You'll Be Surprised at the Size of ConocoPhillips' War Chest

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One of the effects of the oil market downturn is that energy companies have been hoarding cash. Most cut back expenses to the bare bones and sold assets to shore up their balance sheets, which means several companies are holding massive amounts of cash on their balance sheets. ConocoPhillips (NYSE: COP) has one of the biggest cash piles among independent producers at a whopping $10.3 billion as of the end of last quarter. For perspective, that's more than double the war chest of big oil behemoth ExxonMobil, which ended last quarter with $4 billion in cash.

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Here's a look at how the U.S. oil giant built up its war chest, and what it plans to do with all of that money.

Accelerating the accelerator

Last fall, ConocoPhillips unveiled a new strategy to create value for investors by allocating its cash flow toward a variety of priorities that balanced shareholder returns with growth all while strengthening the balance sheet. In addition to that core strategy, ConocoPhillips unveiled a plan to accelerate its ability to create value by selling between $5 billion to $8 billion in primarily low-margin North American natural gas assets. It planned to use those proceeds to buy back up to $3 billion in stock and get debt below $20 billion by the end of 2019.

The company would go on to supercharge that strategy earlier this year after sealing a deal to sell not only the bulk of its Canadian gas assets, but one of its oil sands joint ventures to Cenovus Energy (NYSE: CVE) for $13.3 billion, including $10.6 billion in cash. That windfall added to the company's already healthy $3.4 billion cash position at the beginning of the quarter.

Meanwhile, the company will have more cash flowing in during the third quarter because it closed two more asset sales. At the end of July, it closed the sale of its San Juan Basin assets, receiving $2.5 billion in cash. Then, at the end of September, it closed the sale of its Panhandle assets for $184 million. Those two cash infusions, when combined with the fact that the company is generating free cash flow, will add more money to its war chest.

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Putting its cash to work

ConocoPhillips would have had an even more massive cash pile at the end of last quarter. However, the company spent $3.2 billion to pay down debt and another $1 billion to repurchase stock. Meanwhile, the company has already committed to retiring another $2.4 billion in debt during the third quarter, with the aim to get total debt down to $20 billion by year end. By doing so, the company will reduce its annual interest expense by $300 million, which should entirely offset the lost cash flow from the assets sold to Cenovus. Meanwhile, the company plans to pay down another $5 billion in debt over the next two years to hit a new target of $15 billion by the end of 2019. That would shave another $150 million in annual interest payments, giving the company more cash flow to allocate in creating value for investors, including increasing the dividend, buying back more stock, or investing in high-return growth projects.

The other thing ConocoPhillips plans to do with its war chest is buy back stock. The company expects to repurchase a total of $3 billion in shares this year and another $3 billion by 2019, which is double its initial buyback plan. One of the benefits of the repurchase program is that it enables ConocoPhillips to grow production at a faster clip when measuring it on a per-share basis. For example, the company currently estimates that it can increase output by 3% this year after adjusting for the impact of asset sales. However, it can boost that rate up to 8% on a per-share basis by completing its repurchase program.

That ability to grow at a faster pace without adding more oil to a still-saturated market is leading more large oil companies to choose buybacks over accelerating production growth. Fellow U.S. oil giant Anadarko Petroleum (NYSE: APC) recently joined the buyback bandwagon after announcing a $2.5 billion repurchase program. Anadarko CEO Al Walker commented on the decision to repurchase by saying that it was "a very attractive use" of its more than $6 billion war chest. The move would be accretive to both earnings and production per share because the company could repurchase 10% of its outstanding stock given its price at the time. That said, with the stock surging since announcing the move, Anadarko won't get quite as much bang for its buck, though I'm sure no one is complaining.

The prudent way to put its war chest to work

Many of ConocoPhillips' peers sold assets during the downturn to give them the cash to drill more wells, which has only added to the oil market's oversupply issues. That's why ConocoPhillips plans to use its war chest to get its balance sheet in tip-top shape and repurchase its cheap stock, which will enable the company increase output by a higher rate on a per-share basis. This plan aims to create a windfall of value for investors as the oil market gets back up on its feet in the coming years.

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Matthew DiLallo owns shares of ConocoPhillips. The Motley Fool owns shares of ExxonMobil. The Motley Fool has a disclosure policy.