ConocoPhillips

Moat: 3/5

Understandability: 3/5

Balance Sheet Health: 4/5

ConocoPhillips is one of the world’s leading E&P companies focused on oil and gas production, processing, and transportation, operating primarily in North America, with operations also in other parts of the world.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview and Competitive Landscape

ConocoPhillips (COP) is a global independent exploration and production (E&P) company, meaning they focus on finding and producing crude oil, natural gas, and natural gas liquids. Here is a breakdown of their operations and what makes them unique:

Revenue Distribution

ConocoPhillips primarily generates revenue through the sale of crude oil, natural gas, and natural gas liquids. These products are sold worldwide, but the majority of their production is concentrated in North America. Their assets and operations are divided into several geographic regions:

  • Lower 48: Primarily onshore operations across the United States, including large shale plays.
  • Alaska: Major production region focused on Alaska’s North Slope.
  • Canada: Significant oil sands and natural gas operations.
  • Europe, Middle East, and North Africa (EMEA): Production in Norway, the North Sea, Qatar, and Libya.
  • Asia Pacific: Operations primarily in China, Malaysia, and Australia. The geographical diversity provides some insulation against regional economic downturns, however, the primary factor remains that they primarily are focused on oil and gas.

The oil and gas industry is characterized by:

  • High Volatility: Commodity prices are notoriously unpredictable, often driven by global economic and political events. This creates significant swings in revenues and profitability.
  • Cyclical Nature: The industry follows a boom-and-bust pattern, influenced by oversupply, price wars, and economic slowdowns.
  • Geopolitical Risk: Operations are subject to political and regulatory risks, especially in overseas operations. These can impact production costs, contractual agreements, and asset ownership.
  • Intense Competition: E&P companies face intense competition from both large multinationals and smaller independent operators, all vying for exploration opportunities and market share.

In this environment, ConocoPhillips stands out through its focus on a lower carbon portfolio, its large-scale operations, diverse geographic locations, and a strong financial position. As a large scale enterprise they are able to extract value from economies of scale that other smaller players are not able to achieve.

However, it is crucial to recognize that while a big fish can dominate a small pond, and create a local moat, this does not protect it from competition in the global market, and this is where a lot of risks come in.

Margins and Profitability

  • ConocoPhillips’ profitability is heavily tied to commodity prices. When oil and gas prices are high, profitability can be impressive, but conversely, when prices decline, profits can be substantially reduced.
  • Net income, which is influenced by the volatile commodity prices, can vary significantly from quarter to quarter.
  • Their margins are high with commodity prices at the moment.
  • In short, while the business is capable of generating impressive profits, it is also exposed to commodity price swings.

Financial Analysis

ConocoPhillips’ financial situation can be characterized by:

  • Strong Cash Flow: The company generates substantial cash from operations, enabling them to fund capital expenditures, share repurchases, dividends, and acquisitions.
  • Significant Debt: They also have a significant amount of debt. The debt is being used to fund operations and acquisitions, and that is putting a strain on their financial health in times of high interest rates, but this is common in the industry.
  • Robust Capital Program: They have planned a capital spending of about $11.5-$11.8 billion for the coming year.
  • Shareholder Returns: They are committed to returning capital to shareholders through dividends and share repurchases. They recently increased their dividend by 14 percent to $0.58 per share in Oct 2023.
  • Sensitivity to Global Conditions: Their profitability is heavily dependent on global supply and demand for oil, natural gas, and LNG. A decline in global demand can have a substantial effect on profitability.
  • Tax Volatility: Their tax rate has been volatile, mainly because of their international operations. They are also prone to being affected by government regulations, and tax policy.

The financials are clearly dependent on factors out of the control of the company itself which is a risk. For example, if China’s demand of oil decreases significantly the revenue of the company would decrease significantly, thereby impacting financial performance.

Recent Concerns and Controversies

ConocoPhillips has faced the following challenges and controversies:

  • Volatility in Commodity Prices: Prices can fluctuate wildly, causing volatility in earnings and investment decisions. In the second half of 2023, ConocoPhillips benefited from higher commodity prices that pushed up their margins but volatility makes any prediction of the future quite difficult.
  • Geopolitical Risk: Operations in unstable regions carry considerable risks. Their operations in Russia have been terminated in 2022, and the operations in Norway were negatively affected in Q4 of 2022, both as a result of the Russo-Ukrainian war.
  • ESG Pressure: They must consider the environmental concerns of the investors and new government regulations in order to operate for the long term. They have implemented an action plan to reach net-zero emissions by 2050, which might be quite expensive.
  • Macroeconomic Factors: Economic conditions, like high inflation, have made it more difficult for the company to grow.

