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ConocoPhillips (NYSE:COP)

Q4 2006 Earnings Call

January 24, 2007 11:00 am ET

Executives

Gary Russell - GM of IR

Jim Mulva - Chairman and CEO

John Carrig - EVP of Finance and CFO

Analysts

Paul Cheng - Lehman Brothers

John Herrlin - Merrill Lynch

Doug Leggate - Citigroup

Gene Gillespie - Howard Weil

Mark Gilman - Benchmark

Paul Sankey - Deutsche Bank

Nikki Decker - Bear Stearns

Neil McMahon - Sanford Bernstein

Dan Barcelo - Banc of America

Presentation

Operator

Good day, ladies and gentlemen, and welcome to the ConocoPhillips Fourth Quarter 2006 Earnings Call. My name is Jen and I will be your coordinator for today. At this time all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of today's conference. (Operator Instructions).

I will now turn the presentation over to Mr. Gary Russell, General Manager of Investor Relations. Please proceed, sir.

Gary Russell

Thanks, Jen and welcome to everyone who is on the conference call today for ConocoPhillips fourth quarter 2006 results. With me today are Jim Mulva, our Chairman and Chief Executive Officer, and John Carrig, our Executive Vice President of Finance and Chief Financial Officer.

The presentation material that we use today is going to help us explain the financial and operating performance of our company during the fourth quarter of 2006. And you can find this presentation on our website, www.conocophillips.com.

On page 2 of the presentation, you will find our Safe Harbor statement. It basically says that our presentation and the responses to your questions today will include forward-looking statements about our current expectations. Actual results may differ materially from our current expectations. And you can find a list of the items that could cause these material differences in our filings with the SEC.

So, now I'll turn the call over to our Chairman and Chief Executive Officer, Jim Mulva.

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Jim Mulva

Hi Gary, thank you and good morning and I appreciate everyone joining us for our fourth quarter 2006 earnings conference call. I appreciate your interest in our company. And so, I am going to start my comments on slide for page 3. You can see for the fourth quarter of '06 we generated $3.2 billion of net income, $5.6 billion of cash from operations. Two, previously disclosed impairments reduced our net income for the quarter by about $285 million and that's about $0.17 per share and I will talk more about these two items in subsequent slides.

During the fourth quarter we were able to reduce our debt-to-capital ratio to 24% so down 1% from the third quarter. We reduced our debt level of $700 million so at the end of the year it was at $27.1 million and we obviously continue to fund our capital and investment program.

Now for the fourth quarter of 2006, we produced $2.49 million BOE a day and now that includes about an estimated 438,000 BOE a day from our LUKOIL Investment segment. Again I will talk more about all of this in subsequent slides. Well our refining and -- refineries ran at 95 -- 94% of crude processing capacity so that's down 1 percentage points for the previous quarter. Now with respect to the metrics, return in capital employed and income per barrel from upstream and downstream, we have some slides and we will talk about that later in the presentation.

So I am going to move on to page 4, this slide on page 4 shows comparison of fourth quarter net income to third quarter. Our worldwide refining and marketing margins were significantly lower and in the third quarter. In addition our crude oil natural gas liquids prices along with Penreco margins were lower than the third quarter. So the net of all of this along with other market impacts resulted in a decrease in fourth quarter net income of about $1.2 billion that's the 1.158 read are on the last slide of this page as compared to the third quarter.

Now we had higher E&P sales volume, they were partially offset by lower volumes in our refining, marketing and chemical segments. But these higher volumes improved our fourth quarter net income by $153 million. At third quarter we recorded one time negative tax adjustments as a result of recent tax legislation you recall the United Kingdom, Alaska and Venezuela now this shows up as a positive variance quarter-to-quarter that's the $508 million in this chart. Since we didn't have adjustments in the fourth quarter and the other items $182 million reduced our fourth quarter compared to the third and that includes the absence of business interruption claims, higher operating expenses drive low cost and higher asset impairments, but partially offset by improved foreign currency exchange impacts and higher DD&A, as a result fourth quarter net income was $3.2 billion.

Now I am going to move on to page five that talks about total company cash flow. We started the fourth quarter with the cash balance of $696 million, we generated about $5.6 billion from fourth quarter operations. We spent $4.2 billion during the quarter on our capital program and investments. Investments included the acquisition of 1% of LUKOIL stock and that 1% cost us about $753 million. Fourth quarter we paid our $593 million in dividends, reduced our debt by $700 million. Additionally we repurchased $250 million ConocoPhillips stock in the fourth quarter. So together with the Burlington Resources first quarter of 2006 share repurchases, our pro forma repurchase program and all of '06 totaled approximately $1 billion. After considering other resources of cash flow, we ended the quarter with $817 million in cash. I am going to move on to page 6.

Page 6, you see the two pie charts, that show the sources and uses of cash for the full year of 2006. Now with respect to the chart on the left, it shows total cash available for the year was $25.4 billion, about 85% of that was generated from cash from operations. As you look at the pie chart on the right, you can see what we have done with $25.4 billion in cash. We spent $16.3 billion, or about 64% of available cash to fund our capital investment program. So if you look at all ‘06 we effectively reinvested little more than 100% of our net income back into the growth, development of our businesses.

Further looking on the right hand pie chart, we returned $8.3 billion or about 33% of available cash to our shareholders and debt holders, from a dividend share repurchases and debt reduction.

I am going to move on to page 7, which this chart of -- this slide you can see as we compare our cash return to shareholders and debt holders for the year of 2006.

As mentioned previously we returned about a third of our available cash or about $8.3 billion shareholders and debt holders. Now this is a little over a half of what the other companies on this chart, peer average doing about 55% and this is the result because ConocoPhillips has a much higher reinvestment rate where we reinvest our cash back into the growth development of our businesses.

