ConocoPhillips (COP) Earnings Call Transcript & Summary

Good morning, and thank you, everyone, for joining this session with ConocoPhillips and Chief Operating Officer, Matt Fox. Matt, thank you so much for being here today.

Happy to be here.

So I've got a bunch of questions queued up here. I thought we'd take a fireside-chat approach and just have a dialogue for 30 minutes. So probably the best place to start would be to just talk about this macro environment. It's obviously been rapidly evolving situation. ConocoPhillips has a ton of work in terms of proactively thinking about the macro environment and how to lay out their business plan based on what's -- how they foresee things happening rather than what is just currently happening. And so I'm curious how you and the team are thinking about what's happened in these past few months and what it could mean for the next 6, 12 or 18 months for the industry.

Yes. That's -- it's difficult to make those sort of long-term projections when you're in this sort of massive period of uncertainty. But we -- and as you know, Phil, we project a full range of outcomes. What we have been thinking about there is the implications of what we're going through for mid-cycle prices. We don't really know what mid-cycle price is going to be, but we're trying to say is there's something structural that might come from what we're going through just now that would influence mid-cycle prices. And where we're coming down is the -- it's likely that the demand trajectory will be lower than we thought pre-COVID that we don't know how much lower. But if you're on a balance of probability, there's more probability for lower than higher, for sure. So that, in and of itself, if you just consider that in isolation, would make you believe maybe mid-cycle prices will be coming down. But on the other hand, this is going to have significant implications for supply and supply growth, especially in the U.S., and it's obvious why. But obviously, rates are coming down as people are choking back capital dramatically. We are likely to go through a period of below mid-cycle prices for a while. The combination of that price and lower production means that companies have less cash to reinvest, assuming that the market doesn't inject equity or make debt easy to get. That would mean that the growth trajectories will slow down in the U.S. for a few years at least, so -- and may not get back to the trajectories we were on before. So we think the supply will come down and demand will likely come down. And that may end up balancing at a relatively unchanged mid-cycle price. It just depends on the balance of those 2 things. So we don't see an underlying structural change in the price outlook, although there may be some structural changes in supply and demand that may still balance around the same point. We do think of these scenarios, of course, we were modeling ranges from $40 to $70 a barrel. That was our P10 to P90 range. And obviously, we're well outside that sort of 1 standard deviation or 2 standard deviation, the level certainly were earlier this year. But the -- so maybe we should be widening a range of volatility. And as we think about this and making sure that we're designed for an even wider range of volatility than we thought we needed to be designed for.

So you don't -- I guess, as you look at the change in demand versus the change in supply, do you have any concern moving forward about shale being able to fill the gap? Obviously, that is highly influential to the potential price scenario.

Yes, it's a fair question. And it comes in, there's a balance of how much the rates come down and how long do we sit below mid-cycle prices over the next few years. It's possible that you'd find yourself in a place where that shale growth is inadequate. But bear in mind, there's a lot of other production of the -- outside the U.S. that could find its way back to the market. So it's possible that this could result in another swing to the upside in a few years because of the lower investment pace in the U.S. I wouldn't bank on it, but it's a possibility, that I'm sure.

Sure. Let's switch to maybe more company-specific question on the near term. You've given specific guidance. And quite frankly, you were one of the first in the industry to shut in production -- in large amounts of production, not only in the United States but even in Alaska, not only Lower 48 but also Alaska. And so how are you looking at that today as we are here in the middle of June and into July? Obviously, prices have tightened up, differentials have tightened up as well. So where do you stand on your shut-ins? And how quickly would you consider bringing them back?

Yes. So we issued a couple of weeks ago, maybe 3 weeks ago, a short slide deck to explain how we are thinking about the -- of what drove us to the conclusion that we should curtail production that's on our website, and I think Mark made that available to those who are calling in. But basically, what we were looking at was a sort of trade-off between short-term prices and long-term prices, obviously. But the -- and we created a very simple sort of diagnostic tool in the slide deck if people have access to. So that's Slide 6 in that deck. That's a really nice little graphic, I think, that explains the -- how we were thinking about it. I can describe it, and then I'll get to your question because it's very relevant to answer that question. Basically, this construct is a graph with an x axis that is next month's expected price because you know that we enter into agreements to sell in the trade month, and we actually deliver and receive the price in the calendar month. So we are in the trade month for July now, and we'll receive whatever the average price in July is, minus the differential that we expect. So that's the x axis is your expectation on next month's price. The y axis is your expectation of mid-cycle price. And then on the chart, there are blinds of Iso-IRR, if you like, that go from sort of Southwest to Northeast running across that chart. So for example, if you believe that next year's -- next month's price was going to average $30, for the sake of argument, that looks low now, but if it's going to average $30 and your mid-cycle view was price was going to average $50, you can plot the point there, and you can then interpolate what that implies with the internal rate of return. For those 2 numbers, $30 and $50, for our assets, we were estimating a return of between 20% and 30%. So at $30 a barrel outlook for the forward month, it was pretty obvious that you should be curtailing production if you had the balance sheet strength that allowed you to forego the cash. Now [indiscernible] reaches something like a 10% return, it's around $40 a barrel. So the -- we're now in that window here where it's not as obvious that economically that you should be curtailing. And it varies from asset to asset. So for Alaska, for example, we're curtailing in June. But in July, it's pretty clear that it will be economic to produce a deferral was unlikely to be a good economic decision. So we're bringing production back in July in Alaska. In the Lower 48, it's less obvious, and so we're going to bring some production back in July, but we're not going to ramp fully up. We are still concerned about July and August actual realizations because that might be very dependent upon how many people bring production back and how much can stack. Right now, it looks quite constructive. But things can change. So we're going to bring some production back in the Lower 48. We may essentially bring it all back in Alaska because it's more obvious there.

