Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message| ()  

Executives

Sigmund Cornelius - Chief Financial Officer and Senior Vice President of Finance

Clayton Reasor - Vice President of Corporate Affairs

J. Mulva - Chairman, Chief Executive Officer and Chairman of Executive Committee

Analysts

Edward Westlake - Credit Suisse

Edwasrd Westlake

Paul Cheng - Barclays Capital

Philip Weiss - Argus Research Company

Mark Gilman - The Benchmark Company, LLC

Arjun Murti - Goldman Sachs Group Inc.

Paul Sankey - Deutsche Bank AG

Douglas Terreson - Morgan Stanley Dean Witter

Jason Gammel - Macquarie Research

ConocoPhillips (COP) Q2 2010 Earnings Call July 28, 2010 11:00 AM ET

Operator

Good day, ladies and gentlemen, and welcome to the ConocoPhillips Second Quarter 2010 Earnings Conference Call hosted by Jim Mulva, Chairman and CEO; and Clayton Reasor, Vice President, Corporate and Investor Relations. My name is Jenn, and I will be your coordinator for today. [Operator Instructions] I would now like to hand the presentation over to your host, Mr. Clayton Reasor. Please proceed, sir.

Clayton Reasor

Thank you, and thank you, everybody, for participating in our Second Quarter Earnings Conference Call. Joined today by Jim Mulva, our Chairman and CEO. And this morning, we’ll be discussing the company's second quarter results and also provide an update on the status of our returns enhancement plans that we had announced earlier this year. The summary of key financial and operating results for the quarter will be provided as well as our outlook for the remainder of 2010.

As in the past, you'll find our presentation materials on the IR section of the ConocoPhillips website, but before we get started, I'd like you to refer to our Safe Harbor statement on Slide 2 of the presentation. It’s a reminder that we will be making forward-looking statements during the presentation and during the Q&A, and actual results may differ materially from what is presented today. Factors that could cause these actual results to differ are included in our filings with the SEC.

Please move to Slide 3, which is a summary of our key second quarter results and highlights. Adjusted earnings for the second quarter were $2.5 billion or $1.67 per share. Cash from operations was $3.5 billion. Capital efficiency increased as annualized cash returns on capital invested improved to 22%. Our E&P production, excluding LUKOIL, was 1.73 million BOE per day.

The competitiveness of our refineries allowed us to achieve U.S. refinery utilization rate of 96%, and excluding Wilhelmshaven, the international rate would have been 88%. We completed $5.8 billion in asset sales, primarily the Syncrude and CFJ asset. And debt was reduced by $2.7 billion in the second quarter, with an additional $2.7 billion reduction planned next month.

Turning to Slide 4, you can see that total adjusted earnings for the company were $2.5 billion, up $1.5 billion compared to last year. The majority of these earnings were generated by our E&P and R&M businesses. Our E&P segment improved by almost $750 million, primarily due to higher commodity prices, partially offset by lower volumes. And compared to the second quarter of last year, R&M adjusted earnings increased by over $700 million, mainly due to improved global Refining and Marketing margins. The amount in the Other column reflects an increase in corporate costs, partially offset by improvements in Chemicals and Midstream earnings.

Moving to Slide 5, total cash flow. We generated $3.5 billion in cash from operations and $5.8 billion in cash proceeds from asset sales, primarily from Syncrude and CFJ sales. We repaid $2.7 billion in debt, funded a capital program of $2.2 billion, paid approximately $800 million in dividends and repurchased $390 million of ConocoPhillips common stock. At the end of the quarter, we had a cash balance of $4.1 billion, $2.7 billion of which will be used to pay down debt in the third quarter.

Now let's review our upstream production for the second quarter on Slide 6. You can see that production was 1.73 million BOE per day, down 7% from the second quarter of last year. Looking at the chart, you can see that 23,000 BOE per day of the reduction is attributable to market factors, including PSE impacts due to higher prices. And moving to the right, roughly 12,000 BOE a day stems from the expropriation of our assets in Ecuador and asset sales in Canada and the Lower 48.

We produced 50,000 BOE per day less this quarter compared to previous year's quarter from planned maintenance in Norway, Australia and the Lower 48. In Norway, this reflects our routine three-year or once every three-year turnaround in the Greater Ekofisk and Eldfisk area and that had an impact of about 35,000 BOE per day.

What happened in Australia, we had a full field shutdown at the Bayu-Undan field and the Darwin LNG plant and that impacted production 23,000 BOE per day. The remainder of the planned downtime was 7,000 BOE per day coming from the Lower 48. The 54,000 BOE per day bar shown above operations is largely normal field decline offset by new production. The majority of the decline came from 87,000 BOE per day in North America, and the remaining 38,000 BOE per day came from Norway and the U.K. Offsetting that, we had 75,000 BOE per day of new production from China, Canada and Indonesia.

So now I'd like to turn to Slide 7, E&P adjusted earnings, which were $1.5 billion, up about $740 million from the second quarter of 2009. Higher prices and other market impacts contributed about $1 billion to the increase in earnings. This increase was partially offset by $321 million decrease from lower sales volumes, primarily from the planned and unplanned downtime that I just mentioned.

We have a positive $50 million in Other. Is largely comprised of lower dry-hole cost, foreign currency effects and lower DD&A. And looking at the table at the bottom of the slide, you can see that both U.S. and international earnings improved significantly from the prior year. Oil and natural gas realizations are up significantly.

Moving to Slide 8, our unit metrics for the E&P segment. You can see that E&P income per BOE was nearly double that of a year ago, and this primarily reflects the increase in realized prices that I mentioned earlier. Comparing this quarter's E&P results to the first quarter of 2010, we saw earnings impacted by lower natural gas prices, the volume and cost impacts of planned and unplanned maintenance activity, fewer over-lift volumes and foreign currency movements. E&P earnings were impacted by several items, such as the estimated $70 million in lost earnings from LNG sales volumes during our scheduled maintenance in Australia, a sequential earnings reduction from unfavorable foreign exchange movements of negative $64 million, and in our Russian affiliate, earnings were reduced by $17 million, a result of higher export taxes.

