ConocoPhillips (COP) Earnings Call Transcript & Summary

Welcome to the ConocoPhillips Market Update. My name is Liz, and I will be your operator for today's call. [Operator Instructions] I will now turn the call over to Phil Gresh, Vice President, Investor Relations. Sir, you may begin.

Thank you, Liz, and good morning, everyone. Thank you for joining us today for our market update call to discuss this morning's announced transaction between ConocoPhillips and Marathon Oil Corporation, as well as an update to the company's distribution plans. On the call today, we have several members of the ConocoPhillips leadership team, including Ryan Lance, Chairman and CEO; Bill Bullock, Executive Vice President and Chief Financial Officer; Andy O'Brien, Senior Vice President, Strategy, Commercial, Sustainability and Technology; and Nick Olds, Executive Vice President of Lower 48. We have a slide presentation posted on our website that we will be walking through on today's call. A couple of important administrative reminders. We use some non-GAAP terms this morning, and reconciliations to the nearest GAAP measures are included in today's release and on our website. Also please note, we will make some forward-looking statements based on current expectations as well as statements about the proposed transaction between ConocoPhillips and Marathon. A description of the risks associated with forward-looking statements and other important information about the proposed transaction can be found in the joint press release and on Slides 2 through 4 of the presentation. Finally, as a reminder, we'll be taking questions at the end of the prepared remarks, and we'll take one question per caller. Now I'll turn it over to Ryan.

Thanks, Phil, and thank you to everyone for joining our market update call to discuss ConocoPhillip's acquisition of Marathon Oil Corporation. Now logistics dictated that we host this call in person from New York this morning, and Lee felt strongly he wanted to be in Houston with his team and the Marathon Oil employees. Otherwise, he would be joining us on the call this morning. I want to start off by saying that the acquisition of Marathon is a perfect fit for ConocoPhillips. Under Lee's leadership, Marathon has demonstrated many of the same values and priorities around safety, strong operational performance and a commitment to ESG leadership and a CFO-based return on capital framework where our shareholders come first, and Marathon has a high-quality asset base with adjacencies to our own assets that will lead to a straightforward integration and meaningful synergies. Turning to Slide 6. I'd like to start by covering some key highlights. First, this is an all-stock transaction with an enterprise value of $22.5 billion, inclusive of $5.4 billion of net debt. ConocoPhillips will be issuing roughly 144 million shares in connection with the transaction. We expect the transaction to close in the fourth quarter of 2024. From a financial perspective, the acquisition will immediately be accretive to earnings, cash flow and return on capital per share. We expect to achieve at least a $500 million synergy run rate within the first full year following the closing of the transaction. And importantly, we see this transaction lowering our total company free cash flow breakeven, which unlocks additional return of capital to our shareholders. Along with this transaction, we are providing several shareholder distribution updates. First, we have announced our intent to increase our ordinary base dividend by 34% starting in the fourth quarter. This is independent of the transaction. Second, upon closing the transaction and assuming recent commodity prices, we will increase our annual share buyback run rate to over $7 billion, over $5 billion today. And third, looking out further, we plan to buy back at least $20 billion in shares in the first 3 years post close. That will allow us to retire the equivalent amount of newly issued equity in 2 to 3 years. Moving to Slide 7. I wanted to frame out how this transaction fits within our disciplined M&A framework that you are all very familiar with. As a reminder, our 3 key tenants are: that an acquisition must meet our framework, it must make our plan better, and we have to be able to make the assets better. And Marathon clearly meets all 3 criteria. In terms of our framework, Marathon's core Lower 48 assets are competitive within our portfolio, adding more than 2 billion barrels of resource with an average point forward cost of supply below $30 WTI. Second, as I already mentioned, the transaction makes our plan better as it's immediately accretive to earnings, cash flow and return on capital per share. And third, we have a clear line of sight to making the assets better through a combination of synergies, differential technology and increased scale. Bottom line, Marathon fits very well within our current operations, and we see a number of opportunities to unlock value from the combined portfolio. So next, I'm going to turn the call over to Andy to walk through some of those opportunities in more detail.

