This year, ConocoPhillips (NYSE:COP) is taking on a different form. The exploration and production major recently presented at the Credit Suisse 19th Annual Energy Summit, giving investors a clear picture of its investment plan over the next half decade. The most striking part of ConocoPhillips' investment plan is that it is slowing production relative to previous periods. Strangely, this is happening amid a general decrease in upstream production volumes for the industry overall. Shouldn't the oil major be ramping up production to gain a competitive edge?
Interestingly, the seemingly irrational move to slow production at a time when the industry needs greater volume signals a great buying opportunity for the long term.
Think of it as freeing up cash
ConocoPhillips will spend $16.7 billion in capital expenditures in 2014, up modestly from $16.3 billion in 2013. This slower approach is justified in the fact that ConocoPhillips aggressively pursued exploration and production relative to integrated oil players in 2013. This is evident in ConocoPhillips' upstream volumes. In the lower 48 segment ConocoPhillips increased total production by 7% in Q4. This is even as most of its peers, particularly integrated oil majors, saw production volumes shrink during the same period. ExxonMobil (NYSE:XOM), for instance, saw its upstream volumes drop by 1.8% in Q4.ConocoPhillips already has an edge in production volumes. As such, slowing down on production in 2014 allows it to still maintain its edge while at the same time freeing up its cash.
If you look more closely, you will realize that a central theme in ConocoPhillips' broader strategy for 2014 is limiting cash involvement and padding up its coffers.
In addition to slowing down on production, ConocoPhillips is reducing its exposure in risky geographies. These areas typically have huge, unpredictable costs, including the need for tighter security and higher wages to reflect risk in the areas. Operating in such areas thereby places a lot of uncertainty on margins -- especially now when, with the exception of the recent rally in oil prices, price levels have on average been low, suppressing margins for exploration and production majors whose profits are a closer function, relative to midstream, downstream and integrated players, of oil price movements.
ConocoPhillips divested its Algeria business unit for $1.75 billion last December. Similarly, it also sold off its Kashagan unit in Kazakhstan's zone of the Caspian Sea for $5.4 billion in October. The E&P major also noted in its earnings report that it would not price its Libya operations into its production outlook for 2014.
Limiting exposure in risky geographies has a two-fold benefit. On one end, it allows ConocoPhillips to more accurately forecast its earnings -- as previously mentioned, unpredictable costs in risky geographies place a lot of uncertainty on E&P margins, which are generally more sensitive to oil price fluctuations. On the other, the oil major's asset sales in risky geographies allows it to free up cash while at the same time preserving assets in core strategic areas. This allows it to boost its cash position without compromising its strategy. In 2013, ConocoPhillips was able to rake in $10 billion from the sale of assets it considered nonstrategic.
Dividend policy allows it to stay in the game
ConocoPhillips' dividend policy allows it to rope in deep-pocketed income investors. Recent actions by the Fed (the reduction in bond buying) have put an upward pressure on interest rates in the bond market, leading to a major inflow of capital into bond funds. Currently, the average corporate bond fund yield is 3.04%. In comparison, ConocoPhillips has a dividend yield of 4.21%. To sweeten the pot, ConocoPhillips' dividend has grown at a rate of 8.65% over the past five years, higher than the industry's average dividend growth rate of 5.93% over the same period.
Using the dividend growth pattern in the past half decade as a basis for argument, ConocoPhillips is likely to maintain marginally higher yields than other securities in the broader market. This will allow it to maintain its spot as a top pick for income investors, enabling it to continually raise sufficient capital through equity.
ConocoPhillips is limiting its cash involvement while at the same time placing measures (dividend policy, divestment of nonstrategic assets) that allow it to boost its cash position.
This raises the question: Why is ConocoPhillips so keen on preserving and growing its cash position?
The answer? It's preparing for a rainy day. The WTI benchmark crossed $100 per barrel last week. Higher prices are E&P players' best friend. ConocoPhillips is waiting for the oil price rally to take a more definitive pattern. When this happens, deploying huge amounts of cash to accelerate exploration and production will translate into higher margins. According to ConocoPhillips, every $1 change in crude oil prices per barrel in the United States results in its profits fluctuating by between $75 million to $85 million either way, depending on whether the price change is negative or positive.
As such, it makes perfect sense for ConocoPhillips to build up its cash position and hold off on aggressive production until a clearer and more accommodative oil price pattern emerges. Think of the bumper profits it will make if it accelerates production at a time when oil prices per barrel average $10 more than last year's levels. No wonder it's strengthening its financial muscle. Investors should watch this E&P player; a huge rally could be coming its way.
Lennox Yieke has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.