Okay. Got it. Stepping back in this bigger picture, you obviously gave a very thorough 10-year business plan back in November. And obviously, everything has kind of changed, at least for now. I'm wondering if you're trying to reframe that Analyst Day, maybe not all the 180-or-so slides, but to kind of just reframe the high-level big picture of how you think about growth in capital spending and those type of thing, $40 world instead of the $50 world and $50 WTI real, I think, is what it was basically based on. How would you reframe that for investors today if this was, indeed, the environment moving forward?

In a $40 world? Is that what you said instead of $50?

Yes.

$40 is just a few dollars above our sustaining price. So the -- we would not see significant growth in a sustained $40 world. That would be pretty much at our sustaining price. We would be able to see dividend growth and maybe modest production growth on the margin, but really, that's pretty close to the sustaining price for ConocoPhillips. And so had we put the plan together on that basis, it would have been more like a sustaining case than the 3% to 4% growth that we were -- that we would anticipate in a $50 mid-cycle world.

And so sustaining CapEx, I think you've talked about in the high 3s is around $3.8 billion or so. So maybe there's a little deflation or something there. But is it -- you're talking in that order of magnitude for the spending associated with that profile?

Yes, yes, yes. That's right. That's what we would take capital down to and then we'd be generating enough cash from operations to cover that capital and to cover a growing dividend, and that growing dividend would represent more than 30% of that -- of cash from operations being returned to shareholders. So the underlying model would stay the same, if you follow me. It would just be, obviously, a lower growth rate, and the dividend itself would be what would constitute the return on shareholders.

Okay. And how about the Big 3 within in that construct? Would you -- would there be -- obviously, there's base decline rates across the business. So does shale kind of grow and offset some of that base decline rate to get you to the overall flattish profile? Or how do you think about that?

Yes. That's how that will likely work. Now if we were anticipating a $40 mid-cycle price, then it would change our -- we talked in November about our optimum plateau, how we think about the optimum pace of development of the unconventionals. And we showed that we're -- basically, what we're doing is we're maximizing NPV within the constraint of an incremental cost of supply of $40. If we would anticipate in a $40 world, we would probably drop that constraint maybe to $35 to get us an extra cushion on for the return on the investments. If we drop that threshold to $35 million, then the optimum pace of development would be slower. We'd encourage it to grow more slowly than $35 incremental cost of supply. So I think it would end up being pretty consistent. Actually, there may be a slower rate of growth in the unconventionals. And because it just -- it happens to be the sustaining capital sort of price, it would be the growth in the unconventionals would be offsetting decline in the conventionals.

Right. Okay. That makes sense. How about Willow? I mean where would -- how do you think about that today in general? And how that would come to pass in a $40 case maze because there's still -- is the return still economic enough at $40? And would you -- obviously, it'd be chunky spending, right, so is that something...

That would be the challenge. The cost of supply of Willow is well below $40. So it's a competitive cost of supply even in a $40 mid-cycle price, and the challenge would be funding it in a $40 price environment. We may -- we would probably consider because we use the same model, the same asset model for the -- to get the optimum pace for development of Willow. We will probably end up running -- building a smaller facility actually and running at a lower rate for a longer period of time if we were to optimize Willow in a lower price environment. But the project would still be an attractive project, obviously, contingent upon what the Alaskans do with their fiscal regime.

Yes. I want to get to that in 1 second. Just a follow-up then. Remind me with -- you had a press release a couple of years ago, talking about what the initial capital requirements would be. Has anything changed in your opinion of what that capital requirement would be? And if you did a smaller facility, what kind of magnitude difference in costs would be -- would that imply?