In addition, the impact of crude sales volumes versus production reduced earnings by about $20 million for this period versus the previous quarter. Our E&P cash contribution per BOE is competitive among our peer group and our largely OECD-focused portfolio provides greater exposure to price movements in the future.

Moving to Slide 9, market conditions for Refining and Marketing were much stronger this quarter. R&M's adjusted earnings improved over $700 million versus a year ago. Realized refining margins improved more than $550 million, primarily driven by stronger distillate fracs. In the U.S, distillate market cracks almost doubled while internationally, they improved by about 50%. In addition, we made nearly $100 million from our premium coke production at Humber and Lake Charles refineries. Additional contributors to the improved refining margins were $41 million from our increased margins was attributable to our Chemical industry feedstock such as cyclohexane, propylene, tylene, xylene and benzene. And marketing margins were better by about $150 million compared to this quarter last year. $42 million improvement related to volumes is primarily driven by our U.S. refining capacity utilization increasing from 93% to 96% as well as an increase in our marketing volumes of unbranded fuels.

The $101 million of negative variants in Other is almost entirely FX-related. It reflects unfavorable foreign exchange impacts this quarter compared to the favorable ones we received in the same quarter of 2009. And this quarter's foreign exchange impacts were largely due to the dollar strengthening compared to the weakening in the same period. The table at the bottom of the slide provides U.S. and International earnings as well as realized margins.

So let's move now to Slide 10, which shows the year-over-year variances for our other segments. Results in our Midstream segment were $30 million higher this quarter compared to a year ago, mostly due to higher NGL prices. Our 50% share of CPChem generated $138 million during the quarter. This is $71 million higher than the second quarter of 2009 and due to higher ethylene, polyethylene and benzene margins. In fact, looking at equity earnings for the Chemicals segment, this is our second best quarter since CPChem was formed. LUKOIL adjusted earnings were improved by $187 million compared with the same quarter last year. The increased earnings was mostly driven by higher average realized prices partially offset by higher taxes. Adjusted corporate expenses were $365 million after tax for the quarter compared to $157 million last year. The majority of this variance was a $150 million impact related to foreign exchange, and the remainder was higher interest expense related to the absence of tax settlements and higher effective tax rates of about $20 million and $15 million, respectively. We’re increasing our full year estimate for corporate expenses from the estimated $1.2 billion to approximately $1.4 billion for the full year 2010. This increase is primarily due to the FX losses I just mentioned of about $90 million for the year and approximately $150 million for the Mako payment costs to retire the debt that I’d mentioned earlier.

Turning to Slide 11, our debt-to-cap ratio. As stated before, we paid down $2.7 billion of debt this quarter, resulted in balancing debt of $26.3 billion at the end of the quarter for a reported debt-to-cap ratio of 28%. Debt is down some $4 billion versus the same time last year. We also ended the quarter with a cash balance of $4.1 billion due largely to the timing of the receipt of the Syncrude proceeds in late June.

Netting out our cash position, debt-to-cap is at 25%, the top end of our stated debt-to-cap ratio, but down from the peak of 34% at this time last year. Cash on hand will be used to pay down additional debt during the balance of the year, and towards that end, we’ve called $2.7 billion of debt, which will be settled in the third quarter. Another $500 million in maturity is expected to be called in the fourth.

All in, we expect that year end debt level around $23 billion and cash balances around $2 billion. So let's move to Slide 12, our ROCE and cash returns on capital invested.

You can see that on the charts on Slide 12, we've shown steady improvement in our returns. This has been driven by better earnings and cash flows while maintaining capital discipline. Year-over-year, our ROCE improved by 6%, and although price was a large component of improved ROCE, constrained capital spending, paying down debt and investing in higher-returning businesses also contributed to this improvement. And this is in line with our previous guidance around expectations that 2/3 of the improvement comes from prices and 1/3 comes from our disciplined approach to capital.

As a result of our recent Wilhelmshaven decision, we expect capital employed in the R&M segment to fall. We ended the quarter with capital employed in R&M of $23.4 billion, versus $23.6 billion last year, and for the full year 2010, we expect to spend approximately 90% of our capital in E&P, consistent with our plans of investing in higher-returning business segments.

So that completes our review of our second quarter of 2010, and I'll wrap up with some operational and project returns and plan status on Slide 13 before asking Jim to make a few comments before we go into Q&A.

Looking at Slide 13, I guess the place to start is, just to be consistent with previous production guidance, we expect 2010 E&P production to be close to 2008 production levels with approximately 1.8 million BOE after adjusting for the impact of asset dispositions and PSC impacts related to higher prices. New production from our ramp-up of Canadian Oil Sands, Bohai Bay, Indonesia , Qatargas 3 will partially offset production declines in North America, Alaska and the North Sea assets. Asset dispositions of Syncrude and other parts of our E&P portfolio are expected to have annual impact of about 20,000 a day during 2010. And we expect PSC impacts will reduce production by about 10,000 BOE per day.

Regarding refining, during the third quarter, we expect a slight decrease in total utilization rates in the current quarter and expect to see U.S. refining capacity rates to be in the low 90% range. We expect R&M pretax turnaround expenses to be slightly less than previously guided, $500 million for the year.

Controllable costs are expected to be lower in 2010 compared to 2009, as we continue to take steps to control costs while ensuring the safety of our employees, the integrity of our assets and conducting planned maintenance at our refineries.

The most important elements of our company is culture, our safety, maintaining an asset integrity and environmental stewardship. We recently completed a 35-day shutdown in our Bayu-Undan field and Darwin LNG facilities. This shutdown involved over 1,400 employees and contractors and was executed as planned with no major incidents or environmental impacts. We are on track to deliver our cost reduction targets of about $350 million from E&P and about $200 million reduction in cost in Refining and Marketing.

