ConocoPhillips
Q4 2005 Earnings Call Transcript

Published: 30 Jan 2006

[Operator:]

Good morning ladies and gentlemen, and welcome to the ConocoPhillips Fourth-Quarter Earnings Conference Call. My name is Joan and I will be your coordinator for today. At this time all participants are in listen-only mode. We will be facilitating a question-and-answer session towards the end of today's conference. Operator Instructions I would now like to turn the presentation over to Mr. Gary Russell, General Manager of Investor Relations. Please proceed sir.

[Gary Russell:]

Thanks Joan. And good morning, and welcome to the ConocoPhillips fourth quarter earnings conference call. I'm here today with Jim Mulva, our Chairman and CEO, and John Carrig, our Executive Vice President of Finance and CFO. During today's call, we will be referring to presentation material, which will help us more fully discuss our fourth-quarter financial and operating performance. This presentation is designed to give you a better understanding of the factors that had a significant impact on the quarter's results and can be found on our website

[James Mulva:]

Gary, thank you and good morning. I appreciate all those who are participating in our conference call and taking an interest in our company. I am going to start on slide number three, titled "Highlights." You can see from the highlights the Company had another strong quarter. It generated 3.8 billion in income from continuing operations. This is about 100 million higher than our net income, because of a small loss in discontinued operations and an accounting change, which we will discuss a little bit later in the presentation. Our cash flow from operations was $4.7 million, so with these strong results we're able to fund the capital program and continue to strengthen our balance sheet and our financial flexibility. During the quarter, we reduced our debt by $1 billion to $12.5 billion. As a result, our debt ratio went down 2% from 21% to 19%. For the whole year of 2005, our debt reduction was about $2.5 billion. Also during the quarter, we bought back $759 million worth of common shares, bringing the total repurchases for 2005 to $1.9 billion. During the fourth quarter, we produced 1.88 million BOE a day. This includes 1.59 million BOE per day from our E&P segment, and an estimated 0.29 million BOE a day from our LUKOIL investment segment. With respect to Refining & Marketing, our refineries ran at 88% crude processing capability. That's down 7 percentage points from last quarter. This essentially relates to the impact of the Gulf Coast hurricanes. Our average diluted shares outstanding compared to the last quarter were down a little bit, was down to 1.407 billion shares. If we look at our adjusted return on capital employed, you'll see on the subsequent slide it's quite competitive with the largest companies in the industry. So I am now moving from slide number three to the fourth slide

[Operator:]

Thank you, sir. Operator Instructions Your first question comes from Doug Terreson with Morgan Stanley.

[Douglas Terreson:]

Good morning, Jim, and congratulations on a record fourth quarter.

[James Mulva:]

Thank you, Doug.

[Douglas Terreson:]

In Refining & Marketing, on slide 13, you mentioned that hurricanes and high utility costs affected profits by over $300 million in the quarter, which is obviously pretty significant even for a company your size. And on this point, I wanted to see if we could get some clarification on the specific expenses that are included in those two components of the chart, and also whether you have an estimate of what the opportunity costs might have been related to the hurricane effects from the quarter that is with the lines being down.

[James Mulva:]

Yeah I think John Carrig is going to answer that one.

[Douglas Terreson:]

Okay.

[John Carrig:]

Yes, on an after-tax basis, if you just take the volumes quarter over quarter, we estimate that about $183 million was volume and margin-related from the downtime, and then there's about $55 million - $53 million or so of after-tax maintenance costs associated with Lake Charles in the line.

[Douglas Terreson:]

Okay. Also, on the Mackenzie Delta pipeline project, it appears as if significant progress has been made with respect to the native peoples and the Canadian government since your November analyst meeting. And so on that point, I wanted to see if you guys considered the progress to be meaningful as well, that is whether or not you believe that this thing is back on track, and also whether or not you think it can really be from the transition to the design – from the design to the construction phase during the next 12 months or so, and if not, what you consider to be the major obstacles at this point?

[James Mulva:]

Well Doug, yes, we do believe that progress is being made compared to what we saw and went through in 2000 and earlier parts of 2005. It's very important for us and for our company to really aggressively pursue and push this because we need the resources and we need to develop this. We also know that’s important from a Canadian perspective that we get this pipeline and this project going as quickly as possible. We want to make sure that this pipeline goes -- it really needs to go and it's ready to go before the Alaska gas pipeline.

