Why I Am Bullish On ConocoPhillips

Ask most people, even those who follow the energy markets pretty closely, who is the world's largest independent oil exploration and production company and I doubt that many would get it right. There would probably be a ton of votes for Exxon Mobil (XOM), with the more internationally minded going for Royal Dutch Shell (RDS.A) or BP (BP). In fact, based on proven reserves and current production, is Conoco Phillips (COP). That status as top E&P company was once a sought after thing, but over the last year and a half or so it has become a huge liability as oil prices dropped and then moved restlessly around the bottom.

For COP the doom and gloom reached a peak when they released Q4 2015 earnings in February that showed an even bigger loss than expected and accompanied that bad news with something even worse…a big dividend cut. Since then, though, oil prices have recovered somewhat and COP has reacted accordingly.

(Click to enlarge)

Conoco will be reporting earnings next week and, given the amount of pessimism that surrounds that announcement already, buying in advance of that release may not seem like a bad strategy, particularly for those with a long term view. However, investing in an energy company with huge exposure to prices and less diversification than others in front of what are expected to be terrible results is probably not wise. Buying straight after the release, regardless of what is said, on the other hand, makes perfect sense.

Look at it this way; if the quarter was even worse than the dismal forecasts, then the stock will be available at bargain prices, whereas if the numbers are better than expected it will confirm Conoco's ability to make the adjustments necessary to survive a tough market. Either way it makes COP a good buy and hold stock for the long term. There is, of course, one assumption built into that assessment. For it to make sense you have to believe that prices will, at some point before too long, recover in a meaningful way. That is not a foregone conclusion, but a long term analysis suggests that they will.

During the drop, as I and others have pointed out many times, the main driver of prices has been the supply story. Yes, we heard of fears regarding growth in China and the world in general, but throughout all of this, global demand for oil has been rising. The problem has been that for a variety of reasons, supply has been increasing even faster. Fracking has increased U.S. production massively, while economic and geopolitical issues have prompted Saudi Arabia and other Middle Eastern countries to pump at full pace, putting the once universally feared OPEC at existential risk.

Sooner or later, though, the gradual increases in demand will catch up with even that hugely increased supply. That day may be hastened if OPEC ever gets their act together or enough U.S. companies go under, but even if not investors know it is coming some day. I don't necessarily believe that we won't go lower again. In fact, if anything a retracement back into the mid-30s from here for WTI looks the most likely scenario, but from a long term perspective that would confirm a pattern of higher lows and higher highs since February. That, in turn, would allow for a more solid recovery over time.

If we do begin a solid long term recovery sometime soon then COP's biggest liability, their status as the world's largest non state owned E&P company, will become their biggest asset. That is why, of all of the large, integrated multinational firms, Conoco has the largest upside from here and should be bought after earnings next week as a long term investment.