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ConocoPhillips (NYSE:COP)

Q1 2008 Earnings Call

April 24, 2008 10:00 am ET

Executives

Gary Russell - General Manager, Investor Relations

Jim Mulva - Chairman, Chief Executive Officer

John Carrig - Chief Financial Officer, Executive Vice President

Analysts

Doug Terreson - Morgan Stanley

Arjun Murti - Goldman Sachs

Michael LaMotte - J.P. Morgan

Paul Sankey - Deutsche Bank

Nicole Decker - Bear Stearns

Paul Cheng - Lehman Brothers

Mark Gilman - Benchmark

Bernie Picchi - Wall Street Access

Erik Mielke - Merrill Lynch

Operator

Welcome to the ConocoPhillips first quarter 2008 earnings conference call. (Operator Instructions) I will now turn the presentation over to Mr. Gary Russell, General Manager of Investor Relations.

Gary Russell

With me today is Jim Mulva, our Chairman and Chief Executive Officer; and John Carrig, Executive Vice President of Finance and our CFO; are here with me today. Jim's going to be taking you through a presentation that we believe will help you understand more fully the financial and operating performance of the company during the first quarter of this year. The presentation, as always, you can find on our website, www.ConocoPhillips.com.

If you turn to Page 2, our normal cautionary statement, it basically says that during the presentation this morning and in answering your questions we'll be making forward-looking statements that are based on our current expectations, and those expectations could be materially different than actual results. You could find the items or the issues that might cause those differences in our SEC filings.

So I'll now turn the call over to Jim Mulva.

Jim Mulva

. And I appreciate all those who are participating in our conference call. My comments are going to start on Slide No. 3.

You see in the first quarter net income was $4.1 billion. We generated $6.6 billion of cash from operations. Debt equity ratio is 19%.

During the quarter, as outlined previously, we purchased $2.5 billion of our stock, so if you go back and look back to the first quarter of '07, we've reduced our average shares outstanding by 5.2%. I have a slide here a little bit later to talk about that.

Upstream business, we've produced 2.25 million BOE a day. That includes 459,000 BOE a day, which is our estimate of production coming from the LUKOIL investment segment. On the downstream, our crude processing capacity utilization was 89%. That's down from 95% in the first quarter last year.

And during the quarter we announced a 15% increase in our dividend, so go back to 2002, we've been increasing our dividend at an average dividend at an average annual rate of 15%.

So I'm going on to Slide No. 4. You'll see our first quarter net income, $4.14 billion, or $2.62 a share. That was $230 million less than in the fourth quarter of last year, which was $4.37 billion shown on the left-hand side of the chart.

As we move along toward the right from the left-hand side of the slide, you can see we had $88 million improvement from the results of our asset rationalization program when you go from one quarter to the next. We had prices, margins and other market impacts help us this quarter to $269 million. This benefit was more than offset by the impact of lower volumes in both upstream and downstream that reduced our first quarter net income by $283 million.

Of the tax impacts, which are mainly the absence of the fourth quarter benefits including a one-time E&P item related to the Canadian tax rate change and then there's another in Chemicals which was related to a capital loss, these two things reduced net income $437 million when you compare this quarter to the fourth quarter of last year.

Then there were other items that in the aggregate improved first quarter income $130 million. These included lower controllable costs or impairments or net interest expense, but this was partially offset by the options of a fourth quarter benefit related to the extinguishment of the Hamaca, that's the Venezuelan Hamaca project financing.

So we'll discuss these variances in more detail in our subsequent slide, so I'm going over to Page 5 or Slide 5, and we'll be including this in our future conference calls because we've been buying quite a bit of shares each quarter now. And if you look at the chart on the left you can see that we've reduced our average shares outstanding 87 million shares, about 5% compared to the first quarter of last year. Looking at the chart on the right, that reduction in average shares outstanding improved our first quarter earnings by about $0.14 compared to last year.

I'm moving down to Slide No. 6, total company cash flow. So you start on the left-hand side, you can see that we generated $6.6 billion of cash from operations this quarter. So with this cash we funded the capital program of $3.5 billion, paid $730 million in dividends, and reduced debt $195 million. You can see we purchased $2.5 billion of our shares. We also had $335 million from asset sales and other sources that left us a cash balance at the end of the first quarter of $1.4 billion, pretty similar to what we started the quarter with.