Moving to our Exploration Program Activity. In the Caspian, the Rak More well should spud in the third quarter and achieve TD by year end, and we expect the Nursultan to follow sometime the second half of 2011. We’re currently drilling the Megaladon wildcat in the North Sea. We’ve got a 30% working interest. It’s high-temperature high-pressure well. Drilling’s progressing according to plans and TD is expected late in the third quarter. And we expect to participate in two additional wildcat wells during the year. One, in the deepwater Norwegian Atlantic area with Shell, the Gulf Newton well. It's a deepwater Jurassic target. And one in the Arafura Sea, which is expected in the second half of this year in offshore Indonesia, where we have 25% working interest in partner with Total. As for our Polish shale and Chinese coal bed methane plays, we don't have any new material information. We completed the first Polish well earlier this quarter. But it was more of a data well and we're evaluating the data we’re gotten from it. We continue to look at the Polish opportunities and Chinese opportunities favorably. We’re seeing good return and production growth opportunities in our oil sands areas, both Foster Creek, Christina Lake, as well as Surmont. We've accelerated our FCCL development program and expect average production this year of between 55 and 60 MBOE this year, and we expect the compound annual growth rate over the next five years to be somewhere between 15% and 20% with mid-teens returns or higher on a full cycle basis.

We're also increasing investment and the pace of drilling activity in the Lower 48, Eagle Ford, Bakken and Permian plays. At Eagle Ford, we've been encouraged by our recent well results, continue to look for ways to optimize our operations. Year-to-date, we've drilled 13 and completed seven wells at Eagle Ford and are optimistic about this deal’s potential to support future production and returns growth. We’ve got six rigs drilling in the area, plan to have as many as 12 by year end, in current production of about 7,000 BOE per day. Our APLNG project is targeting FID by the end of 2010. We're encouraged by the withdrawal of the Australian government's recent proposal to enact new resource super profits tax, which would have had an adverse impact on all coal seam to LNG projects. We remain concerned about other possible increases in Australian taxation, such as the newly proposed extension of the petroleum resource rent tax to onshore oil and gas projects and are working to mitigate this exposure. We believe there is sufficient LNG demand to support our project and other projects in the region and look forward to providing further updates on our marketing activities later this year.

At our 2010 Analyst Meeting, we detailed our plans to enhance returns and strengthen our financial position. From 2010 to 2013, we expect to grow our production per share by approximately 3% per year on a compound annual growth rate basis, and we're on target to deliver this. Another part of the plan was to sell $10 billion in assets over the next two years. We've made significant progress with the completion of the sale of Syncrude, our CFJ interest and other miscellaneous assets. The data rooms for North America asset disposition packages have been open since June, and we've seen significant amounts of interest from potential buyers. Our expectation is to receive bids during this quarter and begin closing on our E&P North America asset sometime in the fourth quarter of 2010.

We've engaged an adviser for the sale of our 25% interest in the REX pipeline, and marketing efforts are progressing. Total cash proceeds year-to-date are in excess of $5.8 billion, and we expect to reach between $7 billion and $8 billion for asset dispositions, excluding LUKOIL by the end of the year.

In addition, we continue to take steps to rebalance our portfolio and enhance our returns by reducing the proportion of capital employed in our downstream business, demonstrated by our cancellation of Wilhelmshaven refinery project upgrade and the announcements made earlier this year about other major potential projects. So that concludes my prepared remarks, and before we take your questions, I'd like to ask Jim for a few of his comments before we open the call.

J. Mulva

Okay, Clayton, and appreciate everyone participating calling in on this conference call. I think I would provide a little information regarding our announcement on our plans to sell all of our ownership interest in LUKOIL. Previously, we indicated that we were going to sell half of our interest. As you know, we own 20% of LUKOIL, and we were thinking of selling down to 10%, but the announcement today is to over the time period of remainder of 2010 through 2011 to sell all of our interest in LUKOIL. So let's talk about this for a moment.

It was a strategic relationship with LUKOIL. The objective certainly for ConocoPhillips was to participate in opportunities, both particularly upstream and to some extent downstream within Russia, within LUKOIL. LUKOIL's interest was to do that both in Russia but outside with ConocoPhillips as well. It's been a good experience, good relationship, highest respect for LUKOIL, and everything that we've experienced so far from LUKOIL and with the Russian authorities has essentially been what we would have expected. The development of opportunities within Russia has not come as quickly as we would have thought for our company, as well as for others in the industry.

If we look at our ownership in LUKOIL, essentially the strategic reason for coming to the decision of selling all of our interest over the next 18 months is that we have good financial returns, but our cash returns are essentially the dividends. So we book our share for equity and accounting 20% of LUKOIL's results, but our cash return is essentially about $200 million a year and so we look at the opportunities within Russia. We look at the opportunities that we have elsewhere around the world within our portfolio of the company, along with our emphasis on improving our portfolio returns, our cash returns and distributions to our shareholders, we came to the conclusion that we felt that we could better redeploy those funds primarily through share repurchase, but our emphasis on metrics, the metrics of returns, the metrics of reserves and production per barrel, our earnings in cash, particularly cash returns per share. So if we look at where we have invested in LUKOIL, the shares were purchased over a number of years ago for a total cash outlay of $7.5 billion. Over these years, we have received $1 billion in cash dividends. And earlier, about a month or two ago, we sold 6.7 million shares for $400 million. We had a price of about $58 a share. So we currently have an ownership interest at this point in time of 19.2%. And that book value is $6.7 billion. So we invested $7.5 billion in cash, received $1 billion. I know it's not net present value, but from a cash point of view, we have $6.5 billion invested.