[Douglas Terreson:]

Okay

[James Mulva:]

And so we want to see Mackenzie Delta project go forward first and then followed by the Alaska gas pipeline. So yes progress is being made, and I think we're going to see this thing really move forward as we go through 2006 and our company, along with the other producers are doing everything we can to make this happen.

[Douglas Terreson:]

Okay, thanks a lot. Okay great thanks a lot guys.

[Operator:]

Your next question is from Paul Sankey with Deutsche Bank.

[Paul Sankey:]

Hi good morning gentlemen.

[James Mulva:]

Good morning.

[Paul Sankey:]

Relative to the various moving parts we've had since the analyst meeting for '06 volumes, I wondered if you could either reiterate what the growth rate you expect to be in '06. As far as I remember, it was a 6% growth off the base that you talked back in November. Specifically, I was thinking about any impacts from Venezuela, from the UK tax changes and, of course, from Libya and anything else I've missed? Thanks.

[James Mulva:]

Well frankly, you pointed out all the various things, from one period of time to the next, seem to be moving around. But we feel pretty confident that what we said back in November, in terms of our production objectives for '06 remain valid. So even we have some things that will positively or negatively impact us, we still feel very strong about what we said in November.

[Paul Sankey:]

So we should just think it would be 6% outlook? Because I think the full-year number here for '05 has come in pretty much exactly in line with what you said it would?

[James Mulva:]

Yes. Our number for '06, I think, Gary -- I can't recall exactly

[Gary Russell:]

I think it was 650, I think was the number

[James Mulva:]

1.65 million, and that’s excludes LUKOIL.

[Paul Sankey:]

Yeah and without wanting to get too involved here, I guess there's some margin implications from the replacements of, say, for example, Libya volumes, UK volumes with Libya volumes. Is there any comment that you could make about that?

[James Mulva:]

No really not at this point.

[Paul Sankey:]

Okay great thanks. Is there anything, and again, you may not want to answer this, and I appreciate that. But if you could say anything else about your turnaround schedule, or at least what has been going on so far this year and how it looks for '06, that would be very helpful?

[James Mulva:]

Well, I think we pretty well gave our views on turnaround of cost when we had our presentation in November, analyst presentation. But on the other hand, we do know that for the industry there's a lot of turnaround that is taking place during the first quarter and it’s the result of some of the deferrals and delays on turnaround, as a result of keeping supplies up in the United States as a result of the hurricanes last year. So it has some impact on us as well but I don't know; John, you have anything further to say?

[John Carrig:]

In the outlook, we indicated that the volumes would be relatively flat in the first quarter of 2006 for us, in the outlook section of the earnings release. So that's indicative of the kind of activity we are going to be having.

[Paul Sankey:]

Great thanks. And the last one for me is just on the LUKOIL announcement this morning. I wondered if you had anything to add on the major announcement they made?

[James Mulva:]

No obviously as a shareholder of LUKOIL we are quite pleased with these kinds of announcements and they really are enjoying some very positive exploration success, and we work closely with them, and really nothing further that I can say other than congratulations on good exploration success.

[Paul Sankey:]

Great thank you.

[Operator:]

Your next question comes from Neil McMahon with Bernstein.

[Neil McMahon:]

Hi, just a few questions really around the CapEx. When you did the Burlington deal, you had in CapEx and other in your cash flow estimates there $17.2 billion for 2006 and $15.4 billion for 2007. Just wondering do you have an updated number on that including Libya because it looks like Libya was not included within 2005 CapEx numbers?

[John Carrig:]

The number that Jim mentioned of $14 billion, reflects about a $700 million increase in CapEx associated with Libya for 2006.

[Neil McMahon:]

Okay. And John, just on that, I'm sort of presuming as you are taking the CapEx hit in 2006, you won't be able to book any of the reserves associated with Libya in your 2005 reserve replacement rate? And do you have any guidance on the reserve replacement for '05 yet?

[John Carrig:]

No, we are continuing to apply our reserve management process, and we are not prepared at this point but we'll have an announcement out probably mid-February. We are not prepared to indicate whether we expect to book reserves for Libya or any other country right now.

[James Mulva:]

Reserves are either going to be in '05 or '06.

[John Carrig:]

Yes, they will be one or the other but -- we consult with our experts including our auditors.

[James Mulva:]

I think what John is saying is we haven't yet really come down on this, and you can expect us to comment on where it's booked for all of our results later this month or early in February but we’ll come out with reserve replacement and what the numbers are and what's included in that here in a couple weeks.

