ConocoPhillips (NYSE:COP) continued its string of beating analysts' expectations during the third quarter as its adjusted earnings came in well above their forecast. What was most impressive about that result is that the company delivered stronger profitability even though production came in below the low end of its guidance range. Several factors drove the stronger earnings, including higher oil and gas prices and an increase in higher-margin production from its U.S. shale plays.

Drilling down into the numbers

Metric

Q3 2018

Guidance or Expectations

Difference 

Production

1.224 million BOE/D

1.225 million to 1.255 million BOE/D

(1.3%)

Adjusted earnings per share

$1.36

$1.19

14.3%

Data source: ConocoPhillips. BOE/D = barrels of oil equivalent per day.

While ConocoPhillips' production came in below its guidance range, that's mainly due to the sale of its Barnett Shale assets and an unplanned outage at a third-party gas plant in the U.K., which impacted production from the East Irish Sea. Overall, the company's output rose 6% versus the year-ago period after adjusting for asset sales, driven by its big three unconventional shale plays in the U.S. (Eagle Ford, Bakken, and Permian Basin), its development programs in Europe and Alaska, and the ramp-up of major projects in the Asia-Pacific region. Meanwhile, on a debt-adjusted share basis, which takes into account the impact of share repurchases and debt reduction, ConocoPhillips' production jumped 28% year over year.

Production from the big three surged 48% year over year due to strong drilling results across all three shale regions, though the increase was "only" 38% after adjusting for the impact of Hurricane Harvey in the year-ago period. That fast-paced growth helped drive earnings since this production carries higher margins than the output from many of the company's other areas. In addition to the strong shale growth, ConocoPhillips also achieved first production from Bohai Phase 3 in China -- the largest new project by the company since it spun off its downstream and midstream businesses in 2012 -- as well as from the final phase of drilling at Bayu-Undan in Australia.

Thanks to higher oil prices and an increase in higher-margin production from shale, ConocoPhillips generated $3.46 billion in cash from operations during the third quarter. The U.S. oil giant reinvested $1.6 billion of that money into new oil and gas projects, and returned $930 million to investors through share repurchases and paid another $330 million in dividends. That left it with roughly $600 million in excess cash, which along with the proceeds from asset sales and a partial recovery of an arbitration settlement from Venezuela, boosted the cash and short-term investments on its balance sheet to $4.8 billion at the end of the third quarter.

An oil pump with a dramatic sunset in the background.

Image source: Getty Images.

A look at the outlook

ConocoPhillips expects its production to grow to an average of 1.275 million to 1.315 million BOE/D during the fourth quarter. Driving that increase will be the continued growth in shale production -- which the company expects will surge 35% this year -- the start-up of recently completed projects, and the completion of seasonal maintenance activities at some of its legacy production facilities. That forecast keeps the company on track to achieve its full-year outlook, which projects a production rise of about 6% year over year after adjusting for asset sales.

ConocoPhillips now expects to spend $6.1 billion on capital expenses this year to achieve that production forecast, which is an increase from last quarter's $6 billion budget guidance and its initial spending forecast of $5 billion. Driving the spending increase are higher-than-planned activity levels from some of the company's drilling partners due to stronger oil prices. However, that incremental capital should yield higher production in the future.

Setting itself up for continued success

ConocoPhillips' efforts to reduce its costs the past few years are paying off now that oil prices are higher, enabling the company to generate a gusher of cash flow during the quarter. The U.S. oil giant produced more cash than it needed to drive growth, giving it ample excess to return to shareholders through a needle-moving share-buyback plan and a fast-growing dividend. Those factors set the oil giant up to continue creating value for shareholders in the coming years.

Matthew DiLallo owns shares of ConocoPhillips. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.