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The proposed spinoff of the refining segment of ConocoPhillips (NYSE: COP ) is expected to take place sometime next month. Is there an opportunity here? Absolutely. I believe this move will be of tremendous benefit to the upstream exploration and production segment.
Last July, Marathon Oil (NYSE: MRO ) completed the spinoff of its refining and marketing business, Marathon Petroleum (NYSE: MPC ) . Immediately after the spinoff, ratings agencies downgraded the upstream company, which I thought was stupid. Despite initial hiccups, the stocks have returned 40% and 35%, respectively, in the last six months. Marathon Petroleum, in fact, seems to be among the most exciting refining stocks this year. The success of Marathon Petroleum is why I'm excited about ConocoPhillips' spinoff.
Better margins, higher returns
In 2011, while more than three-quarters of Conoco's revenue was derived from refining and marketing, the segment accounted for only about 30% of after-tax net profits. That's not really surprising, since refining businesses have lower margins compared to their upstream counterparts. I expect the spinoff to allow for better margins and potentially higher returns for shareholders. For Conoco, return on equity for the last 12 months was 18.5% while the corresponding values for ExxonMobil (NYSE: XOM ) and Chevron (NYSE: CVX ) were 26.9% and 23.7%, respectively. While Exxon and Chevron have globally diversified refining segments, that is not the case with Conoco, whose refining margins have dragged down returns. That's why I believe that post spinoff, Conoco might do more justice to its ROE, and to shareholders.
The future looks exciting
In the exploration and production segment, the company holds around 8.4 billion barrels of oil equivalent in proved reserves. Conoco has a high reserve replacement ratio of 112%, which means it has added more reserves than it produced. The company is streamlining its portfolio with plans to sell non-core assets over the next two years. As a pure-play diversified E&P company, Conoco's U.S. and Canadian reserves remain the most exciting prospects and should witness strong growth.
The shale plays of Bakken, Eagle Ford, and Permian, along with the Canadian oil sands of Athabasca, should witness substantial production growth. The Greater Prudhoe area in Alaska is another exciting prospect. Conoco is also in talks with Exxon and BP over a $40 billion project to transport natural gas from Alaska to Asia.
Foolish bottom line
Asset-wise, the E&P segment accounts for around two-thirds of the total value. As a result, shareholders will receive one share of Phillips 66 -- the new refining arm, post-separation -- for every two shares of ConocoPhillips stock held. Watch this space for more on Philips 66.
For now, things look exciting for the upstream segment. As a special mention, I think Conoco should gain immensely from the spin-off. Keep abreast of the situation by adding Conoco to your free personalized watchlist.
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