Feb. 07--In response to lower commodity prices and tightening credit markets, ConocoPhillips is taking significant actions to reset the company's standings, corporate officials said.
During a Thursday webcast by the company, Chairman/CEO Ryan Lance said these two factors have "important implications for the sector" throughout 2016 and 2017. The company announced it would reduce its operating plan and dividend as a result.
"Regarding prices, there are three factors that are driving our actions," Lance said. "First, current prices are much lower than we expected at the time we announced our 2016 operating plan. This is amid bearish supply-demand signals and record levels of inventories. ... Second, we believe this downturn could last awhile longer. Just a few months ago, we thought the market would re-balance by the second half of 2016; now it looks like that could stretch into 2017. And third, greater concerns about global growth suggest it could take longer to reach an equilibrium mid-cycle price after balancing occurs."
While there is much debate about such factors, Lance said the company can't bet on prices turning quickly. Instead, he said the company is taking "prudent actions to prepare for a weaker price environment and for a longer period of time."
Regarding credit markets, Lance noted that credit rating agencies are also seeing the likelihood of a weaker downturn.
"Recently, Moody's and S&P have issued significantly lower price decks. The agencies have industry under review for credit rating downgrades," Lance said. "Moody's has stated that multi-notch ratings are likely, and some have already occurred. The consequences of these downgrades are that debt capacity will shrink across the sector."
For ConocoPhillips, Lance said the bottom line is to maintain a strong balance sheet. He hopes to do this through two key actions: further reducing the 2016 operating plan capital and operating expense, and improving operating costs.
"We believe this is critical and will be a key differentiator in this business. So as difficult as these choices are -- and they were very difficult -- we must do the right thing for the company," he said.
For the past 18 months, Lance said the company has lowered its capital and operating expense levels across the company as prices have weakened -- a move he says will happen once more in 2016. Lance said reductions will improve net cash flow in 2016 by $2 billion compared to the original plan laid out in December 2015.
"We're lowering our capital expenditures to $6.4 billion. That's a reduction of $3.7 billion compared to 2015, and $1.3 billion compared to our original 2016 operating plan," Lance said. "We're dropping down to three rigs in the Lower 48, because it doesn't make economic sense to maintain our original level of activity at current prices. And we don't lose acreage or optionality."
Lance noted that the company is cutting other discretionary programs across the board, which he said are somewhat offset by anticipated cash calls in the company's equity affiliates.
"Our original plan anticipated 1 to 3 percent production growth in 2016; now we expect flat production, given these capital cuts. We're letting Lower 48 volumes decline, but these will be offset in the near term from ramp-up at APLNG and in the oil sands."
Lance said the company also continued to improve operating cuts by reducing its budget.
"We set an initial budget of $7.7 billion for 2016; we're now lowering that to $7 billion. But we don't believe these reductions are sufficient to maintain our strong balance sheet under the Lower for longer circumstances I just described," he said.
To maintain that strong balance sheet, Lance said the company took a "second and more difficult step" of reducing the dividend.
"We announced that we're reducing the quarterly dividend to 25 cents per share, effective with the first quarter 2016 dividend payment," Lance said. "... In mid-December, we were reaffirmed that our dividend is the top priority use of cash. In 2016, this was premised on using up to a couple billion dollars of balance sheet capacity based on similar prices to 2015. After making those adjustments to our operating plan that I just reviewed, we analyzed the impact to our balance sheet under conditions where prices stay in the 30s for longer. We came to the conclusion that our balance sheet could get stretched beyond a prudent level.
"Ultimately, we believed we needed to make a tough choice between protecting the current level of the dividend or maintaining our strong balance sheet through an extended downturn," he continued. "We made a decision to reduce the dividend. This action, combined with the operating plan reductions, will improve net cash flow by about $4.4 billion in 2016. Once we made that decision, our primary consideration was to set a dividend that will be sustainable through the cycles. We are balancing several objectives, including yield, financial strength and lowering the break-even cost of our business. We set the dividend at a level that we believe results in a competitive yield."
According to Lance, the dividend will continue to be a top priority for the company.
"(The dividend) provides important discipline on our investment programs and will remain a core part of our offering," he said. "We believe our dividend is at a level that preserves balance sheet strength and provides financial flexibility through the current downturn."
Lance noted these actions also lower the company's break-even price to approximately $45 per barrel brand.
"What we mean here is that we can keep production flat and pay our dividend for many years at $45 per barrel without needing to sell assets or increase our debt levels," he said. "This significant improvement in our break-even price will allow us to generate greater profitability and cash flow growth when the cycle turns. The combined reset of capital operating costs and the dividend will enable us to generate free cash flow that we can deploy across a range of choices, including increased investment into our low cost of supply resource base, but also including returning capital to the shareholders. The reset will allow us to grow our dividend in the future as our cash flows grow and at a much lower mid-cycle price."
While these were difficult actions for the company to take, Lance said they will improve the company's ability to manager through a weakened industry price.
"(These actions) will improve our medium-term outlook by allowing us to accelerate performance as prices turn, and they will help the long-term performance of the business by making us more resilient in a world of lower, more volatile prices," he said.
A breakdown of ConocoPhillips' fourth-quarter results will be reported in an upcoming edition of the Examiner-Enterprise.
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