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ConocoPhillips’ net income improves despite high production costs

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Jan. 14 2015, Updated 9:04 a.m. ET

Net income improves

In the previous section of this series, we discussed ConocoPhillips’ (COP) production costs. The company hasn’t been efficient in reducing costs. In fact, its lifting costs have increased and exhibited volatility in the past eight quarters. In this article, we’ll look at how rising production costs have affected ConocoPhillips’ earnings.

On a per barrel of oil equivalent (or boe) basis, ConocoPhillips’ net income has more than doubled in the past eight quarters. However, ConocoPhillips’ (COP) EBITDAX (Earnings before interest, taxes, depreciation, amortization, and exploration expenses) has deteriorated 5% during the same period.

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This reflects that the company has not been effectively managing production costs, as explained in the previous section of this series. Other energy upstream companies that increased net income in the past two years include Occidental Petroleum (OXY), Concho Resources (CXO), and Laredo Petroleum (LPI). All these are components of the Energy Select Sector SPDR ETF (XLE).

Why production costs increased

ConocoPhillips (COP) hasn’t been able to reduce its production costs in the past two years. This is due mostly to high energy price volatility in 2014, which increased ConocoPhillips’ purchase costs. The company purchases natural gas and markets it to distributors, utility companies, and other marketing companies.

Brent crude oil, the international oil producers’ benchmark price, has sunk more than 50% in the past six months. Henry Hub natural gas price has also gone down by ~30% in the past one month.

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What are ConocoPhillips’ strategies?

ConocoPhillips (COP) plans to focus more on development projects and project completions in the next three years and reduce spending on exploration projects. It also plans to concentrate on higher margin unconventional shales such as Bakken in North Dakota and Eagle Ford in Texas.

The company also plans to rely less on low-margin North American natural gas. Read Market Realist’s article ConocoPhillips is cautious about its 2015 capex plans in this context.

Based on ConocoPhillips’ own estimates, its North American unconventional shales and LNG (liquefied natural gas) assets are the most productive and are expected to receive 50% of its estimated capital investment from 2014 to 2017. North American gas is expected to record low margins during this period. Overall production is expected to increase at 3% to 5% annual growth rate from 2013 to 2017.

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