Well, that's actually what we're going through just now, Phil, because we're on the -- we had our final appraisal season at Willow this winter. We had to abbreviate that. We only drilled 2 of the 4 appraisal wells that we had planned because we were concerned about a COVID outbreak in these really remote camps, certainly, the Western North Slope in the winter. So -- but that appraisal season is finished. And the timetable that we're on is we're evaluating those results. We're doing those sort of engineering for different concepts. And the concepts here really do come down to how big do you build the facility. Do you build it for 80,000 or 160,000? How big a facility do you build? And that obviously is the primary determinant of the capital cost. So we're going through that whole process at the moment. And the timetable that we're on is we will be in a position to make a concept selection decision by the end of this year. And at that time, we can -- so that's not a final investment decision. That would be another year, we'd have to do the final engineering. So a final investment decision is about a year after the concept selection. So a concept select -- we can select the concept and then FID a year later or we can defer the concept select and defer the FID. But that whole process is ahead of us just now. But the whole concept select is basically about how big do you build the facility, and that determines the capital.

And you obviously have the balance sheet today that if you wanted to fund it from the balance sheet, you could, but I guess, you haven't decided from a willingness standpoint, whether that's something you want to do.

No, not yet. I mean we wouldn't -- as I said, the final investment decision actually won't be until the end of the next year. There are no lease constraints that force us to develop it on any given pace. We've got a lot of flexibility on the pace that we develop it. And it will be influenced by the -- all capital investment in Alaska will be influenced by what the -- what happens with the fiscal regime as well. So that uncertainty is yet to be resolved, and that will be resolved by the end of the year, too.

And what's your view on how that's going, I mean, in terms of the education process with the citizens and how this might play out in November?

We've intentionally been soft playing this a little bit. We just felt it was a bit insensitive under the current circumstances that the -- where people are really not interested in having a dialogue about this. It's all -- they're concerned about COVID. They're concerned about the capital reductions that are already -- that have happened because of the price reduction. But as we go into the summer, then this -- our advocacy and our opponents' advocacy will ratchet up and the -- I mean, I've lived in Alaska through a few of these ballot initiatives and debates about fiscal regime and other things, and it does get -- you end up with a very vigorous dialogue with the Alaskan people, and I look forward again to engaging in that, and it will ramp up as we go through the end of the summer and into the fall.

And what are your latest thoughts on the farm-down process? Obviously, I presume this environment further delays that opportunity.

Yes, maybe a little bit. I mean we always said that we would -- we assume that we would not do the farm-down until next year. The -- so we included in our budget the fact that we would be at full 100% equity essentially in Kuparuk and Alpine. We wanted to get to a place where we had the concept selection done for Willow and the uncertainty resolved there. We want to get to a place for this fiscal regime uncertainty is behind us. So it will be next year is when we will start the process. Well, there are a lot of people interested in the assets. I mean these are very high-quality, long-life assets. So I'm not concerned about our ability to do. It's just a question of when is the right time to take it to market between the price uncertainty, the fiscal uncertainty and making sure that people can see the Willow project, for example, has been real. That's -- we'll get those things in place before we actually take it to market.

Sure. Okay. I guess let's step back and talk about the M&A situation more broadly. Why don't you share with us your thoughts about the current M&A environment today and Conoco's willingness to consider acquisitions? How has COVID influenced that backdrop?

I don't get a sense that there's a lot of imminent M&A out there from when we're talking to colleagues. I think that there's too much uncertainty in the minds of the potential acquirers and those who would be acquired. The volatility in equity prices has been stunning. And the mix is very difficult for managements on both sides of a transaction to really land on what makes sense. I do believe that potential sellers, they still believe that they can get some sort of traditional premium for their assets, and I don't think potential buyers will want to do that. So I think there's probably still quite a significant bid-ask spread. And it might take the -- we might need to get through the recovery some here and a bit more stability before those sort of conversations really get traction. That's my sense of it. And the -- so we'll just have to see how it plays out. But I don't pick up a sense that that's an imminent story of M&A activity ahead of us just now.

Sure. And I think, Ryan is at the conference last year. Ryan talked about this concept of no premium deals maybe becoming a new reality, but it just doesn't seem like it's quite developed there, to your point, so much volatility. I mean is that your stand as a potential buyer that it's hard to make the math work if there's a premium, essentially?

Yes. I mean the markets pricing these assets at pricing some long-term price, we would only be interested in bringing any sort of assets into the portfolio if the all-in cost of supply was below $50, preferably quite about below $50, and if the development of those assets was below $40. And it's not easy to do transactions at that level if people are expecting a traditional market premium. So 0 premium mergers could make sense because you bring the companies together, optimize the capital program, optimize the distribution program, get synergies from the -- both operationally and from the G&A. That could make a lot of sense for the industry. But it takes two to tango, 2 people to see that sort of vision in order for that to transpire. And that may -- that time may come, but I don't think really understand.