Now we announced that we're going to sell this two different classifications of LUKOIL shares. I'll just say the Russian shares and the shares outside of Russia. They have a similar characteristic. So what we have done is we have just announced that we're selling the Russian shares 7.6% to LUKOIL, that it represents 64.6 million shares or about 40% of our shareholding interest. The share price we've announced is $53.25. That results in we receive those proceeds pretax August, I believe it’s 16th, of a little bit more than $3.4 billion. We expect after-tax gain of about $300 million, cash taxes of about $500,000,000 and the transaction, as I said, closes in about August 16. And then what we have in mind is looking at selling the remaining shares and open market shares essentially in London or that exchange or to LUKOIL. Sell the remaining shares and if you look at current prices, that would have a value pretax of about the proceeds of $5.5 billion. For that block the remaining amount of shares’ financial after-tax gain at those prices would be $1.3 billion cash taxes. A little more efficient than [indiscernible 33:10] $100 million. LUKOIL does have an option for our shareholders agreement. It’s a pretty extensive agreement when we entered several years ago. Option for 60 days, it starts today, to purchase all the remaining shares or the shares that they would like, to write a first offer at $56 per share. So if you look at our LUKOIL state, it's been in our investment in LUKOIL and in Russia. It's been a good experience. It's a great relationship. The after-tax proceeds from the stock sales that I went through will be somewhere about $8.7 billion, maybe a little bit more, cumulative dividends a little bit more than a $1 billion, so if you look at it, I know it’s not net present value, the cash out of what we sell and our dividends will be about just a little less than $10 billion. And we invested $7.5 billion.

Most of the cash that comes from the proceeds from the disposition of the LUKOIL shares will be directed towards share repurchase. The cash that comes after tax from asset dispositions, a great deal of that will be directed towards getting our debt down, as Clayton said, towards $23 billion and we essentially are getting very close to achieving that at this point in time. So those are my opening comments. I wanted to talk about LUKOIL. So we’ll open up for questions, Clayton.

Question-and-Answer Session

Operator

[Operator Instructions] Our next question comes from Mr. Paul Sankey with Deutsche Bank.

Paul Sankey - Deutsche Bank AG

Jim, Clayton, could you just talk a little bit more about the actual timing and expectation on the size of buybacks post-LUKOIL? I think you’re fairly clearly saying it's all going to be rotated into buyback. Would you expect that to be done over what period of time? Would you expect to do any further buyback this year assuming that you get down to your debt level target? And then how would you see 2011 playing out as well in terms of your aspirations for further asset sales seeing as you're getting towards the kind of $10 billion level fairly quickly that you originally talked about? Would you consider increasing the asset sale program given that you had success so far in obtaining good prices and would again we expect that to be directly into buyback?

J. Mulva

Okay. Well, you've asked quite a number of questions, essentially what are our basic plans with capital structure and allocation of cash. And so as Clayton said, we look at our debt balance, and we're pretty satisfied at about $23 billion. Although it could go down a little bit more, maybe $1 billion, but we think around $23 billion, $22 billion fits for us in terms of our debt objectives. We'll see the debt ratio at the end of the year, net debt at, say, 25% moving down because we essentially don't pay out all of our earnings in the form of dividends. And the other thing is, is we don't particularly have a hoard of maturing debt coming immediately in the next short period of time. And so we don't feel that we should be paying a premium to reduce debt that's pretty tax efficient. So for guidance, I think you should be looking at us saying as we look at the end of 2010 and going into 2011, we're pretty comfortable with debt at $22 billion and $23 billion. The other thing we've said is that we like to have annual dividend increases. Well, we increased our dividend late 2008 and we had a 10% increase early part of 2010. So you look forward to 2011, why, if we follow through on the plans, you can look at some dividend increase. And look at our capital spending. Capital spending for this year is going to be in the neighborhood of $11 billion to $12 billion. That's what we would expect it will be, $11 billion to $12 billion. And so if we look out to the next year in 2011, where we’ve said we haven't finalized plans or that, but with the things that we are doing in the company probably our capital spend might be in the neighborhood of $12 billion or $13 billion because we have a lot of projects that we are working on. Another thing that we’ll probably do as we look at the end of this year, we'll probably carry cash balances in the neighborhood of, for guidance purposes, let's say $2 billion. The reason we do that is because there may become opportunities for us to participate whether it's deepwater Gulf of Mexico or shale gas, coal bed methane opportunities in the Lower 48 or other places of the world. And so we look at that and we say, well, we just want to have cash available in an order and magnitude of about $2 billion because we think the things we might do might be a couple hundred million dollars, half a billion dollars, something like that. In terms of the deepwater gulf of Mexico, we look at it, and we say well, it's way too early to determine what are the opportunities because we don't know what we have a moratorium on, we don't know what the rules, regulations, risk/reward, liability situation is so it’s really way premature to get into something like that so the guidance we’re really giving you is we’re saying well, we carry $2 billion in cash, we get debt down to $22 billion, $23 billion, don't have to take it down anymore, we raise the divided next year and so then when we look at it and we say, okay, given how we sell our shares while we sell our shares of LUKOIL we'll start really buying our shares probably for the middle of August in an even pace and we like the idea of just kind of averaging this over time. So on the basis of what we did, is we sell LUKOIL shares, we buy our own shares and then we have to take a look at what the market gives us in terms of cash flow from commodity prices and crack spreads. So hopefully, I’ve tried to give you our basic approach to what we're doing for the rest of 2010 and 2011.

Paul Sankey - Deutsche Bank AG

Indeed you have, Jim. In the past, when you've done a buyback, you've been more opportunistic. You’ve timed it, if I'm not wrong in thinking back, and it sounds like this time you're going to go for a more rated approach. Is that correct?

J. Mulva

It will be a kind of a ratable approach so much and we’ll spread this out over 6 to 12, all the way up to the end of 2011. The fact that we sell that first block on August 16, the Russian shares where we’ll actually have sold more Russian shares than we have purchased but we'd like to get back on to a more ratable situation where we sell the LUKOIL shares and we buy ConocoPhillips shares, but there’s a little bit of catch-up in terms of buying our own shares so we might do a little bit more as we go through the third and fourth quarter.

