In May 2011, BP (NYSE:BP) and ConocoPhillips (NYSE:COP) announced they were scrapping their three-year joint venture to build a natural gas pipeline from Alaska into Alberta because of falling natural gas prices. Scheduled to be operating by 2020, the two companies already had invested $165 million and 760,000 hours of labor. The cancellation of the Denali project leaves the joint venture by TransCanada (NYSE:TRP) and Exxon Mobil (NYSE:XOM) as the sole natural gas pipeline in development in the state.
How this ultimately will affect BP and ConocoPhillips is difficult to foresee. What I can tell you is that ConocoPhillips is the better energy stock to buy. Here’s why:
Both BP and ConocoPhillips could be spending more on exploration in Alaska but are holding back because of the state’s oil tax structure. ACES — Alaska’s Clear and Equitable Share — taxes oil companies progressively based on oil prices, meaning the higher oil prices are, the more tax is collected. Gov. Sean Parnell is looking to provide some tax relief so the big oil companies will invest more in Alaska oil projects. BP doesn’t reveal how much it makes from Alaska, where it’s the largest crude producer, but I’m sure it’s plenty. In 2012, BP will spend just $700 million on capital projects in the state, $100 million less than in 2011.
While BP whines a great deal about paying too much in taxes, ConocoPhillips tends to be less recalcitrant — despite paying $2.4 billion in state and federal taxes as well as royalties on its $1 billion in Alaska earnings. ConocoPhillips will invest $900 million in 2012, about the same as in 2011, and — if taxes were slightly lower — as much as $5 billion over the next three to five years. In the mainland United States, COP expects to spend between $1.5 billion and $3 billion in 2012. If Alaska follows through on its tax cuts, you can expect both companies to increase production there. As things stand today, ConocoPhillips appears more committed to its Alaska operations.
The big problem vertically integrated oil companies face (from a valuation perspective) is investors often misprice their businesses based on the fact that they are really two companies: upstream and downstream or exploration/production and marketing/refining. Upstream businesses tend to be significantly more profitable, yet at the same time are far more capital-intensive. So while they might make a ton of money when oil prices are rising, they can’t afford to stop spending or the profit tap eventually runs dry. Downstream businesses, on the other hand, might spend a great deal when building a new refinery, but after that it’s generally a matter of maintenance.
Valuing each business separately as a pure play is a matter of comparing them to other pure plays. Together, it’s not quite as simple.
In July, Marathon Oil (NYSE:MRO), a vertically integrated Houston-based company, spun off its downstream assets into Marathon Petroleum (NYSE:MPC). While the split hasn’t paid dividends just yet, it will. Analysts suggest Exxon Mobil and BP would respectively deliver an additional $80 billion and $100 billion in market cap to existing shareholders by splitting in two. Neither is seriously contemplating the move at this time, while ConocoPhillips, which announced its split in January, will complete its separation sometime in the second quarter of 2012. Given how long it takes to make these splits happen, it seems likely that BP’s would happen sometime in 2013, if at all. Advantage: ConocoPhillips.
Whatever chart you use to compare BP and ConocoPhillips — whether it be one year, three years or five — COP is the clear winner. Once the split takes place in 2012, ConocoPhillips (the upstream business) and Phillips 66 (the downstream business) will easily outdo BP.
As of this writing, Will Ashworth did not hold a position in any of the aforementioned stocks.