For 2007, we expect to continue to show this chart in subsequent conference calls. And for 2007, we expect to employ even more balanced approach to the use of our cash and you could expect as we go through 2007 that we will have proportionately more cash allocated to dividend, distributions and share repurchases.

In December, we announced our reduced 2007 capital and investment program of $13.5 billion, and earlier this month we advise that our plan is to purchase 750 million of our shares in the first quarter of '07 and now we are going to provide an update on our dividends and our share repurchase program later this quarter.

So, I am moving on to the debt ratio slide on page 8. You can see we made good progress since the first quarter this year, since we had improved our debt-to-capital ratio and even increased our book equity and reduced debt. You can see our book equity is growing now to $84 billion. In mid of the chart, you can see we reduced our debt balance on the balance sheet by $5.1 billion from the high point at the end of the first quarter. So, if you look at the bar chart in the right, you can see that debt ratio 24% at the end of 2006 so, that's 6 percentage points lower than at the peak at the end of the first quarter of this year.

I am moving on to page 9. I am talking of several slides on E&P performance. Now, our worldwide realized crude oil price in the fourth quarter was much lower than the third quarter, back it's down $9.94 a barrel went down to $55.10 a barrel for our realized crude production in the fourth quarter.

Our global realized natural gas prices were only slightly higher at $6.12 per MCF versus $5.91 per MCF in the third quarter. And our realized price in US down $0.14 per MCF to $5.84. And our international realized price was up $0.51 MCF to $6.36 MCF.

Our E&P production and sales were higher in the fourth quarter than the previous quarter. As I said earlier we recorded one time negative tax adjustments in the third quarter as a result of tax legislation in United Kingdom, Alaska, Venezuela, so you see the impact on this quarter-to-quarter in the subsequent slides.

So I am going to move onto slide, page 10. Our production in the fourth quarter was similar to that of the third quarter. Although we saw improvement in the production from our Prudhoe Bay unit in Alaska, the improvement was short of what we expected due to weather related issues at Valdez which adversely impacted our oil lifting's.

Although we saw improved production in the UK after completing planned maintenance that negatively impacted third quarter production. The improvement wasn't as large as we would have expected due to unplanned compressor maintenance issues at our Britannia facility. These improvements that we are talking about here in the slide were mostly offset by our share of production from the Timor Sea due to production sharing contract impacts. And by completing the recovery of the under lifts in Libya, in the fourth quarter, we under lifted as you recall the first several quarters of 2006, so we think we got caught up in the fourth quarter. Then you add the 438,000 BOE a day which is our estimate of our equity share of LUKOIL's production. Now the total ConocoPhillips production approximated 2.49 million BOE a day in the fourth quarter.

Moving on to page 11, E&P net income. Our E&P net income in the fourth quarter was about $2.1 billion that's about $200 million higher than the third quarter. Results in the fourth quarter were about $400 million lower due to lower crude oil natural gas liquids prices partially offset by higher natural gas prices and some other market impacts. Higher sales volumes mainly from crude oil from Alaska some from Algeria, and improved fourth quarter -- that all improved fourth quarter income by a $159 million. As mentioned earlier the third quarter was negatively impacted by recent tax legislations in UK, Alaska and Venezuela, so this shows up that the $508 million positive variance when you compare quarter-to-quarter. And there are some other factors that reduced our fourth quarter E&P net income $83 million when compared to the previous quarter. And that includes Canadian asset impairment and higher exploration expenses partially offset by improved foreign exchange impacts some other smaller items.

Now I am moving from E&P to Refining and Marketing, so I am on page 12. Refining marketing we experienced significantly lower, refining marketing margins compared to the third quarter. Now in the US our realized crack spreads declined $2.71 a barrel in the fourth quarter to $11.39 a barrel. Now international realized crack spread declined $0.24 to $6.22 a barrel. Our US refining system ran at 96% of capacity, that's the same as the third quarter. Our international refining system ran at 87% of capacity that's 2% lower than the third quarter due to planned and scheduled downtime at our Wilhelmshaven refinery. As a result our worldwide crude oil capacity utilization was 94% in the fourth quarter, 1% more than the third quarter.

Our turnaround expenses in the fourth quarter were $94 million pre-tax that's $52 million pre-tax higher than the third quarter. Also in the third quarter we recorded $111 million business interruption claims related to the 2005 hurricanes. Of course that wasn't replicated in the fourth quarter, so it's a variance and we recorded impairment on our domestic marketing assets held for sale.

I am moving on to slide 13. Our refining and marketing net income was $919 million in the fourth quarter so that's $545 million lower than the third quarter. We had significantly lower worldwide crack spreads and marketing margins along with some other market impacts so it reduced our fourth quarter net income as you could see in the slide $496 million. Then we had lower volumes due to slightly lower crude oil capacity utilization that has an impact adverse impact to earnings of $10 million in the quarter. Then we had some other items in the fourth quarter reduced income 39 million that includes the absence of business interruption claims in the fourth quarter and a turnaround cost, operating expenses. Some of this was all partially offset by oil impairment and assets that held for sale, improved foreign exchange impacts and lower taxes.

I am moving on now to page 14. Our estimated equity earnings in the fourth quarter from the LUKOIL investment were $302 million. So, that's down from the $487 million in the third quarter and that's primarily due to lower crude oil prices in the fourth quarter. During the fourth quarter, we completed our purchases of the LUKOIL shares. So, at the end of 2006, we owned 20% of the authorized and issued shares of LUKOIL. But it represents also 20.6% of the estimated shares outstanding.