Thanks, Ryan. So moving to Slide 8. I want to start by talking about how Marathon's core Lower 48 assets line up very well with our portfolio, which you can clearly see on the slide. Starting in the Eagle Ford, this transaction will further enhance our premier position in the heart of the play, increasing our production to nearly 400,000 barrels per day and adding roughly 1,000 new primary locations to our inventory. We also see significant upside potential on refracs. We've been implementing new refrac techniques across our existing Eagle Ford position that expanded our refrac inventory at cost of supplies to compete with our Tier 1 opportunities. We will be doing the same on the Marathon acreage. In fact, based on our detailed analysis, we believe that Marathon has over 1,000 refrac locations in this Eagle Ford acreage. All totaled, we see over a decade of runway in the Eagle Ford. In the Bakken, our pro forma production will double to over 200,000 barrels per day. We really like the Bakken as an all way to play and has the lowest reinvestment rate within our unconventional portfolio. Bakken will drive solid free cash flow generation with a combined drilling inventory of over 10 years. On a stand-alone basis, both companies' Bakken programs are very similar in terms of drilling rigs and factories and we see opportunities to rationalize the combined companies' activities to maximize capital and operating efficiencies. Moving to the Permian. Our existing asset base is clearly much larger in size, making the Marathon acreage position more of a traditional bolt-on, adding 400 more locations to our already deep inventory base. Marathon's position is likely developed today and recent performance has shown strong oil productivity. Marathon's acreage will also provide us more opportunities to core up for longer lateral development via swaps and trades, which is something that we do every day. The Anadarko Basin is primarily focused on natural gas, we see this as a call option on the normalization of U.S. gas fundamentals driven by growing power and LNG-related demand. Finally, in Equatorial Guinea, we'll add 2 MTPA of net LNG capacity to our global portfolio. Equatorial Guinea is a free cash flow engine for Marathon today and Marathon has been working hard to improve this asset, which is evident with the 5-year free cash flow profile that the company has recently outlined. As we further build out our LNG business, we will leverage our technical and commercial capabilities to enhance the value of these assets over time. Moving to Slide 9. Our initial synergy target is at least $500 million per year, which includes roughly $250 million from G&A costs, $150 million from operating costs and commercial improvements, and $100 million from capital costs. From a G&A perspective, we will reduce overlapping costs across the combined organization. Regarding operating costs, we are streamlining field operations throughout the Lower 48, taking advantage of the adjacencies across the combined footprint. We will also leverage our scale on the procurement side. Similar to our prior major Permian transactions, we'll take full advantage of our commercial capabilities in order to maximize realizations and reduce [ T&P ] costs. Finally, moving to capital, we'll also leverage our enhanced cost base and footprint to drive further reductions in drilling and completion costs. Putting it all together, we see $500 million in synergies as a good starting point, which we intend to achieve on a run rate basis within the first year after closing. As we've demonstrated in past transactions, we think there will be upside potential as we close the deal and begin the integration process. Moving to Slide 10. I want to step back and talk about this transaction in the context of our overall portfolio. The key takeaway is that ConocoPhillips remains differential by its depth, durability and diversity while adding further scale to our unconventional portfolio. Following this transaction, we will remain the largest independent global upstream company. We'll enhance our position as one of the most durable companies in the U.S. unconventional industry as measured by debt and -- debt and quality of our remaining inventory, and we will maintain the benefits of our diverse global portfolio with roughly 40% of our production coming from outside of the Lower 48. And this is before the organic investments in LNG, Willow and other conventional assets that will come online over the years ahead. I'll now turn it back to Ryan to talk about our distributions and then to wrap up.

