ConocoPhillips' Huge Opportunity in the Eagle Ford

At a recent analyst meeting at the New York Stock Exchange, ConocoPhillips , the world's largest independent exploration and production company based on output and proved reserves, explained how it plans to continue delivering strong returns for its shareholders over the next few years.

Though the Houston-based company has operations all over the world, its presence in North American liquids-rich resource basins -- particularly Texas' Eagle Ford shale -- will be key in driving Conoco's production and cash flow growth over the next few years. Let's take a closer look.

Photo credit: Flickr/Paul Lowry.

Conoco boosts Eagle Ford resource potential estimate
One of the more encouraging pieces of information delivered at the analyst meeting was a substantial increase in its resource base in the Eagle Ford, arguably the company's most prized asset in terms of production potential and return on capital. Conoco now reckons that it is sitting on 2.5 billion barrels of oil in place in the Eagle Ford, up from a previous estimate of 1.8 billion barrels.

The higher resource estimate is due mainly to a reassessment of the quality of the company's acreage and improved technical knowledge it has gleaned over years of drilling. Conoco is not the only company to revise its Eagle Ford resource estimate upward. Peer EOG Resources also this year increased its Eagle Ford resource potential to 3.2 billion barrels of oil equivalent, of BBOE, up 45% from a previous estimate of 2.2 BBOE, thanks largely to improvements in completion techniques and tighter spacing between wells.

Why Conoco's Eagle Ford program stands out
While there are plenty of world-class operators in the Eagle Ford, Conoco's drilling program stands out for a few main reasons. First, the company's 221,000 net acres are located in the play's sweet spot, where an ideal combination of pressure, maturity, and thickness yields extremely high oil production rates.  

As a result of this location advantage, as well as continued cost improvements, the economics of Conoco's Eagle Ford drilling program are truly impressive. Not only do the company's wells have the highest oil rates per well in the entire play, but the net present value of its Eagle Ford acreage is about 35% higher than that of its closest competitor, according to consultancy Wood Mackenzie.  

Conoco's breakeven costs in the play are just under $40 per barrel, representing one of the lowest production costs in the entire industry. Though location is an important factor, Conoco deserves much credit for improving its returns through a persistent focus on technical innovation that has delivered substantial improvements in drilling and completion costs.

Since 2010, the company has reduced both the average number of days it takes to drill and complete an Eagle Ford well and the average completion cost per unit of proppant, a key ingredient in the fracking process, by 40%. These improvements are due largely to greater use of multiwell pad drilling, which allows the company to drill multiple wells from an existing pad. Greater use of proppant has also boosted the average estimated ultimate recovery per Eagle Ford well by 30%

Having identified more than 3,000 drilling locations across the Eagle Ford, Conoco plans to spend $3 billion in the play from 2014 to 2017. This increased spending is expected to boost its production from the play to more than 250,000 barrels of oil equivalent per day by 2017, which would represent 20% compound annual growth from 2012 levels.

Investor takeaway and one risk to consider
As an increasing share of Conoco's production growth comes from the Eagle Ford and other high-margin North American resource plays, which are generating cash margins in excess of $40 per BOE, margins should expand at an annual rate of 3%-5% through 2017. Assuming commodity prices remain unchanged from last year's levels, this should drive significant cash flow growth.

By 2017, Conoco expects to generate cash flow of $20 billion-$23 billion, the midpoint of which would imply 36% growth from last year's cash flow of $15.8 billion. If the company can achieve that target, it should be able to cover its annual capital expenditures of $16 billion and dividends in 2017 through internally generated cash flow.

However, as with all independent E&Ps, this cash flow forecast is predicated upon high commodity prices. If commodity prices fall by roughly $10 a barrel to about $100 for Brent crude and $90 for West Texas Intermediate, it could slash $1 billion or more from Conoco's cash flow outlook and hinder dividend growth.