So now I'm going on to Slide No. 7, the capital structure of the company. You can see on the left our equity grew to $91 billion. Our debt balance, shown in the middle part, a slight reduction. We ended the quarter at $21.5 billion of balance sheet debt. You can see our debt ratio on the right at 19%.

So now moving on to Slide No. 8, we start talking about E&P. Our worldwide realized crude oil and natural gas prices were higher this quarter than last. In the first quarter our realized crude oil price was $92.88 a barrel. Now that's $8.35 a barrel higher. And our realized natural gas price was $8.03 an MCF. That's $1.37 per MCF higher. Our E&P in production and sales volume were somewhat lower than the previous quarter, and we're going talk about that more in the next slide, which is Slide 9.

Production in the first quarter from our E&P segment was 1.79 million BOE a day. It's consistent with what we gave in our guidance. This is 41,000 BOE a day lower than the first quarter production of 1.84 million BOE a day, and that's reflected in the gold bar on the left-hand side of this chart.

So we move along toward the right, production in the Lower 48 was down 61,000 BOE a day, and that's largely due to the unplanned shutdown of a nonoperated natural gas processing facility in the San Juan Basin and then also the absence of a one-time NGL volume adjustment that we had in the fourth quarter last year.

Production in the Timor Sea was up 14,000 BOE a day. That includes an improvement of 19,000 BOE a day due to the completion of fourth quarter planned maintenance and a 5,000 BOE a day reduction due to the impact of production sharing contracts.

And there was other items that increased first quarter production 6,000 BOE a day as compared to the prior quarter. Then you add our equity share of LUKOIL production, and so that totals 2.25 million BOE a day in the first quarter.

I'm moving on to Slide No. 10 about the income of E&P. Net income in the first quarter was $2.9 billion. That compares to $2.6 billion in the fourth quarter last year. So start on the left, you can see we had lower gains from our asset sales program and that reduced our first quarter income $17 million, and we had prices and other market impacts that improved income $743 million. Lower production and sales volume reduced income $168 million. And we had tax impacts, which were discussed earlier, reducing first quarter income $283 million.

So there are a number of other items in the aggregate that helped us by $4 million this quarter and they included benefits or impairments, lower controllable costs, lower DD&A, which was mostly offset by the absence of that fourth quarter benefit from Hamaca project financing.

I'm moving on now to the downstream. Slide No. 11, our global capacity was 89%. Now that's down 6% from last quarter. On our domestic capacity, our utilization was 90%, and that's 6% lower than the previous quarter. And that's due to higher planned maintenance in our refineries on the East Coast, and then we had the unplanned downtime at some of our refineries on the Gulf Coast. Now our international utilization was 86%. That's also 6% lower than last quarter, and it's due to weak hydroskimming margins that led to run reductions at our Wilhelmshaven refinery in Germany.

Now with respect to Wilhelmshaven, for a good share of the first quarter the hydroskimming margins were below $2 a barrel, which is lower than our cost to operate and therefore we made run reductions. And we saw similar market conditions in several regions in the U.S., and particularly around the Chicago and San Francisco as well as certain parts on the East Coast, where refining indicators were below operating cost for some of the time periods during the first quarter. In spite of these conditions, we chose to optimize our refining operations than to make significant run reductions.

Our realized worldwide refining margins were lower this quarter than last. U.S. margin was $8 a barrel, that's $3.56 a barrel lower than the fourth quarter and the international margin, was $6.42 a barrel and that's $0.30 a barrel lower than the fourth quarter. And then our U.S. realized marketing margins were down $0.25 a barrel.

Now going to the next slide, the Refining & Marketing net income slide, you can see that in the first quarter our income was $500 million. And that's about $600 million lower than the fourth quarter of $1.12 billion, and that's shown on the left-hand side of the chart. And as you move from the left to the right, you can see we had the benefit of asset rationalizations in the first quarter. It helped us $105 million. However, prices, margins and other market impacts reduced first quarter a little over $600 million if you compare quarter to quarter. Now the largest portion of this variance relates to the absence of fourth quarter benefits from our planned crude and refined product inventory reductions.

So during the first quarter of this year, we were building inventories in anticipation of the switchover to summer grade gasoline; we just routinely do this. In addition, we had operating problems through most of the first quarter with respect to our FCC at the Humber U.K. refinery, and that reduced clean product yield and certainly impacted negatively margins and income.