Thanks, Andy. Now moving to Slide 11, I wanted to provide a bit more context for our updated return on capital plan. Let me start with the dividend. Independent of this transaction, we have announced a plan to increase our ordinary base dividend by 34% to $0.78 per share in the fourth quarter. This will effectively roll the current $0.20 per share VROC into the base. We have spent a fair amount of time looking at this. Based on all of our portfolio improvements we have made in the recent years, we feel quite comfortable with the step change in our ordinary dividend, driven by the quality of our asset base and the durability of our stand-alone cash flow profile. And we can continue to grow the ordinary dividend at a rate that is competitive with the top quartile of the S&P 500, and this will only be helped by the transaction. which further reduces our free cash flow breakeven. Moving to share buybacks. Upon the closing of the transaction and assuming recent commodity prices, we will increase the annual run rate of buybacks to over $7 billion, up from over $5 billion on a stand-alone basis today. When combined with our higher ordinary dividend, this would put our total quantum of distributions at a run rate that is over $11 billion. And we are confident that this phase of share buybacks will be sustainable, allowing for at least $20 billion of buybacks in the first 3 years after the transaction closes, effectively retiring the equivalent amount of the newly issued equity within 2 to 3 years of closing. All this is consistent with our long-term framework to return at least 30% of our CFO to shareholders through the cycles as well as our long-term track record that is well over 40% of CFO. So to wrap up on Slide 12. As I've said at our Analyst and Investor Meeting just over a year ago, we will continue to execute on our plan and look for ways to make it better. The acquisition of Marathon does just that. It fits our framework, it makes our plan better, and it makes the assets better. The transaction will be accretive day 1. We have line of sight to at least $500 million in annual synergies with upside potential. The combined company will have a lower free cash flow breakeven, and we are increasing our ordinary dividend and share buybacks, with total distributions that are consistent with our long-term CFO based track record. We continue to get better, and I continue to believe that ConocoPhillips is the must owned E&P in your portfolio. Now let me turn the call back over to the operator, and we'll start the Q&A.

[Operator Instructions] Our first question comes from the line of Lloyd Byrne with Jefferies.

Congrats. Ryan, I've done this for a long time, and I would argue, no one has made more correct M&A decisions than your team, both timing and asset quality wise. So I guess, what I'm interested in is, why now? And what is it that makes this opportunity the right one when so many others have gone through it? And maybe, you talked about scale a couple of times and maybe that's something you could focus on?

Yes. Lloyd. Appreciate the question. Look, we've always tried to be opportunistic. We look at all the kinds of opportunities that are out there. We stepped back a number of years ago looking for where around the world have the lowest cost of supply rocks and then who owns those rocks. So we follow the companies like that, and certainly identified the shale, both here in North America and U.S. Lower 48, Canada and some conventional assets around the world that were very interesting to us. So we followed this for quite some time, tend to be opportunistic, but most importantly, it has to fit our framework. So we were very -- we were just trying to communicate to you and we showed you repeatedly what our framework looks like. We never know when these opportunities come available, and this one certainly became available or came to our attention here a few weeks ago. And we spent some time looking at it. We could see the -- we know the Eagle Ford quite well, the Bakken quite well, and saw the significant overlap and the opportunity that this represented for the company. But we sat back and made sure it fits our framework, that it makes our 10-year plan better and that we have a clear line of sight to make the assets better. And that clearly checked all the boxes for the company. But first and foremost, it fit our framework. It fit how we think about the business, how we think about mid-cycle, prices, how we think about the commodity price. And look, we think we're heading into a period of what I'd call, kind of shale 2.0, which -- it's more about using technology and efficiencies, data analytics and some of the refrac potential that we can get into. I'm sure on the call, a little bit, that we see that allows us to extend some Tier 1 inventory, both in the Eagle Ford and the Bakken, and we're pretty excited about what this next leg is going to show for the company. And so that's why this is such a good fit at this particular point in time for us in the company. We weren't necessarily out looking for something, but it was an opportunity that presented itself.

Our next question comes from the line of Betty Jiang with Barclays.

Congratulations on the deal. I want to focus a bit more on the synergy side. Looking at the $500 million of annual savings, specifically perhaps on the cost and commercial optimization and then the capital optimization, do you think that Marathon did a good job managing costs? Where do you think where the most opportunities are on the cost side? Is that going to get realized in [ LOE ]? And then on the capital optimization side, will we start seeing some different capital allocation across the various plays in Marathon portfolio where you start seeing that topline?

