analyst Day in November?

No. No. QP continues to manage a very good project.

Our next question comes from Jeanine Wai from Barclays.

My first question is on ROCE. It's 11%, very strong for 2019. And the 10-year plan calls for a 1% to 2% improvement per year, assuming your $50 WTI with some inflation. So ROCE about 16% in 2025. So in terms of what is contributing to this improvement, can you talk about the ROCE of the incremental addition -- incremental production adds relative to what you're achieving today? So perhaps any color you may have on the absolute ROCE of the Big 3 or maybe some future Alaska projects or any other conventional projects?