Last fall, ConocoPhillips (COP 0.88%) released a strategy designed to create value for investors in the current low-oil-price environment. The focus of that plan is generating cash flow at lower oil prices so it can allocate that capital toward the dividend, share buybacks, debt repayment, and high-return growth projects. Furthermore, the company said that it planned to accelerate that strategy by selling between $5 billion and $8 billion in assets over the next few years, with sales primarily focused on North American gas assets.
However, thanks to two brilliant moves, ConocoPhillips blew past its asset sale goal in a matter of months, which will enable it to not only meet its targets three years early but set new goals. To top it off, the company accomplished all that while retaining upside in those assets, allowing it to benefit from rising commodity prices.
Image source: Getty Images.
Creatively cashing out in Canada
ConocoPhillips pulled a surprise in its first move, announcing the sale of its 50% interest in the Foster Creek Christina Lake Partnership to Cenovus Energy (CVE 0.21%), which held the other 50% stake in the oil sands joint venture. In addition to that, Cenovus Energy agreed to acquire Conoco's Western Canadian Deep Basin gas assets, which was one of the properties that it had planned to sell as part of its acceleration strategy. In exchange for these assets, Cenovus Energy paid $13.3 billion, including $10.6 billion in cash and 208 million shares of its stock, good for a 20% stake in the company valued at $2.7 billion. In addition, ConocoPhillips received five years of uncapped contingent payments, entitling it to $6 million per quarter for every $1 the price of oil is above $52 per barrel.
Those last two features represent compelling upside potential for ConocoPhillips. While Cenovus Energy's stock has sold off since the deal's announcement, ConocoPhillips can continue holding those shares in hopes of a recovery, with the potential to capture a higher value than what it initially received if Cenovus operates well and oil prices cooperate. Likewise, the contingent payment also represents upside for the company because it will get paid a fee as oil prices rise. As the chart on the slide below shows, the company could capture substantial upside from these two components in a rising oil price environment:
Image source: ConocoPhillips investor presentation.
That structure was even more brilliant than the similarly creative 12.74 billion Canadian dollar ($9.6 billion) transaction between Royal Dutch Shell (NYSE: RDS-A) (NYSE: RDS-B), Marathon Oil (MRO +0.00%), and Canadian Natural Resources (CNQ 0.47%). Just before the Conoco-Cenovus deal, Canadian Natural Resources acquired a slew of oil sands assets, paying Royal Dutch Shell more than 97 million of its shares worth CA$4 billion ($3 billion) and CA$8.24 billion ($6.2 billion) in cash at closing to both Shell and Marathon. In addition, Canadian Natural Resources will make a deferred payment of $375 million to Marathon Oil in the first quarter of 2018. While that transaction structure gives Shell upside potential from Canadian Natural Resources' stock, neither Shell nor Marathon will join ConocoPhillips in receiving contingent payments based on rising oil prices.
Cash now, upside later
ConocoPhillips followed up that savvy deal a few weeks later with the upside-focused sale of its San Juan Basin gas assets to privately held Hilcorp Energy. Under the terms of that agreement, the company will receive $2.7 billion in cash when the deal closes and up to $300 million in future contingency payments. This transaction does have less upside potential because of the cap on those fees and the lack of an equity component. However, starting next year, ConocoPhillips could collect $7 million for every month the price of natural gas is at or above $3.20 per MMBtu, with those payments continuing for six years or until it hits the cap.
A 2-for-1 special
While the upside from those deals is a nice perk, they also provided tangible near-term benefits. One notable accomplishment of these deals is that they helped lower ConocoPhillips' average cost of supply. Before the transactions, the company's average supply cost was $40 per barrel. However, by jettisoning these higher-cost assets, ConocoPhillips dropped its average down to just $35 per barrel. Because of that, the company can better manage lower oil prices because it will earn higher margins on its retained assets.
In addition, ConocoPhillips stands to immediately benefit from redeploying the cash proceeds to reduce debt and repurchase stock, which were the primary drivers of these transactions. Because the company brought in more money than expected, it was able to double its share buyback plan to $6 billion, with the intention to repurchase $3 billion this year, up from $1 billion initially. Furthermore, it now plans to reduce debt to $15 billion, which is an improvement from the initial plan to get debt below $20 billion by 2019.
Investor takeaway
ConocoPhillips had hoped to sell $5 billion to $8 billion in assets over the next few years so it could pay down debt and repurchase stock. However, thanks to these two brilliant moves, the company was able to bring in nearly twice as much money as expected while retaining some upside to higher oil and gas prices. While it's possible that the oil giant might end up empty-handed given that prices have since fallen, the ability to retain some upside could pay big dividends down the road if prices do recover in the future.