Betty, this is Andy. I can take that question. Maybe starting on the cost side of it. And I think taking it sort of really back to sort of the beginning is that we expect this to be a pretty seamless integration after we close. I mean we touched on this in some of the prepared remarks. Marathon is a very good cultural fit with us, similar safety, operation focus and ESG focus. And it certainly helps on the -- as we're going through the integration, we're literally down the street from each other. So I think maybe starting on the G&A side of things, there's some pretty obvious G&A synergies. I think the slide we showed with the math on the overlap of the assets, given the adjacency of those assets, and we expect the back office support to be seamlessly integrated and that's essentially going to remove any duplication. We're also going on full math into all of our systems and processes and fully integrate into our work streams. And then all of the corporate-related functions are going to be combined. So I think on the G&A side, we refer to the scaling as an example of bringing it together into our scale, allow us to take all that duplication out. On the operating cost side of things, some of the examples of synergies there. We both have kind of base examples. We both have field offices and operations that are essentially crisscrossing each other in the field. And we'll mobilize the workforces and combine that footprint, again, sort of seeing the savings there. But then sort of -- more sort of the technical side of running the assets, we see pretty good opportunities to rationalize the work-over rigs that we're running on that combined footprint. So again, there'll be opportunities there. On the capital side of the equation, what we've consistently talking to here are the synergies that we are sort of -- and committing to the $500 million, this is going to be, to start with, again, from our size and scale on the supply chain side of things, we're going to see advantages in things like OCTG costs and rigs, frac and sand. And I don't want to underestimate sort of the value there is in sort of our ability to run consistent programs of scale, how that drives cost savings for us. Another example there in the Eagle Ford, we'd expect to implement super zippers and remote frac operations. That's not something that Marathon is doing today. So that's kind of how we see the way we'll get to the capital savings. But I think you also mentioned the commercial. The things that we see as upside that we haven't baked into the valuation, and we see our global commercial footprint being a real advantage to us, just like we did when we acquired Concho. And we'd expect to see enhanced value across oil, gas and NGL from these assets. And then the other piece is that we are pretty excited about and we haven't factored value into this at this point, but the ability to sort of rework the combined drilling programs within the actual assets themselves and across the basins is going to drive value for us over time. And Bakken is a great example of this, where combining them will be a better company. We see opportunities to reduce the total rig and frac counts that we have. We're both running very similar programs today. We'll be able to level load frac through. So there'll be clear savings there. We haven't factored that in yet. That's sort of what we're excited about and the team is getting their hands on it being able to optimize for those programs. So I think we've demonstrated in the past a track record that we're able to seamlessly integrate assets. We think this one with the overlap is going to be reasonably straightforward for us. And we expect to basically realize a fair bit of upside to that.

Our next question comes from the line of Roger Read with Wells Fargo.

Congratulations on the transaction here. Since you kind of opened it up on a previous response, the refrac opportunity, as we think about that within the overall cost of supply, and as you said, moving some of the, I believe you said, Bakken acreage into a Tier 1 level. Like what exactly is that process? How should we think about that developing?

Yes, Roger, this is Nick. Maybe just start back on the inventory that we spoke about in the prepared remarks on the development side. Again, we start with 2,000 locations across the 3 basins, Eagle Ford, you can think about that, about 1,000 locations there. And then between Bakken and the Permian, that's roughly equally split across that very competitive cost of supply and very competitive in our overall portfolio. Such is the development side. So to your question on the refracs, we have a long history, as you're aware of, with doing refracs, specifically in Eagle Ford, over 5-plus years and where we see roughly a 60% uplift in expected ultimate recovery. And then we continue to test newer refrac techniques and expand that across the entire Eagle Ford portfolio. And what that is leading to, Roger, is expanding that inventory in our own company. We see very promising opportunity to expand that to Marathon. And that leads to the 1,000 locations in Eagle Ford for refracs. Now regarding to the cost of supply component, put a little bit of background on that. A typical refrac costs about 60% to 70% of a new well. We're actually even seeing some of those costs coming even below the 60% mark, which is very encouraging. And again, when you look at the early vintage wells that we do refracs on, we're getting 60% uplift of [indiscernible] compared to that original well location. On the cost of supply, very competitive. They're in the low 30s to high 30s on cost of supply. And as we talked about, that's really expanding, expanding that Tier 1 inventory. So very competitive in the portfolio. And then I think what gives us further confidence is that 5-year history. So we've got demonstrated performance. We've got consistent performance on the refracs. We're looking at these new refrac techniques, really promising results, and that gives us the confidence in that refrac strategy and the go-forward inventory that Andy referenced.