Operator

The next question comes from Doug Terreson with ISI.

Douglas Terreson - Morgan Stanley Dean Witter

Jim, I had a question which pertained to your previous answer. You commented on the significant amount of certainty that we have surrounding the situation in the Gulf of Mexico. But do you have what you consider to be the two or three most likely implications for a company such as yours participating in the play because even though it's not as significant to you as it is a lot of your peers, you do have significant potential out there and so could you provide some insight as to how you think it might shake out, most likely outcomes?

J. Mulva

Well, we really feel that we need to get this industry back to work. And the industry is ready to work. We have to do this because if we don't, drilling rigs and people start to leave the Gulf and they leave the Gulf, they don't come back a month or two later. They leave permanently for one or two years. And we look at the Gulf of Mexico, we know the resource are there. We need to develop our indigenous resources. It's employment and then employment leads to investment, and employment leads to returns, and taxes are paid to states and to the federal government. So for every reason, we really believe that we can put the industry back to work, that's important. The other thing is as we look at our company, we obviously as I said earlier, we’ve got to know what the risk/rewards we need to go with the rules and regulations are and that's hopefully it’s going to get sorted out here more quickly than we've seen so far. For our company, for the past several years, we’ve looked before the Deepwater Horizon incident, we felt that we wanted to have – we were underrepresented in the deepwater Gulf of Mexico. We want to have more of a position. So we in the last several license rounds, we've been picking up acreage pretty aggressively. And then we've been trying to farm in, and we’ve tried to do that. So now, we find with the Deepwater Horizon incident that we find ourselves while we don't think necessarily we’re advantaged, but we don't think we're disadvantaged. And so we look at a company like ourselves and we say we have the capability, the technology, the experience, we can do this. So we want to be opportunistic, and we feel we are the right kind of company to do this. So if smaller companies don't want to continue to participate and we see the risk/reward and the rules and regulations okay, we’d like to do more in the Gulf of Mexico, but we're not going to do this until we know what the rules are and what the risk/rewards are going to be.

Douglas Terreson - Morgan Stanley Dean Witter

Obviously, the divestiture program has been surprising in terms of the proceeds and the valuations and BP received some pretty hefty evaluations as well. And so that's obviously heading well ahead of expectation from where I sit, but on the strategic outlook, could you also provide an update on your European marketing and Asian refining businesses that is how strategic you consider those businesses to be?

J. Mulva

Well, we've announced here just recently that we’re not going forward with the very large project in Wilhelmshaven. You’ve got great refining assets. And you could see by the second quarter results that we've done quite a bit better than we even expected when we went into this year with crack spreads and the business environment. How sustainable are they? They’re really going to depend upon supply and demand situation and the economy and whatever. We continue to really work hard. We did say earlier this year our strategic plan is to lighten up the portfolio on the Refining side and we thought that we could better do this for value creation purposes in 2012. But we're not sitting on our hands, letting the grass grow. We're out there trying to figure out can we venture? Can we somehow or another participate with someone else? Can we pick the asset or can we sell the asset? So the marketplace looks like it's a little bit better than it was six months ago, but we don’t really have any more to pass along than we are working to accelerate our strategy of lightening up the portfolio on the Refining side of the business just like we outlined earlier this year.

Operator

Your next question is from Mark Gilman with Benchmark Company.

Mark Gilman - The Benchmark Company, LLC

Jim, I appreciate your discussion on the rationale for the LUKOIL, but I guess I still don't quite understand exactly what changed between the time that you indicated that you’d sell half the interest and now, when you’re a seller of all of it? Follow-up question after you address that though, you have traditionally utilized acquisition as a means of achieving portfolio-oriented objectives. And I guess as one looks at the global upstream portfolio, the growth component perhaps isn’t what you might like it to be, and I'm wondering what you might do beyond just $200 million to $500 million opportunistic-type acquisitions to remedy that if you think it should be remedied.

J. Mulva

Okay, what's changed with respect to our ownership in LUKOIL. I think it's certainly the business environment. If we look back five or six years ago, what took place with the very deep worldwide recession, the financial crisis in the latter part of 2008, access issues. As I said earlier, the development of opportunities not just within Russia, but outside of Russia and some of the reason for why we put the strategic relationship together was to do more things together in Russia and outside. And that really hasn't materialized quite like we thought. Not because of lack of interest or intent, but the business environment’s quite different than it was. And so we have a pretty complex shareholders agreement. And so we initially outlined and disclosed we were going to sell half of our interest, 10%, but we were also during that time period working on the 20%, essentially selling all of our interest and that takes time. And we just felt we wanted to get going so that's why we announced the 10%. There's not really a change. There has been a pretty consistent approach and it’s taken time and that's really my response on that. The other second question you said is, well, we’ve built ConocoPhillips over last 10 years and there's been a great deal of M&A activities from mergers to acquisitions, ventures, whatever. Things like what we did within Canada with the refining side now with Synovis. And when we look at our portfolio objectives going forward, I really think that the world really has changed. And we’ve said this in our meetings with the financial community, the Analyst meeting, M&A opportunities, you look at them, they're feeling far between. You're very expensive and you have to really question do you create value for the shareholder? Our emphasis is on how do we improve all of our metrics. Return on capital, foreign cash return on capital, work per share metrics and reserves and then, by the way, when we sell ultimately our 20% interest in LUKOIL, our metrics production per share, reserve per share, cash per share all of that, when you look at the ConocoPhillips, E&P segment, they all improved somewhere in the order of magnitude of like 10%. So we have as we’ve said, we’ve got 40 billion plus of resources. We've got plenty of resources. Yes, you never have enough. You keep working for it. We want to improve and get more exploration success, but we can create a lot of value if we, as we said, convert these resources, 1 billion BOE a year into proven reserves, and do this well, we’re going to create a lot of value for shareholders, and we don't compromise the balance sheet and we don’t put a share stock up. And that's really a plan.

