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In new peer group, Conoco facing tough haul

ConocoPhillips is already falling behind its new chosen peer. After shedding its refineries in May, the $69-billion (U.S.) energy explorer set its third-quarter earnings release to coincide with rival Occidental Petroleum – rather than with integrated majors like Exxon Mobil, as previously. The comparison suggests Conoco has its work cut out to keep shareholders happy.

The company could hardly have selected a more formidable competitor than Occidental, which has a $65-billion market value. Occidental boasts an output mix tilted toward lucrative oil rather than cheap natural gas and the flexibility that comes from having a balance sheet with little debt. While Conoco's third-quarter profit of $1.8-billion beat expectations, its output of hydrocarbons – an important focus for investors – slipped while Occidental's increased 4 per cent from a year earlier.

Despite the 1-per-cent decline in output in the most recent quarter, Ryan Lance, the Conoco chief executive officer, believes his company can achieve production increases of between 3 per cent and 5 per cent a year. The middle of that range is what Occidental managed in the third quarter, and analysts hope for 8-per-cent annual output growth at the company.

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Conoco's expansion plans also call for hefty capital expenditure. The company is on track to splash out $16-billion to boost production this year. That is almost $3-billion more than expected operating cash flow, according to Morningstar. Occidental is living more comfortably, with likely exploration spending coming in about $1-billion less than cash flow this year.

Investors surely appreciate Conoco's relatively high dividends – the company is paying out about 31 per cent of profit. That tops Occidental's payout ratio of 26 per cent and dwarfs Exxon's 21 per cent. But keeping that going, while also funding capex, limits the company's room for manoeuvre. Conoco also has to service $18-billion of net debt, while Occidental's debt burden only amounts to about $3.5-billion.

All this means that Conoco's margin for error is relatively small compared with its rival, and also that its ambitions can only be sustained if oil prices remain relatively high. By lining up against Occidental, Mr. Lance has given himself a tough challenge.

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