And I would add one thing, Roger, real quick to remember it's where the rocks are at. So it's the type of rocks that you have and the inventory goes consistent with that. So remember where the volatile window is and where that kind of window is at, that makes a difference on the capability around the refracs.

Our next question comes from the line of John Royall with JPMorgan.

Congrats on the deal. I wanted to go to the return of capital. So can you talk about how you stress test your base dividend given the hike? And if you can confirm the VROC will now fold into the base? And if that's the case, what changed in your thinking there between previously using the VROC and now not? And should we think of the buyback now as kind of the more variable flywheel?

John, this is Bill. Maybe to start with our return on capital and our ordinary dividends. So as we talked about in our prepared remarks and as Ryan said this morning, that irrespective of the transaction, we are quite confident in the cash flows and improvement that we've seen over time in the portfolio. So increasing the ordinary dividend in the fourth quarter as the plan is essentially rolling VROC into that. We really like where we're at in the portfolio on that. And of course, we stress tested the portfolio. You saw in AIM. We do a $40 stress test on that. And it's just an indication of the strength of the portfolio and improvements we've made over time that allows us to confidently roll that into our ordinary dividend. I think it's important that as we look at that, as we think about that as a company, one of the things that we believe continues to be important is the ability to grow that ordinary dividend consistent with the top quartile of dividend paying stocks in S&P. And so we've looked through time in our plans, and we feel quite confident in our ability to do that through the cycle. Then when you think about the overall return of capital, as we indicated today, that at current pricing, we'd expect on close to increase our buybacks by about $2 billion, that will take the total quantum up to a little north of $11 billion. We're currently at about a 40-60 split, that will take us up to 35-65. We really like the value of our shares. We think that there's good value in there. So leading into that, we think, makes sense as a well-balanced portfolio. And then VROC, so certainly, leading into our shares right now, we think makes the most sense. But VROC continues to be a tool in our portfolio, particularly if we see high price excursions again in the future. So that really is how we're thinking about it. It's pretty consistent and it's pretty structured.

Our next question comes from the line of Alastair Syme with Citi.

I just wanted to try and put that in volume terms because I think, you talked at the Analyst Day last year about the back end coming off production plateau at the end of this decade, and I think Eagle Ford in early 2030. So sort of -- does this transaction change your perspective on a pro forma basis of when these basins start to mature and decline?

This is Andy. I'll take that question. So in terms of the way we think about the growth, as we always have said, our primary focus is on the returns and the growth is the outcome, and we really focus on and make sure we execute the scope as efficient as we can, and that's where we're laser focused. But that said, specifically to your question around sort of the impact of this on our overall growth rate, it really doesn't change what we showed at AIM over a 10-year plan at all in terms of the output of what we see the growth of the company being. As we combine the programs, we'll be looking to an opportunity to sort of optimize them as we've previously talked on. And we've not really factored any of the sort of optimizing of the programs into this yet, that's sort of all upside that will be focused on from the growth. And I do want to sort of -- I know we're here talking about this transaction today. But I do want to remind everybody, sort of our growth doesn't just come from the unconventionals. We're going to have a steady run rate of growth coming in terms of -- I think of cash flow growth, but it has production obviously with it, too, as we -- in the second half of the decade, as we have the NFE project, [ whole other ] projects, the NFS project, the Willow coming on. So I wouldn't really be changing anything in terms of what we've previously said about growth.

Our next question comes from the line of Stephen Richardson with Evercore ISI.

A quick one, if I could. On the -- I think it's implicit, but it hasn't been said explicitly. I mean Marathon has been spending about $2 billion a year of CapEx and running about 9 to 10 rigs in the Lower 48. So just wondering if you could confirm as you've looked at it, acknowledging you've got $100 million of capital optimization synergies. But in your base case, you expect to effectively run a very similar program going forward. And if I could also slip in one. Ryan, could you just talk a little bit about the divestiture target here? And is that weighted? I appreciate that's probably across the portfolio, but is it weighted, legacy Conoco or anything you see at Marathon to the extent that you can divulge at this point?