Operator

Your next question comes from Jason Gammel with Macquarie.

Jason Gammel - Macquarie Research

I wanted to ask you a little bit about the unconventional objectives that you're looking at in both North America and Europe. You mentioned your activity in Eagle Ford shale. Would you be able to talk about what the hydrocover on the mix is, just natural gas versus NGLs versus oil? And also, if you can disclose what your IP rate are averaging there?

J. Mulva

Sure, Jason. So looking at Eagle Ford, we're seeing of the 13 wells we’ve drilled and the seven we've completed, we're seeing IP rates anywhere in the range of, let's say, between 1,500 to 2,500 BOE per day. We do have some that are on the higher side of that where we’ve got gas being produced. I guess our best well is around close to six MCF a day and oil is 1,600 BOE per day. So you’ve got an MMcf per day of close to 16. But I would say on an MCF or a BOE per day, on a BOE per day basis, we're seeing something around 2 at Eagle Ford. I think, and that's the information I have on Eagle Ford, right? As I mentioned on Poland, the well that we've finished there was more of a data collection well. We got some logs and things to look at, and we don't have anything to disclose on that this year, and I don't have anything in front of me on Bakken other than to say that within the total Wilson Basin area that we’re producing somewhere around 30,000 barrels a day. This is an area that's interesting to us. We’ve ramped up our capital spend from about, from somewhere around $200 million to close to $500 million. This would also be an area you would expect us to increase capital spending into 2011 and 2012. As you look at places where sources of growth for ConocoPhillips, I would say, Eagle Ford, Bakken, Permian and then as you look up into Horn River or the Mahtne [ph 51:22], or into Poland or China, those are probably longer in terms of the amount of time it takes to wrap up production, you’re probably looking at beyond the 2011 time frame. I don’t know if that helps.

Jason Gammel - Macquarie Research

That’s great. Maybe one more if I could with APLNG, FID approaching by year end 2010, are there any key milestones that we should be looking at along the way that would point one direction or another and I'm thinking specifically potentially HOAs with eventual offtakers?

J. Mulva

Well, that's the real question in the marketplace is that we've indicated that we're going to sell two tranches of LNG and the plan is to get that done by the end of this year. We're working very hard on it with the idea of going forward in FID at the end of this year as well. So if plans haven't changed the record guys are halfway through the year, but we're working very hard on this.

Operator

Our next question comes from Edward Westlake with Credit Suisse.

Edward Westlake - Credit Suisse

Just coming back to the legislation in the House. I've seen two bills, both state at the moment unlimited liability, and therefore, no cap. I’ve heard from other companies talking about a $1 billion cap and cooperative insurance for money above that $1 billion cap for the Gulf. And that makes sense to me. But I’ve just not seen any language to that effect and so I just want to gauge your risk that perhaps the wrong bill gets passed and then I’ve got a follow-up on the side.

J. Mulva

It comes with respect to unlimited liability. We really don't think that's appropriate as it really will end up being quite punitive to the industry and the result will be I don’t think we’ll see the industry getting back to work. I mean, at best, only the very largest companies and it’s a question of where they live, [indiscernible 53:23] the risk/reward it being acceptable to going forward in Deepwater Gulf of Mexico with unlimited liability. So I can't speak for other companies, but I think the result of that will be that we will just not have the activity, and we will not develop the resources if we have that kind of situation. Property insurance for the oil spill insurance fund, we have to make sure that whatever we do, if there are changes to it, and it's done in a way that those funds have collected are really used in the case of a very unfortunate tragic incident. That's what they need to be used for and more of a collective mutual insurance by the industry, in the sense you pay in than to be a vehicle by which the government collects money from the industry and uses it for other things other than it's intended purpose. So this are really very, very important things that need to be sorted out and are going to have a direct impact on whether we get the industry back to work and develop the resources that we know we have in the Gulf of Mexico.

Edward Westlake - Credit Suisse

Just on the greater Poseidon, a specific question, obviously you’ve said testing has validated the significance of the discovery. So in terms of the timing, can you talk a little bit about perhaps the size of the resources you have in the path to commercialization or is it still too early?

Clayton Reasor

So Kronos was a discovery. I guess you could also look at it as an appraisal well, but we haven’t shared what our future drilling activity is in browse.

J. Mulva

No, I don’t believe we have, but we do have planned several more appraisal wells we're going to have to do before we assess its potential and then ultimately, it’s moving forward commercialization. But everything, we're pretty pleased, and it's promising.

Edwasrd Westlake

Do we expect to drill appraisal wells this year?

J. Mulva

Going to have to come back, because I'm not familiar with it.

Clayton Reasor

We'll come back to you on that, Ed.

Operator

The next question is from Paul Cheng with Barclays Capital.

Paul Cheng - Barclays Capital

Jim, it seems like you also operate in the other OECD deepwater area, Australia, U.K., Norway. Based on your discussion with the government in those areas, is there any hint that because of the BP oil spill they have been listening and perhaps that’s going to a substantial restriction their current [indiscernible 55:58].

J. Mulva

If I think I follow your question, they obviously are going to look at [indiscernible 56:08] of what took place with the Deepwater Horizon incident, Gulf of Mexico. But on the other hand, we do see that in the areas that you mentioned there was no moratoriums for us. Obviously, they want to make sure that they're looking and checking and everything’s in good order for any of our exploration or drilling activities in those areas, but no moratorium. And we wouldn’t expect one. And we haven't seen any change with respect to, in those areas, legislation or requirements for different forms of liability here in that regard. It’s just more vigilance, making sure that things are done right, but no moratoriums and no changes, and as we see at this point, regulations or other impacts.