I am going to move on now to the other segments that we reported on and that's on slide or page 15, other segments. The earnings from our midstream business in the fourth quarter were $89 million. So, that's down $80 million from the third quarter. So, the decrease is the result primarily of lower NGL prices and along with some certain favorable tax adjustments, which we recorded in the third quarter wasn't -- didn't happen again in the fourth quarter. We expect with chemicals joint venture our net income was $98 million. That's 44 million lower than the third quarter, primarily due to lower margins in nearly all of the product lines, which is primarily olefins and polyolefins, aromatics, and styrenics. We also had an asset retirement of $16 million net our share related to the idle capacity in the K-Resin business from the chemicals joint venture.

Now, on the emerging businesses, not all that large for a financial impact results for $8 million of net income just slightly lower than in the third quarter, and then in corporate segments our costs were $306 million, pretty similar to the previous quarter. I am going to talk about now on the next slide income per barrel for the upstream and the downstream. And we have started showing this and will show this in subsequent conference calls for each quarter.

So, I am on slide 16 and this chart shows for prior years and three quarters year-to-date where we can compare with larger other oil companies and then we show the fourth quarter, what is our income and E&P per barrel of oil equivalent. And you can see $11.69 in the fourth quarter. We don't have the numbers for the industry, so obviously we don't have blue bars. So, we feel that we continue to work on this seems to be competitive with the peer group.

I am going to go to page 17, we show, what is our income per barrel for refining and marketing, and we show for the same period of time. And you can see for the fourth quarter, we have $3.36 a barrel and we feel we're certainly competitive with the peer group.

So, now I am going to go on to page 18. We always show this slide and that's why in the shaded area in the background, we show as a peer group, that's return on capital employed for the larger, integrated, publicly traded companies. So, that's ExxonMobil, BP, Shell, Total, Chevron. And so, the bar chart reflects ConocoPhillips' return on capital employed with no adjustments for purchase accounting. Adjustments though have been made to several of the peer groups shown in this shadowed area to reflect purchase accounting for some other transactions and we always attach table one, so you can see how we made the adjustments.

So, as you can see on right hand side of this slide, our annualized return on capital employed for the fourth quarter of 2006 is 13% and then for the full year, it's 17%. And so, when we get the information for the other companies when they report, quite obviously, we will update our charts.

So, now I am going to -- coming to the final two slides, the pages that we have in our presentation. So, I am moving on to page 19, which is the outlook. We feel we have had another good strong financial year in 2006. For 2007, we are going to place and continue to place a lot of emphasis on operating excellence, both upstream and downstream, and to do this well we need to operate obviously very well day-in and day-out to execute out major projects, replace our reserves, constrain our cost.

In light of our preliminary reserve replacement that we announced earlier this month for 2006, I would like to take a few moments and provide some additional insights on our reserve replacement picture. Our reserve replacement history has been somewhat uneven. Some years are stronger than other. As access to resources becomes more and more challenging, cycle times grow, investments are quite high. As a result of the complexity of the major development projects that we have, we would expect our reserve replacement to continue on an annual basis to be somewhat uneven. A better indicator of how well we perform, we always feel, a longer term, like a five-year average. If you look at five years, our five year pro forma average reserve replacement excluding acquisitions, we might say organic replacement, has been around 65%.

In the future, we would expect to book reserves from our substantial on book resources associated with our legacy assets that's we have Lower 48, Australia, Alaska, Norway, growth areas of Canada, Russia, Qatar and China. And we will continue to pursue new acreage opportunities to supplement and support our current resource space.

Now in 2006, our preliminary downward revisions totaled 260 million barrels with about 65% of that 260 million coming as a result of further technical assessment of our reserves in the Caspian. Now we are talking about Kashagan, let me be a little bit more specific. Analytically when we booked Kashagan, we booked the portion of the production expected from Phase I development as opposed to a more limited area of reserves existing from the appraisal wells coming from exploration. So that is the reason on Caspian and Kashagan.

Then the other part of that 65% relates to the accumulation of more information regarding corrosion, facility, lifespan, wave height data in the North Sea, particularly related to Ekofisk, Eldfisk facilities in the North Sea. So if the longevity of the facilities is shorter than you plan, then you are going have to be making new investments to make sure that you capture those resources in the future. Now we haven't approved those new plants yet, so we took some reserves of the books that we would expect over time, but new investment we will be adding reserve back-end.

So, those two issues accounts for about 65% of the $260 million barrels. And another 25% of that $260 million, so it all adds up to about 90% these regions from the $260 million came from a well performance and contract extension issues in Alaska and our exit from Dubai. We left Dubai as you recall, yes we have reserves on the books but we effectively were making essentially no money on the production and so we felt it didn't make sense to be pushing barrels and committing human resources and all when we could better deploy our human resources do other things to grow and develop the company.

So as I have discussed on previous earning calls, our oil and gas reserves governance process is strong. We do this very thoroughly to enhance it further, we the management of the company last year we selected an independent third party to review our reserves analysis and procedures and we just believed that this is good governance that's independent review enhances governance process to review third party assessment of our reserve position. And the independent review confirms that our reserve position in the aggregate is correct.

The Caspian Kashagan revision that I mentioned earlier was an outcome of this review. It represents less than 1% of our total reserves and so we expect we have an ongoing relationship in review -- independent review of our reserve position and it's on a rolling three year period of time, so everything gets clicked at on a routine basis and so we always keep updating our situation we just think this is good governance. So there is nothing new unusual to further report we are just giving you more detail of what a price when we announced our preliminary reserve replacement numbers earlier this month. Now information regarding our 2006 reserve replacements can be available later in February and its part of our Annual Form 10-K filing with the SEC.