So overall, our volumes in R&M were lower than the fourth quarter. That reduced net income $127 million. It's mainly due to lower utilization, as I talked earlier, reduction in our ownership of the Borger, Texas refinery from 85% to 65% that’s consistent with our joint venture agreement with EnCana and then there are other items that in the aggregate improved income by $21 million, and that included lower operating costs somewhat offset by higher taxes.

I'm now going to go on to Slide No. 13, the other segments. Our estimate of first quarter equity earnings from LUKOIL is $710 million, slightly higher than last quarter, which we estimate at $649 million. It's primarily due to higher estimated realized prices for crude and refined products and to some offset by higher export tariffs and extraction taxes.

Now, our earnings reflect that we own 20.6% of LUKOIL. In the second quarter we expect our ownership to go back down to 20%, and this is the result of LUKOIL's issuance of treasury shares with an acquisition they made, a purchase of a power company in Russia.

Income from our Midstream business was $137 million. That compares to $162 million in the fourth quarter, and it's down primarily due to lower realized NGL prices.

And our Chemicals joint venture contributed $52 million, a little bit higher than the previous quarter after you adjust for this one-time capital loss tax benefit of $65 million in the fourth quarter. So after the adjustment, the higher income is mainly due to better olefin and polyolefin margins.

And the Emerging Businesses contributed $12 million in the first quarter compared to $2 million in the last. It reflects primarily improvements in income from our Immingham plant in the United Kingdom. This improvement is mainly the result of higher spark spreads, somewhat offset by unplanned downtime.

Then our Corporate costs, $170 million that's $92 million less than the fourth quarter. It's primarily lower interest expense and reduced losses from foreign exchange.

Then we go on to Slide 14, we look at our E&P metrics on a BOE equivalent and we compare that to prior periods of time. And then when we use the peer group on all of our slides, like in the past, our peer group is made up of the large international oil companies. That's Exxon Mobile, BPShell, Chevron and Total. Obviously, we don't have the information yet because they haven't reported it in the first quarter of '08.

So the chart, top of the chart, shows income and cash per BOE. It goes from 2003 all the way through the first quarter of '08. Effective purchase accounting certainly negatively impacts our earnings per BOE because about everything that we've done in the past in terms of acquisition merges with purchase accounting. But you can see that our cash contribution continues to be very competitive as does the income contribution.

So we go from E&P, then, to the next slide, which is Refining and Marketing, and it's for the same peer group and the same time periods of comparison. Obviously the downstream is a bit under pressure because of them market conditions, but we think we will see that our income and our cost per barrel will continue to competitive with the peer group.

So now I'm going to move on to Slide 16, return of capital employed. Again, the shaded area in the back on this slide represents the high and the low of the peer group that I previously mentioned, and the bar chart reflects our return on capital employed. There's no adjustments for purchase accounting. Adjustments made to the peer group reflect purchase accounting for them. We always include it as an attachment in Table 3 for the presentation. And then you can see for the first quarter of '08 our return on capital employed is 15%. It's 1% higher than for the annual number last year of 2007.

Now I'm going to the last slide that I have under outlook. We made a number of announcements and developments in our company. The first, we're quite pleased to be working with BP on their development and construction of the gas pipeline that moves natural gas from Alaska's North Slope through Canada to the Lower 48. Ultimately the pipeline will move 4 billion cubic feet of natural gas to the markets in North America, the Lower 48. We're pleased to be under way with developing this project.

Then in addition we were the successful bidder on several prospective leases in Alaska's Chukchi and the Gulf of Mexico recent lease sales, and this is an important step in the development of our exploration portfolio.

And then we look to the second quarter. We expect the company's E&P segment production will be lower than the first quarter, and this is the result of seasonal planned maintenance. But for the full year 2008 production we expect to be consistent with our operating plan as we outlined at the March New York analyst meeting.

Our second quarter exploration expense is to be about 250 million. In the downstream, we expect crude capacity utilization to be in the lower 90% range in the second quarter. This reflects primarily some planned maintenance at several of our facilities and also taking into consideration the potential of ongoing weak hydroskimming margins at our Wilhelmshaven refinery.

Our second quarter pre-tax turnaround costs should be about $175 million, and we expect our share repurchases in the second quarter will be like the last several quarters, between $2 and $3 billion, which is in line with our plans to complete $10 billion in share repurchases for calendar year 2008.