Moat Assessment: 3/5

ConocoPhillips has some characteristics that can lead to a moat but overall it can be seen as having a middling moat.

  • Brand Recognition: While they are a recognizable brand, this only matters to some extent in this commodity industry. They may have a preferred position with some customers as a reliable producer, but this alone doesn’t provide a sustainable competitive advantage.
  • Scale: ConocoPhillips has significant scale in production, enabling them to operate at potentially lower average costs. They also enjoy scale in areas like marketing and logistics.
  • Location based advantages: They have significant amounts of reserves located in attractive locations, like the Permian basin in USA which has a favorable geology and good infrastructure.
  • Proprietary Technology: They have proprietary technology that improves exploration success and reduces costs. However, these technologies are often acquired by competitors, lowering the value of any single technology.
  • Switching Costs: In general they sell to industrial customers and there are few switching costs from one supplier to the other, for these large corporations it is relatively easy to switch.

Justification for 3 / 5:

ConocoPhillips has a decent competitive position and some moat characteristics, but is ultimately a commodity company. In such an industry it is incredibly hard to build truly long lasting moats, as the product is not really different and price will typically be the driving factor. All large oil corporations are quite similar to each other, and can not attain a true moat without government intervention (like state owned petroleum companies)

Understandability Rating: 3 / 5

While the basics of oil and gas production are understandable, the nuances of their industry can be a bit complicated. The complexity increases with geopolitics, government policies, and new technologies. For these reasons, the company is not very easy to grasp completely for a general investor. Justification:

  • The business model of extracting resources and selling them at market price is fairly straight-forward.
  • Understanding the impact of global supply and demand and geopolitical situations can be complex.
  • Financial statements can be difficult to interpret because of exploration expenses and depletion costs.
  • The presence of multiple business segments and international operations make it a little bit more difficult to completely understand the business.
  • Overall there are a lot of factors that a person who does not know the industry would have to understand to rate it correctly.

Balance Sheet Health Rating: 4 / 5

ConocoPhillips is a huge company with many assets, which is a clear plus for their balance sheet. They also have a high amount of cash and relatively solid short-term investments. At the same time they have a lot of liabilities which are mainly tied to long-term debt. Although there are risks with this situation, it’s quite normal in the industry. Justification:

  • They have significant amounts of cash and assets on the balance sheet, even in comparison to their size.
  • Debt levels have been stable, but it’s still considerable. This represents a risk in high interest rate environments, as the debt is often variable.
  • Their revenues and profits have always been strongly correlated with oil and gas prices and global demand.
  • Overall, they seem to be able to keep their balance sheet at a good level, but it still relies on outside factors to some extent.

Risk Factors and Business Resilience

Risks that could erode the moat:

  • Commodity Price Volatility: A sustained drop in oil and gas prices would directly and significantly decrease ConocoPhillips’ profits and returns. Although the company can somewhat hedge their positions, a major price decline may harm the business resilience.
  • Technological Disruption: New technologies, especially in renewable energy and exploration, can render existing oil and gas assets less valuable. This will be relevant as the world aims to get to net-zero emissions, which can also bring more government regulations.
  • Regulatory and Policy Changes: Environmental regulations and carbon taxes could increase costs and limit the company’s access to desirable assets or markets. For example, any carbon tax can significantly lower the profitability of the company.
  • Geopolitical Events: Political instability or conflicts in countries where ConocoPhillips operates can disrupt production and investments. Their withdrawal from Russia in 2022 is one such example.
  • Market Share Instability: The industry is also somewhat prone to share volatility, which is evident in the case of the airline industry. This is especially apparent between the large, established producers. A loss in market share could be detrimental to their long term goals.

Business Resilience:

  • Experience and Scale: Years of experience and their size provide a high degree of knowledge of the industry, and ability to work within it’s volatile nature.
  • Strong Balance Sheet: They have cash on hand to support their operations, and are committed to shareholder returns through dividends and share repurchases.
  • Geographic Diversification: Their global reach gives them exposure to different markets and also decreases their reliance on a single region. This provides some stability to cash flows even during regional economic downturns.

Despite potential risks, it’s likely that ConocoPhillips will continue to do reasonably well for the foreseeable future. Their strong presence in the US market, alongside a good global portfolio, gives them the tools to succeed as a major player in the energy industry.