Now let's complete some comments on this final slide. We are pleased to start 2007 with the closing of the transaction to create integrated North America heavy oil business with EnCana, I want you to know the integration efforts are progressing well in-line with our expectations. So, having completed our LUKOIL share repurchase, we look forward for the strength in our strategic relations with LUKOIL, looking at opportunities that we can be doing upstream and downstream.

Then turning to our asset rationalization efforts, you see, we generated proceeds of about $500 million in ‘06, we can expect to get about $1 billion in this month, or I say the first quarter. And you will see that when we finish and report the first quarter results. The balance of our rationalization efforts is on target we expect essentially we complete that in '07. And looking at the first quarter, as we announced, we expect the company's E&P segment, this is not LUKOIL, and the E&P segment production can be lower than the fourth quarter. Now, let me explain this a bit.

The increase, we are going to see an increase let's say about 25,000 barrels a day that we get our share of the upstream EnCana joint venture. We expect that a lot of this is going to be offset by the affect of the disposition program that we have in the order of 48 and Canada asset dispositions. Continued improvement in Prudhoe Bay, we expect, we are going to see increase in the fourth quarter 20,000 barrels a day, but that somewhat offset by plan downtime that we are going to have in the first quarter in the North Sea.

And then we no longer have this catch-up, fourth quarter catch-up and the under-lift position in Libya. In addition, the OPEC production quota reductions do have an impact on us is going to impact us somewhat, Venezuela and Libya and that's going to increase first quarter production. If the currently announced quotas continue through the first quarter then the impact of the quota reduction to our worldwide production is reduction of our 30,000 barrels a day.

Now, you step back from all of this and you compare the fourth quarter of '06 to the first quarter of '07, we're thinking that we're going to be down somewhere in the neighborhood of about 25,000 barrels a day oil equivalent. Now, in our downstream refining business, we expect crude oil capacity utilization to be in the mid 90% range in the first quarter. Now, remember now, our crude oil refining capacity starting January this year is 2,729,000 barrels a day now that's down from the 2,901,000 barrels a day and it just reflects the contribution of some of our refining capacity at Wood River and the Borger refineries into the downstream joint venture with EnCana.

Now turnaround cost, are expected to be about $60 million for the quarter. As I said before, we announced our December, in December our reduced 2007 capital on investment program compared to '06 to '07. So, '07 capital investment program $13.5 billion and we told you earlier this month that we plan to repurchase 750 million of shares in the first quarter of '07 and we're going to update you with more information regarding dividends and share repurchase. The reason that we announced the 750 million is we're really completing the final part of our previously announced share repurchase program. So, we will tell you more as we go through the first quarter because we will discuss dividends and share repurchase with our Board and that's why we announced -- we made the announcements we have, expect more information as we go into the February and March time period.

Then last thing I will say we look forward to updating the investment community on the status of our financial operating, spending programs as well as our continuing asset rationalization efforts, when we meet with you in New York at our March 14th meeting. So that the way it concludes prepared remarks and so I think John Carrig, Russell and myself will try to respond to whatever questions you may have of us.

Gary Russell

Okay Jane I think, we are ready to take some questions.

Question-and-Answer Session

Operator

Thank you gentlemen. (Operator Instructions) Gentlemen your first question comes from Paul Cheng with Lehman Brothers.

Paul Cheng - Lehman Brothers

Thank you. Good morning. Jim giving all the political noise or think just the way how they look at foreign investment in Venezuela, have you changed your view and looking at Venezuela the position, within your portfolio as a page for future investment, and how would you adjust or assess the risk profile right now? Secondly that last time you talked about some of the downstream projects maybe under review not necessary going to be pursued forward. Can you talk about any project has been canceled or postponed and how you view on that factor at this point? Thank you.

Jim Mulva

Okay. First Venezuela is obviously a -- gets a great deal of attention in the media and the finance community, I can show you it gets a lot of attention within our company ConocoPhillips. We have good assets obviously in Petrozuata, Hamaca, and the development of Corocoro. It is also the opportunity of working with other partners for gas opportunities. We continue to evaluate look at that but our posture with respect to Venezuela, obviously it's a difficult situation that we have to make sure that we are communicating and working with the Pedevesa the ministry and the Venezuelan authorities and also after certainly be looking out after interest of our company. So its difficult given discussions and negotiations to comment too much more about that other than to say that in our portfolio we really look at this point of time to Petrozuata, Hamaca, and Corocoro really is our position and I don't think you can see that are expected there is going to be significant additional investment at this point of time other than those three positions that we have in Venezuela. Now with respect to downstream investment, we will continue to go forward with our investments at Wood River and Borger as we announced as part of the joint venture within EnCana.

One of the things that are not just for the downstream, the [Vest] the joint venture within EnCana, but everything we look at upstream and downstream has been tremendous significant cost pressures on investment. So we want to make sure we slow down, we really take a good hard look to make sure that we don't try to accelerate projects that we execute them a lot of cautiousness and good prudent in terms of making sure that we get value for our investments. One thing I -- one project that I would like to talk about is the Wilhelmshaven refinery. We made the acquisition of the refinery and offset in the late part of 2005, and we said we are going to have a very substantial deep conversion project that we would start executing immediately. Well, what we found is that the escalation of the cost of the deep conversion project was far more than what we expected. So, we sensibly stopped, and we said we want -- we don't have to do this as quickly as we would like. We want to make sure that we get this right. So, we slowed this down. We are doing a lot of analysis. So, I would to say that I don't think you are going to see us approve a deep conversion project in Wilhelmshaven in 2007. On the other hand, what we are doing is we feel reasonably good that we will have a god project, but we are going to take more time, and I think that is something that's going to be more of a 2008 time period for going forward, not 2007. So, I am trying really to respond to your question.