So that completes our prepared remarks, and so now John, Gary and myself will respond to questions and observations that you may have of our performance.

Questions-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Doug Terreson - Morgan Stanley.

Doug Terreson - Morgan Stanley

In the Middle East, the Shaw gas project would obviously represent an important and positive development. And while you guys have experience on projects of that nature, I was wondering what two to three factors do you feel differentiate ConocoPhillips as it relates to selection on that project? And also, while I realize that it's very early, the path forward that's ahead of us on development of this project during the next 12 to 24 months.

Jim Mulva

Well, we do have experience in handling sour gas, and of course this is a very attractive project, a very large project technically and challenging for any company and also for ourselves. We've been very interested in pursuing this project. Nothing has been formally announced, but we continue to work very closely on all the aspects of this project with ADNOC. And so we would expect hopefully in the next month or so that we can be making a formal announcement going forward on this really important project for our company.

We think our approach towards this project is pretty innovative, both on the technical aspect as well as the commercial aspect. As I've said, Doug, we've been working on this for actually several years, and this is really a good, important one. And hopefully - as I said, I'm optimistic - that we'll make a formal announcement on this here in the next month or two.

Doug Terreson - Morgan Stanley

Jim, you guys were successful on almost 100 tracts in the Chukchi Sea. And while I realize that you wouldn't be involved if you were not optimistic, my question is how optimistic are you in that area, and also the next steps as it relates to drilling and development in the Chukchi Sea?

Jim Mulva

Well, we have 10-year leases. We feel that we really know the area quite well. This goes all the way back to the historic presence of ourselves through ARCO Alaska. And of course we have the benefit of that and the experience. We think that a lot of the things that we see in the Chukchi is similar to what we see in the North Slope of Alaska. Even though they're 10-year leases, we have to get under way pretty quickly, so we are working really hard, both on the technical side but also ultimately the lining up that we will be doing our drilling as soon as we can.

But we have the infrastructure in Alaska, and we're really pretty pleased about this promising area. And as you know, several wells have already been drilled out there, so we know that we're on hydrocarbon province. So it really fits in really well for us to develop our exploration portfolio, but it also helps as we continue to look at exploitation of the oil resources we have, then the gas pipeline from Alaska, and then Chukchi, really, hopefully being successful, sets us up for many decades to come in Alaska.

Operator

The next question is from Arjun Murti - Goldman Sachs.

Arjun Murti - Goldman Sachs

Jim, I realize the analyst meeting was only about six weeks ago, but even since that time oil prices have continued to move higher and I think general confidence in the bullish natural gas outlook in the U.S. has improved. Can you comment on how you're thinking about capital spending over the next year or so? I think relative to your $15 billion budget, you'd talked about potentially plus or minus $1 billion around that. How are you guys thinking about capital spending now in light of commodity prices?

Jim Mulva

We see an environment that's pretty surprising to ourselves in terms of very robust oil and gas prices. But our capital spend as we look at 2008 - 2009 is still going to be around $15 billion. It may be because of cost pressures or some other unique opportunities it might be up a billion or two, maybe a billion this year, maybe $1 or $2 billion next year, but we're really thinking about $15 or $16 billion.

As we said, the priority is not debt reduction. We're very satisfied and think we've got the right capital structure. So if we find that we have more cash flow, it's not really going to be going toward capital spending. It's going to be going towards more distributions to the shareholder in the form of share repurchase.

Arjun Murti - Goldman Sachs

That's really helpful. One follow up. On your Lower 48 gas production, it had been pretty steady between 2.1 and 2.2 BCF a day. It looks like it fell a little bit in the first quarter. Is that natural declines or is it some one-off effects and would come back to a higher level going forward?

Jim Mulva

I think it primarily goes back to the San Juan gas processing plant that was down. That is a real significant impact to our natural gas production in the Lower 48, and it's really the primary reason why we are somewhat less on the total company's BOE production.

Arjun Murti - Goldman Sachs

The last question was just on the Alaska gas pipeline. Can that substantively move forward without Exxon's participation?

Jim Mulva

Obviously, it makes a lot of sense for all of us to be a participant, so we continue to work very closely obviously with BP, but we also work closely in everything that we do with Exxon Mobil. So hopefully in time I would like to see and would expect and hopefully that all three producers are part of the project.

Operator

The next question comes from Michael LaMotte - J.P. Morgan.

