Week Ending October 23, 2020

ConocoPhillips Buying Permian Producer Concho Resources in $9.7 Billion Deal

This Article Appears as Published in Foster Report No 3321

By seeking to combine with Concho Resources in an all-stock deal valued at $9.7 billion, ConocoPhillips is looking to significantly boost its resource base in the Permian Basin and as a shale producer. ConocoPhillips’ global asset base heavy on conventional production combined with Concho’s shale focus in the Permian makes for a good combination, executives said October 19 during a conference call with financial analysts.

With oil prices hovering around $40/barrel, Concho is not selling at the bottom of a down market and it believes the benefits to be gained from adding scale and heft, with a strong balance sheet, will enable the combined company to weather market transitions well, said Tim Leach, chairman and CEO of Concho.

ConocoPhillips’ conventional production base is low-cost, and Ryan Lance, chairman and CEO, has said in the recent past that any acquisition would have to meet the company’s threshold for a low cost of supply to meld nicely with current assets. The combination with Concho adds a lot of unconventional resources in a manageable way that fits well and complements ConocoPhillips’ legacy assets in Alaska, Canada and the Middle East, Lance told analysts. The combined asset base would have a nice balance among higher-declining resources and lower-declining resources, with the average decline rate moving from about 10% to 12% through the deal, officials said.

The combined production assets would have a resource base of about 23 billion barrels of oil equivalent (boe), with an average cost of supply below $30/barrel West Texas Intermediate price. The companies said the deal would create the largest independent oil and gas company, with pro forma production of more than 1.5 million boe/day, and assets that include LNG and oil sands besides the conventional and unconventional production.

Source: ConocoPhillips presentation

ConocoPhillips has some production in the Permian, and the addition of Concho, which is based in Midland, Texas, brings together some contiguous acreage positions in “the core of the core” within the Permian, in the Delaware and Midland basins, the companies said.

The companies expect to capture $500 million in annual cost and capital savings by 2022, which is expected to come from lower general and administrative costs and a reduction in ConocoPhillips global new ventures exploration program. Additional supply chain and drilling and completion savings are not yet included in the cost reduction estimates, officials said.

The companies also highlighted their commitment to environmental, social and governance (ESG) issues, with a plan to reach greenhouse gas (GHG) emission targets and actions consistent with the Paris Agreement plan to limit the rise of global temperatures. That commitment includes becoming a net-zero company for operational emissions by 2050 and endorsing the World Bank Zero Routine Flaring by 2030 initiative, with a goal of reaching that target by 2025.

During the call with analysts, Lance talked about technology gains expected in the coming years to aid reaching the net zero emission target for operations. Developing carbon capture, utilization and storage projects and working with steam generators, solvents and other technologies can help meet emission reduction targets even with Canadian oil sands assets in the combined company’s portfolio, Lance said.

For ConocoPhillips, the deal met the company’s clear criteria for mergers and acquisitions (M&A) because it is consistent with the financial and operational framework of that criteria, Lance said in a statement on the deal. On a pro forma basis, the combined company net debt is about $12 billion as of June 30, 2020, and the leaders vowed to maintain a strong investment-grade credit rating during different commodity price cycles.

The terms of the transaction have each share of Concho common stock exchanged for 1.46 shares of ConocoPhillips common stock, representing a 15% premium to closing share prices on October 13. The combination would create a company with an enterprise value of about $60 billion.

The deal is expected to close in the first quarter of 2021, subject to shareholder approval from both companies, regulatory approvals and other closing conditions.

Upon closing, Lance would retain his position and Leach would join the ConocoPhillips board and leadership team as executive vice president and president of Lower 48 operations in the U.S.

The transaction follows other recent M&A announcements and some predictions for more M&A activity in the upstream sector facing low commodity prices and reduced demand associated with the COVID-19 pandemic. Chevron completed its acquisition of Noble Energy earlier this month and last month Devon Energy said it was buying WPX Energy, another producer that focuses on the Permian region.

The deal has customary terms for termination fees if something were to happen such as a better offer for Concho, but Leach and Lance minimized talk of that happening, vowing to present shareholders with a strong value proposition. When asked if Concho has been approached by others, Leach said the company was evaluating a lot of options for a long time, without naming possible suitors. “We know what is going on with other companies and other opportunities,” and “we’re convinced this deal is the best,” Leach said.

ConocoPhillips has been committed to sustainably and affordably meeting global energy demand, and several years ago eliminated a production growth target from its capital allocation plans – establishing cost of supply as the primary basis for future spending. That change ensures the company can develop resources in any scenario and provides investors with a cost of supply curve to develop their own view of potential stranded resources within the company’s portfolio, the company explained.

At several points during the call with analysts, officials said they would not chase production growth if it did not make sense financially or stay in line with the balance sheet and energy transition taking place around the world. The emphasis on lower emissions and a transition to net zero emissions operationally at the combined company is a serious step that can be carried out, Lance and Leach said.

The companies share a track record on commitment to ESG excellence and would become the first U.S.-based oil and gas company to adopt a Paris Agreement-aligned climate risk strategy to meet net zero emissions operationally by 2050. The deal would revise ConocoPhillips’ GHG emissions intensity reduction target to 35-45% by 2030 from an earlier target of 5-15% over the same period.

The combined company would have a clear vision for reaching the ESG commitments, but retain flexibility on different ways to reach them, with use of renewable resources, carbon offsets and enhanced methane monitoring at production sites, officials said. Those efforts include advocating for a carbon price in the U.S. through membership in the Climate Leadership Council.

Source: ConocoPhillips presentation“Meeting the world’s energy demand during a transition to a lower-carbon future requires an approach that recognizes the need to reduce emissions, operate responsibly and offer competitive returns,” Lance said. “And that’s what our strategy is intended to do,” he said in a statement on the ESG element of the deal.

The emission reduction and ESG targets are not just aspirational goals with fingers crossed, but a long-term commitment to reduce carbon intensity, officials said. By the end of 2020, two-thirds of production in the Lower 48 states will have continuous methane monitoring devices at operational sites to enable repairs and emission-saving actions, and that will play a big role in the climate strategy, they said.

The company’s performance on the ESG front will also be included in executive and employee compensation programs.

By Tom Tiernan ttiernan@fosterreport.com

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