Paul Cheng - Barclays Capital

So you still feel pretty comfortable with that? It’s not totally status quo, but it's not really dramatically changing the working environment in the OECD or outside U.S.

J. Mulva

Yes, that's what we have experienced and we see so far.

Paul Cheng - Barclays Capital

In terms of the Wilhelmshaven refinery in Germany, is there a timeline when you guys will decide what to do with that facility. I mean that status quo is probably not acceptable, based on where they are. If you can’t find a buyer and not sure that there’s a buyer for the Calgary refinery at this point, when you will decide that you need to take the next step going to be with that?

J. Mulva

Well, essentially, Clayton commented on this, but we've essentially written that down to its value as a term loan. And as a term loan, it creates value for us so we can continue to run it long-term as a term loan, then the option is, how can we carry more value than just running it as a term loan?

Sigmund Cornelius

That's exactly right. But I think just because we made the announcement this quarter, there have been discussions about Wilhelmshaven and how to venture it or convert it on an ongoing basis. So whether or not we make those final decisions this year, I don’t know if we’ve put a timetable on ourselves to say they’ll be done or not.

J. Mulva

No, we haven’t placed a timetable on us because we're satisfied whether there’s a term on it creates value for us, not a great deal of value, and we recognize its value as a term loan on the balance sheet, so everything we do from here has got to have upside.

Paul Cheng - Barclays Capital

So I mean is that means that in the third quarter, you're already running this as a terminal, you are no longer running oil through the refinery?

J. Mulva

It’s shut down.

Paul Cheng - Barclays Capital

It’s shut down totally, right? Have you laid off all the people yet?

J. Mulva

Oh, no. There’s regulations, labor rights and all, in Germany and in Europe that the employees stay for some extended period of time, but we can come back to you on that. So the cost associated with the personnel will take some time as it works off.

Paul Cheng - Barclays Capital

Maybe this is more for Clayton. A number of simple accounting questions. In LUKOIL, given your decision here that in the third quarter and going forward, accounting-wise that how you going to report it? Are you going to report it just as the cost base and given your decisions here at the end of the third quarter and going forward, accounting wise, how are you going to report the cost space and report the earnings from dividend or do you still going to be in the equity income?

Clayton Reasor

Well, we plan to use the equity method of accounting for our investment of LUKOIL until we believe we no longer have significant influence. I think that's the term. And so we'll look at what the situation is. But given our rights, it's unlikely that we would lose significant influence until our ownership falls below 10%. So the short answer to your question it we will use equity accounting, we would expect to use equity accounting until our ownership falls below that level. And then when stop using equity accounting, we’d no longer report our equity share of LUKOIL earnings. We wouldn't report our equity share of LUKOIL production and reserves.

J. Mulva

Given the 7.6% that's being sold plus the 0.8% already sold, you're getting up 8.4% sold at the end of August, and we don't know for sure, but you could just say that probably, it will be at the 10% or less probably by the end of this year. So we’re going to be losing equity accounting pretty soon. And we’ll come out and give you more guidance on that when we better determine it but maybe you should be thinking that when you look at 2011 there’s probably not equity accounting.

Paul Cheng - Barclays Capital

The effective tax rate, if I excluding the impairment charge and the asset sales gains, what is the effective tax rate for your international E&P and R&M for this quarter?

Clayton Reasor

I’ve got that. It's in my stack of papers, Paul.

Paul Cheng - Barclays Capital

That’s fine. You can just email me or call me later on.

Clayton Reasor

Okay. I’ll give you a call, but we’ve got that.

Paul Cheng - Barclays Capital

And also, on the inventory side, you have maybe of the over lift in the second quarter. So at the end of June 30, inventory-wise are you now balanced or are you underneath or over lift?

Sigmund Cornelius

We're pretty close to balanced. We're less over-lifted now than we were. There’s a slight over-lift position, but it's immaterial, one or two a day.

Paul Cheng - Barclays Capital

Sequential to the first quarter when I'm looking at your realization and your unit profit rating in the upstream, maybe I got it wrong, but it appears that your unit cost, excluding the Exploration, maybe up about $1 or so. Don’t know whether that is true, and if that is the case, other than, say, the natural mix or that the lower production drive the unit cost higher, is there any other factor that we should consider?

Sigmund Cornelius

Yes, when we look at our controllable cost for both E&P and Refining and Marketing, we're down, if you add them both together, we’re down about $300 million. But the biggest sources of the increase are higher foreign exchange costs, foreign exchange, but I can walk you through that calculation. We actually show absolute costs being flat to lower in our segment. So if there's an increase, the increase would come from, I guess, smaller production or not adjusting for foreign exchange. But we don't show an increase in -- we don't see an increase in our prevented operating cost.

Operator

Our next question comes from Arjun Murti with Goldman Sachs.

Arjun Murti - Goldman Sachs Group Inc.

Just a follow-up on your comments on APLNG where I think you expressed release that the super profit tax has been pulled off the table. But there is the chance that the offshore, I think it's PRRT, comes onshore. Would that be key to a make or break on moving forward with APLNG? How do you see that impacting your decision to move forward with the project?

J. Mulva

Well, obviously, the proposed super profits tax was just not a starter for our project or all of the projects. So our move to something significantly less is welcome. But on the other hand, probably our methane to LNG is really a new activity. And that's a great opportunity for Australia and for Queensland for investment, appointment and a lot of fiscal taxes to be paid to the entities. And so it's -- although it's LNG ultimately, it has different, very different, dynamics and has an offshore traditional project where you have liquids and gas and you bring it ashore and you have an LNG project. So we are continuing to work to state that case to the Canberra and to the authorities of the government that we really shouldn’t be looking at any changes in taxation. Where we really should be looking at is incentives for this type of a project. So hopefully, I’ve tried to give you some color on this, Arjun.

Arjun Murti - Goldman Sachs Group Inc.