Michael LaMotte - J.P. Morgan

A quick follow up on the San Juan, is it back up now? Is there going to be any impact in the second quarter?

Jim Mulva

Yes, it's back up and running, and I don't think there's any impact in the second quarter.

Michael LaMotte - J.P. Morgan

And then to return to this question of Capex briefly, help me perhaps understand a little bit better the return trade-off, if you will, between increasing Capex on the upstream side and increasing the buyback. I would imagine with the higher commodity prices that the returns have to be pretty good in the upstream. Certainly, the returns that we're seeing from the independent producers in the Lower 48 would suggest that. How do you all view it? I mean, clearly excess cash goes to buyback, but if I look at returns of a buyback program versus Capex, what's the thought process there?

Jim Mulva

Well, first of all, we don't give up the optionality of doing any of the drilling in the future. The question is when do we want to capture those opportunities? Do you want to do them today or you want to do them a year or two from now? We like the discipline of the share repurchase. We think the purchase of shares is a very attractive investment opportunity for the company.

And then we also want to make sure that we're concerned that the service industry and our own people, that we have the oversight of doing this really well. So, while you never give up the opportunity option of drilling the wells and adding to the production, it's really a timing question.

We take all those into consideration and that's why we'll drill these wells, but it may not be this month or this year. It may be next year.

Michael LaMotte - J.P. Morgan

And then on the service side in particular, a couple of your peers in the Lower 48 have talked about - after several quarters of falling services costs - have talked about stabilization. I'm wondering if you're seeing the same thing and if there's an opportunity to perhaps go long in terms of contract duration to try to stave off any potential reinflation in service costs over the next few quarters.

Jim Mulva

That's difficult for me. I'm not as close to it as our operating people on what we're seeing on the cost side. I think there might be in some unique areas a little bit of moderation in escalation or cost. That's good; we'd like to see it go quite a bit further. But no, I don't know. John, do you have anything more to say on that?

John Carrig

We tend to look at it where we have long-term utilization needs; we will go a little bit longer. But we do see some moderation, but whether it has an uptick as a result of the recent surge in gas prices remains to be seen. So we try to manage the cost structure across the board, some long, some short, but by and large we're current with prices.

Jim Mulva

And historically we don't go out and line up long-term rate contracts.

Michael LaMotte - J.P. Morgan

On the downstream. Jim, perhaps you could provide some color on what the biggest differences are in ethanol's impact in the gasoline market this year versus last year.

Jim Mulva

Well, obviously there's more ethanol, and that is a substitute for volumes. And we see that. We also see that there's some indication of reduced demand because of the cost side of it. So for these reasons, obviously we do see some impact, particularly on the gasoline side of the business.

As you know, the margins and the crack spreads are very strong on the distillate side of the business, not strong on the gasoline side of the business. So you can see that that does have impact with respect to ethanol as a substitute and as well as demand in terms of the cost structure of gasoline.

Michael LaMotte - J.P. Morgan

Is there a notable difference this year in terms of the distribution and logistics around ethanol versus last year, at risk of dislocations to gasoline markets and a potential spike here in the second quarter?

Jim Mulva

I don't think so, but maybe we could come back and talk with our people and respond back to you offline.

Operator

Your next question is from Paul Sankey - Deutsche Bank.

Paul Sankey - Deutsche Bank

On Alaska, I think you talked about $30 billion for that pipeline. Could you, to the extent that you possibly can, talk a little bit more about how you get to that number and about the timeframe there?

Jim Mulva

Well, really, this is on the basis of old studies several years ago. And that's one of the things that we really are working on very hard over this next several years with BP, and that is just what is the cost structure going to be as well as the engineering and the environmental and the permits and working towards the open season. So there's no basis. It's really old numbers. We're going to have to do the work to come up with the new basis of what we think is the cost structure.

Paul Sankey - Deutsche Bank

Jim, I was with John Carrig not long ago, and I think he was saying that almost from the point of construction start it's going to take 10 years to build. Is that something that, you know, are we literally that far away from this thing ever delivering?

Jim Mulva

Well, I'm not going to dispute what John said in anyway. He's sitting right next to me. But on the other hand, from the time we are right here we're looking at 10 years, maybe longer than 10 years. By the time you go through all this study work and engineering and permitting and then going through with the open season and then the construction of the pipeline, we're looking at 10-plus years. But we've got to start now, which is what we've done with BP.