And then to the extent you kind of canvass all the opportunities that are out there, from your perspective, if ConocoPhillips is looking opportunities, I mean, how big of a transaction is kind of in line to consider? I ask this is because you obviously have a decent amount of availability on the balance sheet. But are you -- would you consider larger transactions that might require higher equity at some stage? Or is it more you're looking at bolt-on for your own business?

This could be a good period for asset acquisitions that could be companies that need capital to kickstart their growth again, for example, and may choose to try to sell assets. So it's possible that some -- and of course, there could be bankruptcies. It's possible there could be some high-quality assets available at a reasonable price and short of a corporate acquisition. So we will have our eyes open for that. On the corporate side, given the volatility, it's hard to believe that all cash transactions will be acceptable to sellers. I think that the -- so it's likely for corporate acquisitions, so we need to be probably a significant equity component. But the -- that's, again, it takes two to tango and in an uncertain world, it might be that the company being acquired would want equity rather than cash or at least some significant component of equity. But I think on the asset side, I believe there will be bargains that could show up here over the next year or so.

Got it. So in terms of buybacks, I mean, again, with the balance sheet, you certainly could do them if you wanted to. But are you more interested in retaining that flexibility or optionality that comes with the balance sheet rather than returning additional cash?

I think for the -- until we've got a better sense of the recovery pace and we know what sort of shape the balance sheet is going to be in, I think we'll probably hold off until we get a better sense of that. I mean obviously, we are committed to returning at least 30% of our cash to shareholders. But the -- we want to make sure that we have the balance sheet strength for the long term. So that's how we'll be thinking through the next several months, I think.

Sure. As you said, the dividend is 30% and 40%-ish. So one other one, just you continue to be a shareholder of Cenovus. How do we -- through a large range of prices for equity. So I guess, where do you stand? You've always said you're now a long-term holder of the stock. But I'm just curious, what is the framework you're using to think about the value of that?

Yes. We -- obviously, we know those assets very well. We own them for a long period of time. We don't believe that they're fully valued just like we don't need the cash. We're not going to exit in an undisciplined way. But -- so it's not in our immediate plans to do anything about it.

Right. Okay. I think we probably have time for 1 or 2 more questions here. But I guess, just thinking about the shale side of things, maybe just disaggregate your thoughts around, obviously, Bakken is an asset that you've been talking about more of a flat plateau from here; Eagle Ford, modest growth to a plateau; and then Permian, there's a huge runway of growth still. So...

And Montney also.

And Montney. And maybe even beyond 2030, Montney. So maybe you could just elaborate on your latest thoughts of how you'd frame each of those assets individually as you look out.

Yes. I would say nothing sort of fundamentally or strategically has changed for those assets. Obviously, we've seen production decline during this period where we've not been investing the capital. So we'll be reconsidering the -- come back to our asset trajectory model, our optimization model. Once things level out here and decide, okay, what's the optimum pace to go back to the investment. The underlying concept of Bakken essentially being a plateau, Eagle Ford being within a few years of plateau and the Permian with a significant ramp and Montney a significant ramp. That -- the fundamental characteristics of that haven't changed. But tactically, we'll be starting from a different place when we go back to investing again, and we just need to rerun the models and work out okay. And with this, if it is a new view of mid-cycle price and with the new starting point, what makes more sense. We'll be going through that process really around sort of October time, as we're heading towards our budget decisions at the end of the year. By that time, a lot of -- hopefully, quite a bit of this uncertainty is behind us. We may have a clearer view. It still won't be very clear of the trajectory that's ahead of us, and it should be easier to make some of those decisions. We'll know if the OPEC Plus group are maintaining discipline, we'll know if there's a second wave, if there's anything, we'll have a better sense of what's happening to demand. We'll have a better sense of what's happening to overall supply in the Lower 48. And I think that will be a good time to be making those sort of investment pace decisions towards the end of the year.

Right. So I guess at this point, you would not say that your definition of the right plateau levels has changed at all, just maybe a timing...

Yes. Yes. Those optimization models really do impose quite a bit of discipline on how you think about your balance and maximizing value with a -- constrained by a low incremental cost to supply. So it's -- so we'll get back to that sort of discipline. So the fundamentals haven't changed.

Yes. Absolutely. Well, Matt, I just want to say thank you again for being here today and participate in this fireside chat with me and your participation in the JPMorgan Energy Conference. Too bad it had to be virtual this year, but hopefully, look forward to seeing you again in person soon.

Same here. Thanks, Phil. Thanks a lot.

All right. Thank you.

Goodbye.