Paul Cheng - Lehman Brothers

That's good. Jim, can I just add a follow-up on how about the Saudi Arabia joint venture refinery project, the (inaudible) refinery. Is there any change in your view about the viability of that project?

Jim Mulva

Well, I would say with respect first to Yanbu and working in Yanbu with Saudi Aramco, we feel really good about this project. We like it. It certainly has all the issues resolved in terms of escalation and making sure we get this right. I know Saudi Aramco feels the same thing and we have make sure we take the time and we get this right. But we haven't changed our expectations in terms of what we would like to do at Yanbu with Saudi Aramco. I'll have to say though that the other opportunities in the Gulf and the Mid East really are quite challenged. And so, I'll have to say, we will have to really take a good hard look at whether we want to do something more in that regard. Cost of the projects and cost of the capacity is pressing pretty hard, and we as a company have to step back and say, no, we can't do everything. We have to prioritize what we want to do in terms of upstream and downstream. And the other thing that we want to really make sure is increase our distributions for our shareholders in the form of dividends and share repurchase. So, we just want to make sure we are very prudent, and so we are going to be quite a bit more constrained and modest in terms of our capital spend.

Operator

Thank you, sir. Your next question is from John Herrlin with Merrill Lynch.

John Herrlin - Merrill Lynch

Yes, hi, Jim. With $55 well, we forecast you with your assets sales to have close to $8 billion in free cash. I know you are going to talk about the buyback program later in the quarter, but if you are going to split that $8 billion, how would it be divided between common stock repurchases and debt repayment?

Jim Mulva

Well, I think what you are going to hear from us obviously, as we said we like the discipline of increased dividends. So, we are going to take good hard look at the increase in our dividends next board meeting. Share repurchase, we've essentially given you a signal when we say we are buying $750 million in the first quarter. So, when we come out with our increased -- hopefully, increased dividends and share repurchase and announce that, what we expect to do for the reminder of the year, and we will announce that later in the first quarter, then essentially debt reduction becomes whatever it is. And so, we then look at it and say we'll, if we have a stronger environmental and oil gas prices and crack spreads, we'll pay down more debt. We don't change our share repurchase or dividends, but on the other hand, if the market environment is not as good as we expect, we don't contemplate changing a dividends obviously or share repurchase. So, debt reduction becomes a swing factor, but if the marketplace for one reason or other becomes even stronger than we would expect, then I think what you are going to see is, we would ramp up share repurchase.

John Herrlin - Merrill Lynch

Okay. One other follow-up for me. You ended 2005 with about 26% of your proven reserve base PUDs. Your peer groups are more like 40. You addressed some of the reserve changes like Kashagan, but do you think that your company gets penalized for actually having one of the lower PUD camps in the industry?

Jim Mulva

Well, I don't know. John, do you want to say anything on that?

John Carrig

Well, we recognize we have the percentages that you mentioned and I don't know the figures of the others exactly, but in the order of magnitude we agree with what you say and we think that in order to -- for us to mature those potential PUDs that it requires some work that we need to focus some effort on and our E&P folks are in fact have that in hand. We don't think it's a reflection of our resource base as such, but it's -- there is additional intensive -- manpower intensive work to make those PUDs -- to bring those PUDs to fruition if we--

Jim Mulva

Well, that's the reason why we spend the money that we do. We also think that we have a strong resource base that gives us the opportunity to do it. And may be in the eyes of many is a mature area, but it does give us the opportunity to capture resources, and it's one of the reasons when we go through our meeting in March 14th, why we spend the money that we do, so that we could capture these resources and create value for the shareholders, and we intend to really cover that in quite a bit of detail on March 14th.

John Herrlin - Merrill Lynch

Okay. Thank you.

Operator

Your next question is from Doug Leggate with Citigroup.

Doug Leggate - Citigroup

Good morning guys. Two questions if I could, the first one is numerical, it's related to the DD&A and the upstream. I think last quarter, you had given us some guidance that I have stepped up, but this quarter in the U.S. is used to come down quite a bit again. So I wonder if you could maybe just comment on that. My second question is more I guess strategic and can it relates to or how you discuss in terms of the five-year is their replacement, I guess you slowdown your investment in Venezuela. And I guess John's question about the free cash flow, are you happy with the portfolio of debt that you have right now and do you think that perhaps there is further acquisitions down the pipe that maybe you need to try and bolster the outlook going forward?

Jim Mulva

Well John Carrig will cover and Gary, DD&A. In term we were never satisfied with our portfolio, we always want to have more acreage. We want to have more drillable prospects. But we do like our portfolio, we do think we have quite a bit of opportunity but we always like to be doing more than what we have. In terms of acquisitions, I thought I was pretty clear on that, we have made a very substantial acquisition in Burlington Resources earlier in 2006. I think the market environment, availability of the cost whatever I don't see acquisitions we may buy something for $500 million or $1 billion or $2 billion if it's a right opportunity it's a right kind of asset. And I don't think for cost and everything else find availability or whatever reason, cost particularly everything. I just don't think those opportunities are there. So we are very focused on our organic capital spend of $13.5 billion and ramping up our distributions in terms of dividends and share repurchase, we are getting our debt down some, but not quite as aggressively as we did in 2006, so I don't see the prospect for our acquisitions.

Gary Russell

In terms of the DD&A what we saw is we continue to push down the purchase price to the asset base further down into the asset base and just as it were not been in the third quarter it did come down somewhat in the fourth quarter, so our view is that it's probably best to take the three quarters annualize it down to get a more reasonable rate for 2006 in terms of DD&A.

Doug Leggate - Citigroup

That's great. Thanks very much.

Operator

Your next question is from Gene Gillespie with Howard Weil.