Paul Sankey - Deutsche Bank

And I think, Jim, what you're saying is $600 million over what timeframe with BP is that, just in the initial work?

Jim Mulva

Over the next year or two.

Paul Sankey - Deutsche Bank

Right.

Jim Mulva

The next two years, plus.

Paul Sankey - Deutsche Bank

In the past we talked about Mackenzie Delta coming first. Could you update us on that pipeline?

Jim Mulva

We continue to work that really closely with partners and with the regional authorities and all. I will just say I'm pretty optimistic. I think we're going to see something hopefully happen as we go through 2008 on Mackenzie Delta pipeline. And I think Mackenzie Delta will come before Alaska. This makes a lot of sense. I know it's very important for the partners. It's important for Canada. But I think sequencing in terms of purchase of steel and use of services to do these pipelines; it makes sense for Mackenzie Delta to come first. And it's further along than the gas pipeline in Alaska.

Paul Sankey - Deutsche Bank

The tentative date there, are we five years away maybe?

Jim Mulva

Oh, I don't know. Maybe we could talk to our people and come back to you on that.

Paul Sankey - Deutsche Bank

On the downstream, you've talked about guidance for how much utilization you'll have in 2Q. How much of that is the required turnaround work and how much of that is the voluntary shutdowns that you've talked about? In other words, what would you be running at if it was - if we were in a strong crack environment?

Jim Mulva

We have quite a bit of planned maintenance, as we do in the second quarter. In terms of what's impacting, that impacts our utilization. Normally, we run 95% or so, so when we say below 90s, we're taking into consideration planned turnaround. I think really the only facility we expect to run everything other than planned turnarounds, other than Wilhelmshaven. And what we're really saying is we're under way with making that a very sophisticated refinery but until we do so, that's the one that's going to impact utilization. It's really Wilhelmshaven.

Paul Sankey - Deutsche Bank

Jim is that then totally shut down, Wilhelmshaven, not running?

Jim Mulva

We make run reductions.

Paul Sankey - Deutsche Bank

So we can kind of strip out 50% of Wilhelmshaven's capacity, perhaps, in terms of getting it the other way?

Jim Mulva

Well, I don't know what percent it is. But, I mean, there are times that we have accelerated turnarounds that have  I think this past year we went almost to a full shutdown - that we were doing maintenance. But normally we make run reductions. We don't shut the facility down completely.

Operator

The next question is from Nikki Decker - Bear Stearns.

Nicole Decker - Bear Stearns

So on the Denali project, I'm just curious, have you had discussions yet with the Alaska legislators, and what is the status of the AGIA program? Is that ongoing?

Jim Mulva

We talk with everyone, both the Federal government, the Canadian authorities, and we certainly talk with Governor Palin, her administration, the legislators, everyone up in Alaska. And so the AGIA process continues to go, but as the governor indicated, she, you know, is seeing ourselves going forward with BP and hopefully in time with Exxon Mobil. The AGIA process has been helpful to move everything along, so I give credit to the governor.

But what the governor has said and what we hear from everyone in Alaska, they're very pleased that BP and Exxon are moving out on this gas pipeline. So what it really is saying is there's far more certainty that this project is going forward and it's going to be done.

Nicole Decker - Bear Stearns

But there are two proposals on the table right now, the AGIA proposal that I think TransCanada is heading up, and your proposal.

Jim Mulva

Well, the governor and the state legislature are going to have to sort through how they handle AGIA. But what we've announced is BP and ourselves, we're going forward with our project. It's not dependent upon funding from anyone. It's not dependent upon any approval by the state or the legislature. We're going forward with the project, and we think given our history and our knowledge and given that we are producers, we think we are really the right project to be going forward to see this pipeline come with certainty.

Nicole Decker - Bear Stearns

operating costs seem to have stabilized this quarter which is somewhat surprising given the higher commodity price environment. Can you comment on whether that is the case and maybe on whether it's a product of the environment or more due to self-help? And particularly my observation is in the downstream, where I think you made some comment, Jim, on lower operating costs quarter-over-quarter.

Jim Mulva

Well, what we've been doing is everywhere we can, but let's talk about the downstream. We're trying to use productivity improvements, efficiency, whatever to hold our cost structure on an absolute basis constant. But if you're having some unplanned turnarounds, that gets hard to do on a per-unit cost. But what we're really trying to do, as we outlined at the New York analyst meeting, we're trying to hold our absolute cost structure flat as we go through the next several years.

