Strike while the iron is hot, ConocoPhillips CEO Ryan Lance said Tuesday of the decision to pay $9.5 billion for Royal Dutch Shell plc’s Permian Basin portfolio.

The world’s largest exploration and production (E&P) company late Monday agreed to buy Shell’s West Texas portfolio, spread across 225,000 net acres of private land in the Delaware sub-basin. 

ConocoPhillips was invited by Shell to participate in the sales process earlier this year, Lance told investors Tuesday. “The bar is very high” for buying assets. When all was said and done, though, the prospect to take over a massive and well-run asset  proved irresistible.

“We were presented with a unique opportunity to add premium assets at a value that meets our strict cost of supply framework and brings financial and operational metrics that are highly accretive to our multi-year plan,” Lance said. “Our financial strength allowed us to structure a competitive offer for this transaction and we are very excited to enhance our position in one of the best basins in the world with the addition of Shell’s high-quality assets and talented workforce.”

Rumors about Shell selling the Permian leasehold had been swirling for a few months. ConocoPhillips plans to fund the deal with available cash on hand. The transaction does much more than expand its control over the biggest oil and gas field in the country, Lance said. It also “enhances our ability as an E&P company to have a valued role in energy transition by accelerating progress” via its “triple mandate.”

The mandate’s objectives, he said, “are to responsibly produce energy to meet transition demand, generate compelling returns on and of capital.” ConocoPhillips has laid out environmental, social and governance (ESG) goals that include becoming a net-zero emissions producer by 2050, an ambition advanced with the Shell purchase.

“This deal hits on all the objectives of our mandate,” Lance said. “Most of all, any deal must make the company better…This acquisition handily meets all three criteria.”
Shell’s assets would help reduce the greenhouse gas (GHG) carbon intensity of the Permian portfolio, Lance said. The previous GHG intensity goal target for 2030 was to reduce emissions by 35-45%. The target now is 40-50% from the 2016 baseline, on both a net equity and gross operated basis.

Whether it was the time to invest in more Permian assets may be a question for some investors. ConocoPhillips earlier this year completed its $9.7 billion takeover of Permian pure-play Concho Resources Inc. Combined, said Lance, the two Permian deals will make “a stronger company, with a powerful 10-year plan that has been positively received by the market.”

In addition, the Shell leasehold is “100% on nonfederal land on the Texas side” of the Permian, i.e. private land. That means there would be no threat of any potential federal drilling ban that has been suggested by the Biden administration.

The Shell assets extend across 225,000 net acres, with more than 600 miles of operated crude, natural gas and water pipelines, as well as infrastructure. Estimated 2022 production is 200,000 boe/d, roughly half of which is operated. Occidental Petroleum Corp. (Oxy) has partnered with Shell in the Permian.

The assets to be acquired are around 50% weighted to oil, with 25% to natural gas and 25% to natural gas liquids. 

The company in June announced a 10-year strategy plan keyed around an average West Texas intermediate oil price of $50/bbl. At recent strip pricing and estimated 2022 production, ConocoPhillips stands to make hay, Lance said. Next year’s cash from operations from the Shell assets alone could be $2.6 billion, with free cash flow of $1.9 billion, based on a preliminary estimate of 2022 capital.

With the purchase, more assets are going to be sold, Lance said. The targeted level of dispositions has been increased to $4-5 billion by 2023 from $2-3 billion. Around half of the projected sales “are expected to be sourced primarily from the Permian Basin as part of the company’s ongoing portfolio high-grading efforts,” he said.

“The opportunity to announce a very attractive acquisition in conjunction with an ordinary dividend increase and an improved emissions intensity reduction target speaks to the strength of our company and a clear commitment to delivering on all aspects of our triple mandate.”
The company should thrive through a combination of “resilience, returns and ESG excellence. That’s the combination it will take to adapt, thrive and win in the new energy future.”

To sweeten shareholder enthusiasm, ConocoPhillips has bumped up its quarterly dividend by 3 cents to 46 cents/share. 

The decision to increase shareholder returns and strengthen the 10-year plan makes the deal a positive, energy analysts said Tuesday.

“On a valuation basis, the $15,600/acre net purchase price (after backing out production value) amounts to an impressively low” 2022 earnings multiple, said Raymond James & Associates Inc. analyst John Freeman.  BMO Capital Markets analyst Phillip Jungwirth called the purchase “compelling in many ways.” It is “highly accretive on all metrics,” including shareholder distributions and return on capital employed. In addition, ConocoPhillips is maintaining its “balance sheet strength.”

The Shell portfolio, said Jungwirth, “is top-tier within the Delaware and competes for capital.” In addition, ConocoPhillips’ track record of returning capital (8% 2021) is unmatched.”

The BMO analyst said investors may push back on the size of the nonoperated position, controlled in part by Houston-based Oxy. However, ConocoPhillips would operate 50% of 2022 volumes, “above our expectations.” Oxy also is a “top-tier operator in the basin: and would prioritize capital in the joint venture.

“We also believe ConocoPhillips can bring capital efficiency and scale benefits to the operated acreage,” Jungwirth said.