Gene Gillespie - Howard Weil

Jim you talked around this a little or referred to in any way in several of your comments with, it was somewhat interesting and a little bit alarming to me to look at the return on capital numbers, 13% annualized and for the fourth quarter and 17% for the year and this was an industry question more than anything on industry observation and I am using you as an example because this is your call. But looking at similar numbers and assuming that the peer group is in that 17-18-19 between 20% range. $66 oil price environment that compares to about 17% average for the same group in 2003 in the $31 oil price environment. That suggests to me that there is a tremendous amount of cost escalation on the margin and I know that you are dealing with that with your capital program, capital reallocation program, but am I missing something here or is that correct?

Jim Mulva

No, I don't think you have missed in anything Gene. Situation is frankly speaking increased price in terms of oil price and whatever is not necessarily a friend of the industry, because it leads to cost escalation just as you pointed out an increase it goes to fiscal take as well. And so essentially for the reasons of cost escalation and fiscal take the increase is a price assigned no, it's not dollar for dollar. Essentially for one reason or another doesn't come through in terms of return on capital employed. So we are faced with this increased fiscal take increased cost -- increased costs, difficulty on access in terms of getting access to new resources and so the real dilemma for the companies is if we don't have the right opportunity we got to be careful when we don't throw money at whatever the opportunity is, if it's not a good opportunity then we need to return the capital in the form of dividends and share repurchases. So I am -- you outlined the scenario I agree with you -- kind of amplified hopefully the points of how I see it confirming what your observations are.

Gene Gillespie - Howard Weil

Thank you.

Operator

Your next question is from Mark Gilman with Benchmark.

Mark Gilman - Benchmark

Hi Jim, John, Gary, etcetera good morning. I had a couple of first specific things that if you wouldn't mind. First could you comment briefly on the performance of the Ekofisk growth project it frankly seems for a period now if it's been somewhat disappointing. Secondly, could you quantify what you are putting on the books for Burlington Resources reserves at year-end relative to what Burlington had on its books at year end '05? Thirdly, I am having trouble with the first quarter production arithmetic. It would seem to me the decline you are talking about is roughly equivalent to your expected OPEC curtailment. I don't see any allowance for a rebound from the intensive level of North Sea maintenance that adversely impacted the fourth quarter. And finally with the projects in the Middle East that you referred to in general terms regarding additional discipline is that the Abu Dhabi project? Thanks a lot.

Jim Mulva

Okay, Mark, first on Ekofisk growth. We, the issue of Ekofisk growth, we think there is always the opportunity and we are quite really excited about Ekofisk where we have got two, three, four growth there because we know we got a great resource, a lot of oil and gas resources that are there to be developed. The issues for us as you look in this past year, we really have an operated well in the North Sea. And in that regards at both in the Norwegian side and the United Kingdom side. So I don't want the operations to impact the view with respect to what are the growth opportunities. So we are excited about and really looking at how we can go on to the growth of Ekofisk. Its technically challenging, but we can add a lot of resources by doing that, and we think we can do it and the challenge is to do it in a cost effective way, because everything that we do offshore now even in the North Sea, like around the world, we are getting pushed on cost escalation. So we want to make sure that really when we look at the Ekofisk growth, we think we are going to sort out technically that we can do accomplish the challenges of growth at Ekofisk and redevelopment of Ekofisk. I think its going to be more of a challenge on the cost side. Now in terms of the reserves the [BR] or what they had in 2005 and all I don't know John, may want to comment, but I think that really comes out in the 10-K, and people can look at the 10-K and compare to what we have, but I don't know.

John Carrig

Right, I think we indicated in the interim. The purchases were about $2.5 billion I don't have a specific breakdown with me right now and that will be, but we can certainly address that, I just don't have it in front of me.

Jim Mulva

Yes, and then the next thing that I would is going back to the production numbers, its more detail on that first quarter compared to the fourth quarter. Now, Maybe Gary, you could call Mark and talk to him after the conference call.

Gary Russell

Yes, I will call and give you some details, Mark.

Jim Mulva

In terms of Abu Dhabi, your question on Abu Dhabi, well that is one of the projects that I was essentially inferring, two with respect to really challenging with respect to capital cost, where is the source of feedstock and all that. It has issues that are different from the Yanbu refinery that we're working on with Saudi Aramco.

Mark Gilman - Benchmark

Okay, thanks a lot Jim.

Operator

Your next question comes from Paul Sankey with Deutsche Bank.

Paul Sankey - Deutsche Bank

Hi, good morning, gentlemen. Jim forgive me I may have missed this. I just slightly missed what you were saying. Did I hear you reiterate that on a five year rolling average, you would be replacing 100% of your reserve on an organic basis, I think you may have said that, I am just not sure?

Jim Mulva

No. We're saying, I think on a 10 year, longer-term basis yes. But on a five year basis I think I was saying that is closer to about 65% organic, we more than replace our reserves when you bring in the business as the acquisitions.

Paul Sankey - Deutsche Bank

Okay, I have got it. There was kind of 265 in there, what was cash against it.027-1.35

Jim Mulva

The other thing that I will say is, on March 14, we will share with you, our plans in terms of how we see reserve replacement and all as we go out and over the next number of years. You will get that on March 14, for future years.

Paul Sankey - Deutsche Bank

Right, this might be one for then, but you listed a quite impressive number of places where you can add reserves, Australia, Alaska, Norway, Canada, Russia, Qatar and China, but you didn't mention Kashagan. Does that mean these bookings is essentially internal 28-0.11 deep booking or was it just on a mission?