[Neil McMahon:]

Okay good. So there's no sort of hard and fast rule that it has to be booked at the same time as your CapEx spend, is sort of where I was going with it. And then, just lastly, given the change in the tax rate in the UK, have you got any – like in terms of like CapEx numbers, have you thought about changing your activity in the UK and how you look at the UK in terms of investments there going forward? And really, maybe Jim, just a viewpoint of where does the UK sort of stand now, when you start to think about the world and future opportunities for investment? Thanks.

[James Mulva:]

A few things, we have a number of projects underway that we are committed to, and we are certainly going to complete those projects. In terms of future investments, it's a pretty mature province. And we don't think that this most recent announcement on change in taxation as have other companies responded already, is not going to be very helpful for looking at new investment and encouraging you to making the marginal investments to add some incremental capacity. But anything that we've already approved and committed to, we are going to carry out and do. It's a pretty mature province and not very helpful to adding the incremental capacity that might come along.

[Neil McMahon:]

Great, thanks very much.

[Operator:]

Your next question comes from the line of Nicole Decker with Bear Stearns.

[Nicole Decker:]

Good morning, my questions are on the downstream, primarily. One, on the German refinery, any guidance as to what the potential income contribution might look like in 2006?

[James Mulva:]

Well, in terms of the German refinery, obviously it's going to depend upon when we complete the transaction but we think we will have it done certainly in the first quarter. So we get the results of this for maybe three quarters of the year. We are not going to see the real strong financial results of this until we upgrade the refinery for deep conversion. That's going to take investments over a number of years. So it's a rather modest income and return for the investment but we have made this acquisition and we are making the deep conversion investment that’s something developing a strategic legacy asset that will be in place here four or five years from now. We are quite pleased with it but it's going to have modest returns and will go up and down with what you would expect of a Northern Europe refinery; it doesn't have the sophistication that we would like it to have when we complete our investment program. And you'll see the financial results are rather modest until we do complete that deep conversion.

[Nicole Decker:]

Okay and when would we expect to hear results or progress on negotiations with Saudi Arabia at the Yanbu?

[James Mulva:]

You are talking, okay on the new grassroots refinery.

[Nicole Decker:]

Yes.

[James Mulva:]

We continue to work and talk with Saudi Aramco, and I think it's just premature at this point in time. We don't have any more information that we have or are prepared to disclose at this point in time. But we are certainly very interested in the project, and hopefully this will become an opportunity for investment, we talk more about in the marketplace, should we be selected to go forward on this project?

[Nicole Decker:]

And finally, on the Lithuania refinery, is it fair to assume that you are not participating in the bidding process?

[James Mulva:]

No, I think what we've done is, we along with LUKOIL submitted a bid a number of months ago. We were informed that our bid was not competitive, and so as a result we have kind of withdrawn into the background. And, should this opportunity ever come back to us, we would be interested in. But I think there are some other companies that might have a more aggressive bid that Lithuanians may be talking to but we'd be interested in it, but we’ve really put this in the backburner at this point in time.

[Nicole Decker:]

Okay thank you.

[Operator:]

Your next question is from Gene Gillespie with Howard Weil.

[Gene Gillespie:]

Jim congratulations on a great year.

[James Mulva:]

Thank you, Gene.

[Gene Gillespie:]

You guys are spending a lot of money. You spent a lot of money last year; you're spending a lot of money going forward. I guess my question is, how sensitive is particularly your 2006 E&P budget to the dramatic rise in service costs and that relationship to commodity prices?

[James Mulva:]

Well Gene, good point. I can't recall the exact percentages but obviously we are seeing quite a bit of pressure in terms of the cost side of operations and maintaining production. And we also see that for the large capital programs and all that we carry on going forward on the capital side of the business, cost pressures as well, the availability of contractors, costs. They are not as aggressive in terms of lump sum as they were in the past. So you see fewer lump sum bids and more bids that are cost plus. And the impact to us as an industry both for operations and for the capital program, is cost pressure upward. And we indicated what we thought those numbers were in terms of our November presentation by E&P to the financial community up in New York. I don't think that has really abated much at all. And so it's going to push in terms of higher finding and development costs ultimately, operating costs on the industry. So I can't really say too much more other than a confirmation of what we said in November.

[Gene Gillespie:]

Thank you.

[Operator:]

Your next question comes from Mark Flannery with Credit Suisse.

[Mark Flannery:]

Hi, a simple question on the corporate charge. What should we expect for guidance going forward on that number?