On the upstream, if you look at our charts and all, it looks like - it certainly looks like the incoming cash flow came to the bottom line far better in terms of our upstream than in the fourth quarter, but in the fourth quarter we had a lot of unusual items. The first quarter this year was, you know, really very, very clean. It's just a few discrete items that you can see.

But there's - all of us in our industry, but certainly in our company a lot of emphasis on let's make sure we minimize our lost profit opportunities, let's be on top of our cost structure. But we continue to see push in terms of escalation, and the foreign locations are not helped by the weakness of the dollar.

But I think we are doing everything we can to constrain our costs and maybe you're starting to see that in the operating results in the first quarter.

Nicole Decker - Bear Stearns

So getting back to the downstream, could you provide some detail on the lower operating costs?

Jim Mulva

I'll get back with you, Nikki. I can do that.

Nicole Decker - Bear Stearns

Where was the asset sale in the downstream? Was it domestic or international?

Jim Mulva

It was mainly retail locations domestically.

Operator

Our next question is from Paul Cheng - Lehman Brothers.

Paul Cheng - Lehman Brothers

Jim, when we're talking about Chukchi and Alaska, can you tell us what kind of drilling program that you have in mind and in terms of the timeframe and how many wells you're going to drill? I know it's just early days any kind of rough idea how big is the structure over there compared to, say, Prudhoe. Any kind of estimate or insight that you can provide.

Jim Mulva

Well first of all, what I referred to earlier in our call, I don't know exactly what the drilling program will be. But given 10 years and it takes a lot of time to do things - many years - we just know that we have to get under way pretty quickly on the drilling of the first well or two. And maybe our people will come out and we can give you some more information on that. I don't have it readily available to me.

Now given obviously we have to have some pretty large structures out there because it's a challenging, tough environment, so they're quite expensive. So we expect to see some pretty large accumulations otherwise we wouldn't be bidding the way we did in this 10-year timeframe. So I really don't have more that I can pass along that that.

Paul Cheng - Lehman Brothers

On the Saudi Aramco refinery project, any update there?

Jim Mulva

Well, we continue to work really closely with Saudi Aramco. I think we're starting to move up towards 20% of engineering completed. I think in the next few months you're going to - next two or three months you'll hear exactly what we're going to do on Yanbu, but hopefully we can get to a position ourselves with Saudi Aramco to announce that we're going forward with it. But it's premature to do that, but we continue to work technically and commercially really well with them. I think you'll hear more on this as we go through this next quarter.

Paul Cheng - Lehman Brothers

And Jim, any update on Sunrise?

Jim Mulva

Sunrise, no. I know that Woodside and Shell, we continue to be exploring all the different opportunities whether to do that offshore or to do that by way of coming to Darwin or going to East Timor. We continue to progress that work, both technically and commercially. I'd like to think - I don't have anything right in front of me - but I'd like to think as we go into the latter part of '08, early '09 that we get to a position that we make a decision on just what we want to do on Sunrise.

Paul Cheng - Lehman Brothers

John, at the end of March, your production or your inventory, is under lift or over lift for the corporation? By the end of the first quarter because this quarter could be under lift or over lift, maybe it's coming from residual on last year, so I just want to know at the end of the quarter, from an inventory standpoint, are we over lift or under lift at that point?

John Carrig

I don't have the number of barrels on the water for you. We could try to get back to you on that, but overall sales were less than production for the quarter.

Jim Mulva

We ended last year pretty close in balance, so if anything we're close to right in balance or a little bit less sales than production.

Paul Cheng - Lehman Brothers

So we should expect, if everything is equal, that the second quarter should be a little bit higher sales than the production going in?

John Carrig

Assuming that the end of the second quarter doesn't have barrels on the water that would tip that in the opposite direction.

Paul Cheng - Lehman Brothers

John, in your analyst meeting you were very kind to provide what is the full year company expense. With the first quarter result out, any update on that number?

John Carrig

No. I mean, we estimated that the Corporate would be $1.2 billion for the year, so that's $100 million a month. And we don't see that changing, that monthly rate changing, on average.

Operator

The next question is from Mark Gilman - Benchmark.

Mark Gilman - Benchmark

Jim, can we assume that re: the Alaska gas pipeline project, that you and BP have essentially relinquished the conditionality that was in place previously regarding tax and fiscal certainty?

