The price of crude oil is one of the biggest risks to ConocoPhillips' stock price as there is a notable correlation between the two as we see on the following chart.
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However, the price of crude isn't the only risk the company faces. Here are three more risks that investors need to keep an eye on.
Risk No 1: Its ability to find oil and gasRight now the world might have more oil than it needs, but that won't always be the case. This is why companies like ConocoPhillips need to keep finding new sources of energy. The company highlights this risk in its annual report by saying, "Unless we successfully add to our existing proved reserves, our future ... production will decline, resulting in an adverse impact to our business." This is actually a lot easier said than done. As we see on the following chart, once divestitures are taken into account the company failed to replace all of its reserves last year.
Source: ConocoPhillips Investor Presentation.
While the company did organically replace 124% of its production, its reserves actually fell 3% over 2013 after factoring in theassets it sold. This isn't a big worry because the company could have held onto those reserves instead of monetizing them. However, the reserve replacement ratio is a number that long-term investors should keep an eye on as we really want to see it at 100% or better each year.
Risk No 2: Inability to fully control its own destinyAnother risk the company highlights in its annual report is the risk that comes from participating in joint ventures. The company notes that, "Our investments in joint ventures decrease our ability to manage risk", which is very interesting to note because joint ventures are designed to help mitigate risk. However, in this case, ConocoPhillips is referring to its ability to control its own destiny.
For example, the company goes on to note that,
What this means is that future development within these joint ventures is out of the company's control to one degree. So, should a partner run into financial trouble due to the collapse of the price of oil it could slow down the growth of the venture. Another risk here is that the partner could be forced to put its stake up for sale. This means ConocoPhillips might have to buyout that partner's stake or even have no choice but to sell its own interests to the new partner. Either option might not be in ConocoPhillips' best interests.
Risk No 3: Weakening its balance sheetA final risk to keep an eye on, especially this year, is the company's balance sheet. ConocoPhillips' management team was very honest with investors that it plans to use its balance sheet to get it through the current downturn as it is willing to fund some of its spending with debt. As the following slide notes, the company's cash flow isn't expected to balance its outflows until 2017, which means its debt levels will rise amid the weak commodity price market.
Source: ConocoPhillips Investor Presentation.
The risk here is that this could stretch the company's balance sheet a little too thin should oil remain weak for several years. The other risk here is that the debt markets could weaken for energy companies as there's the potential for a massive energy bond default wave to hit the industry within a year if the price of oil remains weak. This could make it more expensive for even ConocoPhillips to borrow money at a time when it needs to in order to get it to 2017 when its cash flows are expected to balance out.
Investor takeawayIt goes without saying, but investing involves risk and sometimes as investors we forget that fact. Risks can come in all shapes and sizes and can be both well-known or emerge over time. That's why investors need to be vigilant and at least have an idea what risks a company faces so there are fewer surprises when one of those risks manifests itself and the stock's price takes a dive.
The article 3 Big Risks That ConocoPhillips Investors Need to Watch Closely originally appeared on Fool.com.
Matt DiLallo owns shares of ConocoPhillips and while the risks have made the stock volatile the long-term reward has been well worth it. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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