[James Mulva:]

I think you should expect somewhere $175 million to $200 million a quarter.

[Mark Flannery:]

Right, so back to sort of the previous run rate, as it were?

[John Carrig:]

Well, we indicated in November we thought it would be around 660, and that would equate to around 165. That continues to be our guidance.

[Mark Flannery:]

Great, okay thank you very much.

[Operator:]

Your next question is from Doug Leggate with Citigroup.

[Doug Leggate:]

Thank you, hi good morning guys. Guidance on the tax rate going forward, John Carrig, if you may, thinking more, thinking specifically about the impact of the UK changes? And I have a follow-up if that's okay.

[John Carrig:]

Well, the UK changes, should they be enacted, I mean, if they’re, assuming they are enacted, we would expect that sometime in the second – midyear. And overall, that would increase the marginal rate in the UK by about 9.5%. So that would have an overall impact on the total company but I would say we are still between 40% and 50% on a total company basis. And a lot of that depends on the price and the mix of earnings.

[Doug Leggate:]

Would that number include the impact of Libya? I know it's kind of a little bit convoluted but net-net, I guess the incremental tax rate would go up because of the contribution from Libya. Is that fair?

[John Carrig:]

The government take goes up. I don't have a good, firm number for you on how much of that is taxes, and how much of that is other government take but we will come back to you on that. That's a good question and a good point.

[Doug Leggate:]

Okay thanks. My follow-up is also on Libya. Jim, just as a point of clarity, the production guidance for 2006 -- I'm assuming you guys get somewhere around 45,000 barrels per day net out of Libya. So does the guidance change as a result of that contribution, or does that already include Libya?

[James Mulva:]

No, everything is included in our guidance we gave in November. We assumed that we were going to get some production hopefully, out of Libya. We concluded our agreement in the latter part of the year, so there's no change in our guidance of what we said in November.

[Doug Leggate:]

That was great, thanks very much.

[Operator:]

Your next question comes from Paul Cheng with Lehman Brothers.

[Paul Cheng:]

Thank you, couple of quick questions. Jim, oftentimes there's a lot of debate talking about whether the company should hedge or not to hedge. Given your big reinvestment in Burlington Resources, can you just strategically talking about also on what's your view on that subject, whether you are inclined more towards the hedging or that not at all?

[James Mulva:]

Well, we’ve heard quite a bit of feedback when we announced the Burlington acquisition about hedging. And we indicated that we would give this a real thorough look, which we have been doing and are in the process. We have not put in place any hedging at this point in time. We continue to look at it. There are three aspects of it that I would say about hedging. First of all, you have to look at what is the cost of hedging. Then you have to ask yourself, can you put in place a really good hedge? Because you know that the production of gas has a differential, basis differential. We have to be concerned about what is the cost of hedging? Can you put in place a really good, clean hedge? Next, you have to be looking at there is a marketplace there, does it have the depth and the duration, which ties also back to the cost. And then the last point is we have to be careful also about financial reporting. Do we so distort, from one quarter to the next, the financial results of the Company such that they are so impacted by movements in the valuation of mark-to-market on hedging? So for all of these reasons, it's a more complex subject than the initial question might be. So we haven't put anything in place. And you know our bias historically is we don't do any hedging of oral/gas production or crack spreads. But we are looking at it, we are studying it. But I think any thought that we would put in place, a significant hedging of all of the production of Burlington or in the duration or period of time is really unlikely.

[Paul Cheng:]

Very good, Jim, if I could I just two more questions, one in Asia, I think in your presentation back in November, Jim Nokes was talking about he would like to expand the exposure in Asia. When we are looking at Asia, are you guys interested in sort of the merchant refining operation, or that you will be interested more in an integrated system? And is there any particular countries that it would be monumental (ph) or not? The last question is the nature of Venezuela. From time to time, we have heard some rumor or news coming out from that country, talking about changing the upgrading project, actually Jim gave more in line with the 2001 hydrocarbon more. I'm wondering if you guys have been contacted by the government on a similar subject?

[James Mulva:]

Well, first, with respect to Asia, Jim Nokes indicated -- he's right. Our company is quite interested in seeing how we can enhance our position in Asia on the refining side of the business.