Jim Mulva

No, what we are saying, first of all, what I was trying to say that my comments on Kashagan is that we have taken a more conservative view of reserves on the Phase I development of Kashagan, well by well and what we can claim reserves around the well, but we expect with more drilling, we put those reserves right back on for Phase I development. We are not singling anyway, any change of our view of what Kashagan will ultimately do. So it would be wrong for us to be giving or incurring referring any negative signals on Kashagan.

Paul Sankey - Deutsche Bank

Okay, that's great. I think we could say that one of the problems of reserves replacement in '06 was the lack of final investment decision on any major project. It seems to us that the outlook over the next couple of years is also a somewhat same. Is that a fair reflection and is that the reason why we are going to the 65% number?

John Carrig

No, I think, we will just talk more about that at March 14th but we are trying to say is, all those places where we are North America and Europe is mature, but we also the comments came up earlier we have a lot of really substantial resource and we think that we can add a lot of reserve replacement. But on the other hand we are working for the new LNG opportunities and other things around the world like Timor Sea north of Australia. We think there is opportunities to bring some new LNG projects -- so we but these are all challenging and tough to do. I won't go through all of that March 14th. The other thing I want to say about Caspian and Kashagan, we hopefully we would address Kashagan. We like Kashagan it has its technical challenge and certainly has its cost challenges. But the Caspian is an area for ConocoPhillips that we are really interested in and we are pretty aggressive trying to get more acreage, in particularly, well in the Caspian.

Paul Sankey - Deutsche Bank

And just finally from me, the -- I think the vague guidance if you want, for this years disposals was around $4 billion once your program was complete and I just heard an announcement yesterday that you'd be adding, I don't know if you are adding or not a refinery in Ireland to that program, could you first confirm, I mean the right ballpark for disposal this year? And secondly, is that incremental what we are seeing through Ireland and are you adding to the program as we go on? Thanks.

Jim Mulva

What I would say two points, I think we have said that we are going to be in the neighborhood of $3 to $4 billion and now we have got something that we try to sell or interested in selling. If we don't get the right price, we won't. If it's not tax efficient, we won't sell or look at something else. But, our guidance is still the same. No, it's not changed.

Paul Sankey - Deutsche Bank

Okay.

Jim Mulva

$3 to $4 billion with respect to the Whitegate Refinery, we look at everything. But, I think it's premature to be saying or formally talking about trying to sell Whitegate. It's unfortunate that it gets out like that, but we studied Whitegate. We've studied just about everything to see whether something might have value -- a lot more value to someone else and ourselves. But on the other hand, I don't also want to say we are not interested in ever parting with legacy and strategic positions.

Paul Sankey - Deutsche Bank

Okay. I appreciate it. Thank you.

Operator

Your next question is from Nikki Decker with Bear Stearns.

Nikki Decker - Bear Stearns

Yes, good morning, Jim. My question is on the -- your production in OPEC member nations. You talk about 3000 barrels of impact for the next quarter, how does that work? Have you taken that production down or will that ramp down during the quarter and is the actual production volume impact greater than that?

Jim Mulva

Well, first of all, a few things, we've mentioned not 3000 but 30,000 in fact.

Nikki Decker - Bear Stearns

Oh 30?

Jim Mulva

The next thing I would say is we receive very firm direction of what the production levels must be. So, when we derive this number it comes from directed designated fields in different parts of the world, so we know how we get to that number. The other thing, well, I think is very interesting about ConocoPhillips is proportionately -- I don't know, I would just say this, I think proportionately, we have a smaller amount or lower amount OPEC production compared to our total worldwide production as compared to many other companies.

Nikki Decker - Bear Stearns

Okay. Just -- I just want to clarify the OPEC impact is 30,000 barrels?

Jim Mulva

That's right.

Nikki Decker - Bear Stearns

Has that come off already, that 30,000?

Jim Mulva

Yes, some of its coming off now. That's right.

Nikki Decker - Bear Stearns

Okay. Great, thanks. Your exploration expense was a little higher than I think what you had been guiding to in the fourth quarter, can you talk about that?

Jim Mulva

Well, we would like to thank -- we can't speak for other companies, but we would like to thank whenever we see something that's not materializing or meeting expectations, or we need to suspend it well. We need to write something off the acreage, not what we thought. We immediately write it off, get it behind us and move on. The other thing I would say and we'll share more with this on the March 14th day, when we talk about our total exploration spending, we need to do a better job of communication. A lot of our exploration spending has to do with development, exploration, infrastructure, and where we have a - it's not just pure rank wildcat exploration. We have infrastructure where we think there is resources. We drill around in areas where we expect a high probability of adding resources. So, maybe we need to communicate better that the total exploration that we call explorations spend is not all on just pure rank wildcat where the probability of success is 10% or 20%. A lot of our money that we call exploration is appraisal drilling and it has probability of success well in excess of 50%. But we are going to share that with you when we meet with you on March 14th.

Nikki Decker - Bear Stearns

Great, thank you.

Operator

Your next question is from Neil McMahon with Sanford Bernstein.

Neil McMahon - Sanford Bernstein

Hi. Just got a few questions, as a lot of being answered. The first is, really around your discussion on the CapEx and being just, sort of say, a lot more cautious about big increases and just where you are spending at, would that also apply to exploration expenditure in 2007 and 2008 given the fact that you've seen a big step up in dry hole expense? And then, I've got a few other questions as well.

Jim Mulva

Well, obviously if we cut back our spending, we have to also look at our exploration program. How much do we want to be spending on exploration? I just kind of made some comments on that in the last question. But we also want to look at what -- do we have good drillable prospects. So, I would say that for our company, we have the portfolio that we do, but we are putting more and more emphasis on getting -- doing the study and the technical work and getting into the new acreage positions that we feel are the new frontiers that we would like to be in. So, we are putting more of our money proportionately in to doing that then to just drilling wells, if we don't feel we have the drillable prospects that we would like. And we're going to cover that with you when we meet in March 14.

