Musings: ConocoPhillips and Oil Industry Capital Spending in 2010
Last week ConocoPhillips (COP-NYSE) announced a revision of its corporate strategy by disclosing plans to sell $10 billion in assets and reduce its capital spending for 2010. In an additional shift, the company increased its quarterly dividend by 6.4% to $0.50. The strategy revision seems to acknowledge the mistake of the company's prior strategy of buying assets to expand the company's critical mass and investors' greater interest in current returns.
A major thrust of COP's prior strategy was to build its North American E&P presence, which was largely accomplished by purchasing Burlington Resources in 2006 for $35 billion. COP also bought a 20% interest in Russia's Lukoil oil company and it agreed to an $8 billion joint venture to produce and export liquefied natural gas (LNG) in Australia. According to Wall Street research, COP has reinvested almost 80% of its cash flow for the past five years, yet the mistiming of its acquisitions has contributed to the shares underperforming its primary competitors -- ExxonMobil (XOM-NYSE) and Chevron (CVX-NYSE) -- for the past two years.
COP has reinvested almost 80% of its cash flow for the past five years
By raising its dividend, COP has boosted its annualized yield slightly above that of Chevron and well above ExxonMobil's return. After boosting its annualized dividend to $2.00 per share, the 3.9% dividend yield as of last Friday puts COP's return approximately 0.2% above Chevron's 3.7% yield ($2.72 annual dividend) and more than 60% above ExxonMobil's current 2.4% yield ($1.68 annual dividend). The interesting question is whether COP is going to adopt a radically different approach to managing its affairs going forward. Will COP's focus become more on how to generate greater and more consistent financial returns for shareholders over becoming a larger company and making larger corporate bets on future growth?
Will COP's focus become more on how to generate greater and more consistent financial returns for shareholders over becoming a larger company and making larger corporate bets on future growth?
With that consideration in mind, we thought it interesting to note COP's announcement about cutting its 2010 capital spending after having reduced its 2009 spending and laying off employees earlier this year. COP said it will spend $11 billion, down 12% from its 2009 spending target and fully 23% below what the company reinvested in 2008. It is interesting to note the historical trend in oil industry capital spending since 1970 and how spending has tracked crude oil
prices over that time period. It is worth noting that whenever the industry enjoys a spike in crude oil prices such as happened in 1973, 1981, 1988-90, 1998-2000 and 2007-08, capital spending fell soon after. That reinforces the research that spikes in oil prices are generally associated with generating economic downturns.
COP's spending cut in 2009 puts it in the industry pack. But the announcement of the 12% cut for 2010 puts it in a meaningfully large segment of the industry that responded to the recent spending survey question from Barclays. As shown in Barclays's research report on its mid-year capital spending survey, the bulk of the global oil industry anticipates spending more money in 2010, with almost a third of respondents saying their spending will be up by 20% or more. Almost a quarter of the companies said they would hold spending flat. Yet 17% of the companies are suggesting they will be reducing their next year capital spending by 10% or more. On balance, it looks to us like the industry will be boosting spending in 2010, at least as of this mid-year point, by about 10%-15%. But as we all know, there is still a long time to go before companies really begin to nail down their spending plans for next year. How the global economic recovery progresses through the rest of this year will have a huge impact on that decision. If all the forecasts for continued economic recovery in 2010 prove accurate, then we are probably looking at an increase in oil industry spending. On the other hand, if the world experiences another dip in economic activity, obviously a minority view among economists at the present time, then look for lower or flat spending as the more likely scenario.
The bulk of the global oil industry anticipates spending more money in 2010
The COP announcement has broader oil industry significance because it highlights the growing struggle that major independent oil companies (IOCs) are having in growing their production due to limited access to attractive resource deposits around the globe. Additionally, the more attractive prospects are faced with rising costs and long development timeframes further adding to the financial challenges for boosting shareholder value. Therefore, COP's decision to boost the annual dividend as a way of boosting shareholder return may become a more utilized approach to attracting and rewarding shareholder support for the largest of the IOCs. Watch whether COP once again becomes an industry leader with its new corporate strategy.
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