[Paul Cheng:]

But not in marketing? Well, you know, it could be in marketing, but the primary emphasis is on the refining side. And some of the objectives we have is that we like the business, we would like to tie it back, if we can, to our own existing production in the area. That gives you the integrated aspect. Also, we look at it, from a business development point of view, how could we make investments ourselves or with strategic partners in a way that could tie back to feedstock, whether it's coming up from the Middle East, coming from Asia or potentially even coming from Russia. So we look at all of those potential opportunities, and I think we are quite interested in doing that. But it has to have -- we are not just buying a merchant refinery. We' d like to make sure it has some relevance to our own production and operations, as well as to our strategic partners. And we are already very concerned and interested in making sure that we know where the feedstock is coming from for the long term, so that ties you back to those producing kind of areas. With respect to Venezuela, obviously, as we have to heavy oil projects, Petrozuata (ph) and Hamaca, we have read the same information that you have. But no real discussions and negotiations between ourselves and the Ministry and it's one of those things that I need to be and plan to be in Venezuela talking about here pretty soon.

[Paul Cheng:]

Very good, thank you.

[Operator:]

Your next question comes from Mark Gilman with Benchmark Capital.

[Mark Gilman:]

Jim, John, Gary good morning. Couple of specific things, there's reference in the earnings release to inventory impact in the midstream. I wonder if you could qualify what that was in the fourth quarter?

[John Carrig:]

I think it was on the order of $25 million to $30 million, and it related to both physical sales, as well as to the mark-to-market on some contracts to get mark-to-market.

[Mark Gilman:]

And that's after tax, John?

[John Carrig:]

Yes, I believe that's after tax.

[Mark Gilman:]

Okay, you also, Jim made a comment about the mark-to-market impact in terms of the UK gas contracts, $197 million. Is that an after-tax number? And what did that number look like in prior quarters?

[John Carrig:]

Yes, that's an after-tax number. Regarding the prior quarters, it's moved around, but I –

[James Mulva:]

Pretty small.

[John Carrig:]

Okay, it's pretty small.

[Mark Gilman:]

Okay I noticed that in the fourth quarter, both in international as well as Alaska, we saw a very significant jump in DD&A. Could you give us some color as to what is causing that effect in both those regions?

[James Mulva:]

Alaska, I'd have to come back to you on it. It's increased production, I believe, in Alaska, in part due to seasonality; it had good volume performance. As well as internationally, as well, I think it's more to do with increased production. We went from 15.20 to 15.60 or so, something like that.

[John Carrig:]

15.90.

[Mark Gilman:]

Yeah, my calculations, John, suggest it's the unit rate that's going up, not just the total dollar rate.

[James Mulva:]

I can get back with Jason online on that, Mark. There's nothing that's unique or attributed to a single area or to a single as asset, I don't think, John.

[John Carrig:]

That's correct.

[Mark Gilman:]

Okay one another if I could. In the S-4 that you filed regarding Burlington, I assume that there was a particular price deck that you had assumed with respect to the purchase price allocation. Can you give me some idea as to what that was, and what adjustments might occur if the price were to be different from that assumption, in terms of the allocation as published in the S-4?

[James Mulva:]

As you know, Mark, the S-4 is filed but not yet effective, and we are really not in a position to discuss what the filing was until we become effective. And we would be happy to engage in dialogue after it becomes effective.

[Mark Gilman:]

Okay, very good thanks a lot guys.

[Operator:]

And you last question comes from Jennifer Rowland with JP Morgan.

[Jennifer Rowland:]

Thanks, just a question on reserve replacement. I know you said it might be a bit premature. But do you have any sense yet whether or not you would be able to re-book the reserves related to Surmont that you had to take off last year?

[James Mulva:]

Our expectation is we would not re-book those. That's just based on the price information that I have, that was available at year-end. But I don't believe we would. But that, again, is subject to our final determination.

[Jennifer Rowland:]

Okay and then just another quick, you may have (inaudible) I missed that, I apologize, but where is Alliance refinery now in the restart process? And when do you expect that to be at full run?

[James Mulva:]

No we have started, we have already started the process of restarting, and we expect to have it in full operation by the end of the first quarter.

[Jennifer Rowland:]

Okay thanks.

[James Mulva:]

Thank you.

[Gary Russell:]

Okay, good. We do appreciate your interest and your participation this morning in our conference call. I want to remind you that you can find the earnings release and all supplemental information, as well as the slides that we walked through this morning, on our webpage, conocophillips.com. Thank you.

[Operator:]

Ladies and gentlemen, we thank you for your participation in today's conference. This concludes the presentation, and you may now disconnect. Have a good day.