Neil McMahon - Sanford Bernstein

Just a few more questions, it looks like Iraq is going to open up to foreign investments, probably sometime this year if they pass their new oil law within the next month or so. Have you through LUKOIL got any idea if you are still going to be able to have old Sudan year at contracts that were awarded to LUKOIL is still maintained under the new law or do you think they are going to scrap those contracts?

Jim Mulva

Well, first we don't know the answer to that. But we are working very closely with LUKOIL because we think that, that contract should be confirmed. So, we work through the critical process of Iraq, we invest and hopefully support of respective countries from which we come from. So, we certainly are not giving up, we are working hard to get the West Qurna contract with LUKOIL. We also look on our own ConocoPhillips, what can we be doing with the Iraqi Ministry and the opportunities like the other international oil companies to participate in Iraq. So, we feel that we have good relationships working on but obviously, we got to get the framework, how you make investments sorted out, the new investment. Other than the West Qurna contract with the Iraqis and then we also have to make sure that we have security because we certainly at this point in time don't want to have our employees or contractors in Iraq until the security situation sorts out.

Neil McMahon - Sanford Bernstein

And just last really quick one, it seems a bit strange given the fact that with Kashagan, in terms of the money that is getting spent on this field, the operators quite keen to suggest that they are progressing in terms of developing the field and your de-booking reserves. Does this sort of suggest to me that it looks like the startup time on the field is probably looking more like 20, 10 than earlier, if you feel that you are not quite there, what's the reserves, would that be a fair assessment?

John Carrig

Now, there is two points I do want to make, Neil first of all when we talk about de-booking some reserves that's very unique to ConocoPhillips has nothing to do with Kashagan, the attribute to Kashagan what it is and what it will become. We have taken a more literal conservative view of only recognizing reserves that drawn in a very tight radius around wells that are already drilled. We know that the reserves that note this is a ConocoPhillips change that we did, we expect those reserves with more drilling and oil and production did come right back on the books. In terms of Kashagan, obviously, its challenge, its challenge technically and it's certainly being challenge on the cost side. Its been frustrating in terms of how long it has taken us and the cost of Kashagan is very frustrating to all of the participants in terms of what the schedule is and that's something that I think you may need to address this, as operator. And it would be not appropriate really for us to become meaning outside at what the operator would be saying.

Neil McMahon - Sanford Bernstein

Okay, great. Let's hope [B&I] for once tells us something about the schedule later on this month. Thanks.

Operator

Your next question is from Dan Barcelo with Banc of America.

Dan Barcelo - Banc of America

Yes, good afternoon. A quick downstream question, in light of the stated the union initiatives yesterday, I note your comment on Conoco's ability to basically as they handle some of the logistics associated potentially with the use of more alternatives maybe short-term and long-term? Also related to that any concerns with ethanol production increasing late '07 into '08 in terms of pressures on gasoline. And my second question just wanted to see if I can get an update on Burlington Resources just in general kind of a year-end update, integration, employees any potential that you have been exceeding the $500 million synergy expectations that you set out earlier in this year. Thank you.

Jim Mulva

Okay, first I will cover the Burlington transaction it's gone in many respect very smoothly in terms of what we expect our synergy capture will be. In terms of production we try to address that in terms of our media release production essentially where we though it was in right end of fair way of what the old Burlington indicated production would be for 2007. So we tried hopefully we have given the information as its gone pretty much like we thought production-wise and synergy-wise. One of the challenges though is retention of employees and so we haven't retained as many as we would have liked but we do a lot of work on this and this doesn't change in any way our capability to capture the optionality of the resource that's there that has not yet been developed, so strategic and long-term plans haven't changed. So hopefully the spread as the synergy capture is going to be there we haven't retained as many employees as we would have liked.

Now in terms of President State of the Union speech last night I listened to it, obviously within the industry within the American Petroleum Institute we are talking about all these things, a lot of new changes. The industry has always been very responsive in terms of whatever is required we take the actions to meet the new rule. On the other hand I would say we feel that technology is awfully important we are very supportive of our alternatives and renewable as a company I know the industry is of support of ethanol, but we want to make sure that we do this in a way that's cost efficient, meets the expectations of the consumers. We also want to make sure that from an environmental point of view that we are making fuels that do meet the expectations, cost wise, they work well, we also want to want make sure that we meet in the new requirements of the emissions. And so we think that use of technology and doing this in the right way, we are very supportive of it. In fact we came out a couple of weeks ago, very supportive and working with the governor Schwarzenegger's plans where what he would like to be doing on transportation fuels and the environment out in California.

We think this is quite interesting and we know also is a way of another way for considering of how to provide transportation fuels and a lot of time what has turned out California becomes a model for other states and may be for the entire country. So, we know the bottom line is. We just need to be working with The House, The Senate, The Congress, The Administration and the industry in our country is very open to making sure that we are working at all the alternatives renewable, pushing this in the right way, being very aggressive on the environment and we also need to a great job on conservation, far more than we had done before in terms of conserving more efficient use of energy and I can say as a company, we really are supportive of new [CAF-A] standards for transportation fuels leads to more efficient use of energy.

Dan Barcelo - Banc of America

Thank you.

Operator

Ladies and gentlemen, this will close our question and answer session. I will turn the call back to management for closing remarks.

Gary Russell

Well thanks. We do appreciate you joining us on the conference call today and I would like to remind you that you can find the slide presentation and other materials that we went through this morning on our web page at www.conocophillips.com, and you will be able to view the transcript of this call as well. So, again, we thank you for participating, and we wish you good day.

Operator

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

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