ConocoPhillips To Split; Expect Upstream Consolidation To Follow

Christopher Helman
ConocoPhillips To Split; Expect Upstream Consolidation To Follow

ConocoPhillips announced today its plan to split into two. The third biggest U.S. integrated oil company will separate its upstream oil-and-gas exploration and production division from its downstream refining division. The result will be both the largest independent E&P player, with 1.7 million barrels per day of output, plus the largest refiner, with worldwide capacity of 2.4 million bpd. The move comes on the heels of Marathon Oil's successful move to enact the same kind of split.

ConocoPhillips shareholders were expecting some more announcements of asset sales soon -- a continuation of a two-year restructuring through which the no. 3 U.S. oil company has already raised more than $10 billion by shedding stakes in Canadian oil sands and Russia's Lukoil. Conoco's asset sales had been going so well that the company indicated it would ramp up the program and designate more billions to share buybacks. But what they got today was a surprise.

The move makes good sense in terms of unlocking shareholder value. Despite its shares outperforming its supermajor peer group by more than 25% in the past 18 months, ConocoPhillips's enterprise value is just 5.5 times its expected 2012 ebidta, according to Tudor, Pickering & Holt. Compare that with an average 8 times multiple for large-cap E&P pure plays and 6 times for independent refiners.

"If you look at the integrated company, I think that downstream part was holding back on the value creation of the exploration and production business," Chief Executive Jim Mulva said in a conference call this morning.

Even so, it's hard to see Conoco competing in the long-run for access to big untapped fields controlled by foreign governments. That's because its production, at 1.7 million bpd is significantly less than the world's other publicly traded integrated supermajors. Exxon leads the pack with 4.8 million bpd, followed by BP at 3.6 million, Shell at 3.5 million, Chevron at 2.8 million and Total with 2.4 million bpd. Without the heft, Conoco will have a tough time getting the best projects.

I've suggested in the past that Conoco, in order to gain ground on those rivals, would have been a good bet to gobble up Marathon's newly independent upstream company. That seems unlikely now.

Instead, the M&A dance will likely be among the rest of the big E&P independents, vying to ramp up to Conoco's size. This will mean consolidation among the tier just below the supermajors. Apache, Occidental and Anadarko all do roughly 700,000 bpd. Devon is at 600,000 bpd, while EOG Resources, Marathon and Hess are at around 400,000. Murphy Oil comes in at 200,000 bpd. There's pros and cons to a number of matchups there (comments welcome on what you think good matchups would be).

On the downstream side, Conoco will be the world's biggest pure-play refiner, and in the U.S. it will be on par with Valero Energy. Conoco in its investor presentation today says it intends to make some selective sales of downstream assets. In a May presentation, Conoco indicated it would be most likely to shed its marginal refinery in Germany, as well as two in Pennsylvania and New Jersey. Those Atlantic coast refineries suffer from lower crack margins because of the historically high price of Brent crude relative to West Texas Intermediate -- Brent, at $117 a barrel is $20 higher than WTI.

Thus we won't see sales among Conoco's mid-continent assets -- where refiners benefit from the glut of cheap oil building up at Cushing. The crack spread (or margin between what refiners pay for crude and what they fetch for gasoline and other products) for midcon refiners is higher now than it's been for 25 years, at some $35 per barrel.

Conoco said today that CEO Mulva intends to resign after the split is complete, but a spokesman declined comment on who would replace him. Ryan Lance is currently head of Conoco's upstream, with Willie Chiang atop the refining division. Nothing against those guys, but it's worth noting that neither Lance nor Chiang have ever run a big publicly traded international energy giant like what the two halves of ConocoPhillips are set to become.