Yes, that is helpful, Jim. The asset sales have obviously gone very well, I think U.S. refineries you’d previously said there was a weak market, and you don't want to sell into a weak market, crack spreads have improved, your oil refineries have improved, any change to how you’re thinking about the U.S. refineries?

Clayton Reasor

Well, the only thing I would say on the U.S. refineries, yes, it's improved a little bit. And we've seen a few transactions, smaller transactions take price, that's good to see versus no transaction because you can see that people are starting to get interested. And we talked to all of those people and people who we think ought to for strategic reasons have a participation in it. I would just say that compared to the late last year, early this year, the interest and the discussions, not that I’m signaling in any way a transaction’s coming. I’m not. I'm just saying that there's more meaningful discussions and interest in refineries in this part of the business than there were six months ago. Now whether that’s going to translate into us doing something way premature because we don't know.

Operator

Your next question is from Philip Weiss with Argus Research.

Philip Weiss - Argus Research Company

About the LUKOIL decision, I was wondering if there was any flexibility to reduce the amount that is going towards the stock buyback and possibly put that towards additional CapEx?

J. Mulva

Well, as we sell our shares in LUKOIL, and we said primarily will be used to purchase shares in ConocoPhillips, obviously we can adjust that to some extent if the business environment gets worse for some reason, I don't think so. I think the recovery in the world and the U.S. is slow. I don't think we're in for a double dip, but let's just say we were in for something unfortunate like a double dip. Well then we might look at it from a liquidity point of view and I'll say well maybe we shouldn't be taking the proceeds and maybe we should sit on a little bit more cash than $2 billion or $3 billion. Maybe there'll be opportunities come our way, maybe there's another day to buy the shares so that's really how we would adjust it.

Operator

The next question comes from John Hurling [ph] with So See [ph 1:06:55] General.

Unidentified Analyst

When you look at your costs incurred for exploration in recent years, you've been increasing it, you’re now more high teens rather than low teens. To achieve your goals in terms of getting more upstream exposure, do you have to, one, increase that more? Or two, increase your risk profile in terms of the exploration projects you're targeting?

Clayton Reasor

Yes, I think there’s really some of both there, John. I think that if you look at us over the last two or three years, greater proportions of our capital is going to exploration, and I think our exploration prospects have been more directed at wildcat Big E-type opportunities with running room rather than the traditional exploitation work that we had been doing, say, in the earlier part of the decade. So directionally, I would say more capital into Exploration and the types of wells we're drilling are higher risk.

Unidentified Analyst

Also, with regards to getting more exploration exposure, pardon the phrase, but I think the golden era of refining’s kind of over. Would it make more sense for you to downsize more of your U.S. refining exposure than you've discussed?

Clayton Reasor

Well, we talked a little bit about that. We’ve said that we would like to reduce our refining exposure to 15% of our company's capital employed. We just didn't think that the time to do that was the environment that we're currently seeing given the depressed state of the economy.

J. Mulva

But I would say responding to John, in the short-term, I can't remember the exact number. So should we come off around the neighborhood of gross 3 million barrels a day down to something like 2.2 and we say that's over the short-, the medium-term time period. Now if you look at the longer-term time period, it may be that there’s even less refining exposure and what left is left in terms of refining exposure has got to be only the largest, most sophisticated refineries that have some tie to feed stock, to some kind of venture. Or something like we've done with Synovis. So I think it’s a progression of watching what's taking place in the world and what the risk/reward situation is, but I think the emphasis would be going from 3 million barrels a day down toward 2.2 with time and then even further looking out into the future you have to ask yourself what you think of this business and potentially even growing less than that.

Unidentified Analyst

So sort of a disintegration strategy, so to speak?

J. Mulva

Well, certainly lowering the portfolio towards the refining side of the business, the other you asked on earlier is what about the impact in the U.S? And I would have to say whether it's U.S. or most of our refining exposure’s in the U.S., but we'd have to look at the smaller less sophisticated refineries, do they fit or they don't? Get more challenge.

Operator

Gentlemen, your final question comes from Jack Russo [ph 1:10:15] with RBC.

Unidentified Analyst

I just wanted to see if you had any thoughts on your decline rates that you've seen so far this year since you've started on this program of a little bit less on the CapEx front?

J. Mulva

Well, probably, we'd say the following about production, but I think Clayton has been talking with the buy and sell side in his normal way of how we present and talk about all this. The first is probably when we started the year. The impact on production from asset dispositions is probably a little less than we might have thought on the average for the year. We're getting good value for what we sell, but when we sell it, we're selling it, it’s taking us a little longer than we thought to make sure we get good value. So from a production impact this year, it's probably less than you might have thought. The other bit is the analyst meeting back, I think it was March, we said that just assume that when we're done and we complete $10 billion asset dispositions, we're going to go from something like the 1.8 million BOE a day to something down like, say, maybe 1.7. A little bit more, little bit less than that, but just for guidance purposes, think 1.7. And then we've been saying that for the next several years given our portfolio, that production will go down maybe 1% a year. Actually this is an excellent growth on everything, goes down 1% a year for two or three years, then it starts coming up in absolute terms. And it comes up in absolute terms because we bring on some of these new large projects, and then they go for a very long period of time. Like the oil sands in Canada, they just go for 30, 40 years. So what we've been doing is per share metrics as we buy our shares in, we’re going to see these per share metrics production’s going up even when absolute level production goes down 1% a year. It’s going up by 3%+ and then as we continue, say over a period of time, we keep buying our shares in, but we increase the absolute level then the per share metrics really get levered up quite a big higher more than that. That’s the plan.

Clayton Reasor

So it looks like we’ve run out of time. We appreciate everybody's participation. Happy with any follow-up questions that you may have. You can find the material on our website. You'll see the slides and the presentation material. We appreciate your participation and your interest in ConocoPhillips. Thank you very much.

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 great day.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: ConocoPhillips Q2 2010 Earnings Call Transcript
This Transcript
All Transcripts