Jim Mulva

Oh, we're just going forward. We know that at some point in time we're going to have to talk about the fiscal situation that applies to the gas pipeline, so we're not - nothing is tied to anything in the past. We know at some point in time, though, once we go through engineering and permitting and all that we're going to have to sit down with the state and discuss that.

Mark Gilman - Benchmark

So that's still an open issue?

Jim Mulva

It's an open issue.

Mark Gilman - Benchmark

I notice that we've seen a very steep downtrend in pretax interest expenses going all the way back toward the very early part of last year that's disproportionate with the decline in debt over the same period. Have you dramatically changed the financial structure, shortened up the maturity curve, if you will, to account for that, or is something else responsible for it?

John Carrig

No. We might be a little bit more short-term oriented versus long-term, but our fixedtofloating ratio is not that dramatically different. Now the floating rates have been positive, and because of the cash performance of the company we've had somewhat higher interest income during these periods.

Mark Gilman - Benchmark

I was focusing on strictly expense, John.

John Carrig

Well, I was focusing on net expense as well. But the gross expense, no, there are other factors that get into that number but no, we haven't changed the financial profile of the company dramatically.

Jim Mulva

John, in a way the off balance sheet financing and debt is about the same. The balance sheet's about the same.

John Carrig

Yes, it would come into the fixed floating ratio. But there are tax accruals and other things that get that interest expense number.

Mark Gilman - Benchmark

I can't help but noticing what's become the rather staggering difference between your equity and earnings of LUKOIL and the cash that would be allocable to your proportionate interest. I make this observation in the context of LUKOIL's apparent announcement this morning regarding a dividend increase, but it still seems as if their payout ratios are comparatively low. Are you lobbying at all, Jim, to try to get that payout ratio up so that you can monetize your interest to a somewhat greater extent from a cash standpoint?

Jim Mulva

Well, are we lobbying? Well, we continue to talk and discuss. You make a good observation. Our investment, all the earnings aren't paid out. It has a rather low payout. On the other hand, I do see Vagit Alekperov pretty routinely. We talk about the company. And of course what they have is a lot of opportunity for investment, and they want to continue to fund their investments versus an aggressive payout. But we talk about it, but I don't think you're going to see dramatic changes in what LUKOIL's doing.

Operator

The next question is from Bernie Picchi - Wall Street Access.

Bernie Picchi - Wall Street Access

The Achilles heel of your worldwide refining system, at least in the current environment, has been Wilhelmshaven. Can you discuss where you stand with regard to the equipment upgrading, if anything can be done to sort of accelerate the upgrading at Wilhelmshaven? And then also two or more years, I guess, into the acquisition, could you critique that acquisition vis-à-vis your expectation for Wilhelmshaven at the time that you entered into the agreement?

Jim Mulva

We bought Wilhelmshaven and we purchased it with the idea that we were going to immediately start a deep conversion project I'm going to say, I can't recall, it was 2006. So when we looked at the deep conversion project, we felt it was overly complex and quite expensive, so we took the better part of a year or 15 months to rethink it, and so now we've embarked upon it, improved it, we're going forward. I wish we could do it more quickly than we expect. I can't recall the exact number, but it's the better part of maybe closer to five years than four years.

But we want to make sure that when we do the project that we've got this figured out and we get not too aggressive. We don't want to just throw money at trying to make a schedule that ends up increased costs and don't get the schedule we want. So we want to be realistic in that regard.

Now if you look at the acquisition costs and the cost of what it's going to take to do this, there's no doubt in our mind that we - even at today's crack spreads and margins - this has been a good investment. Now we wish that we made a sophisticated refinery out of it within three years or two or three years, but we can't do it that quickly. And when we use modest normalized crack spreads - whatever you want to say those are - we're looking at a rate of return unlevered in the mid-teens.

So therefore, you know, it makes a lot of sense for us to do this project.

Bernie Picchi - Wall Street Access

And basically I think, John, what you were saying is that the $170 million Corporate item that you're showing for the first quarter is kind of an anomalously low number; that you would sort of guide us to something closer to $300 million a quarter?

John Carrig

Yes, we think you should use the $300 a quarter. Hopefully we can do better than that, but that's what you should use.

Operator

The next question is from Erik Mielke - Merrill Lynch.

Erik Mielke - Merrill Lynch

. Would you mind giving us a quick update on some of the key projects that you're developing in 2008, particularly Britannia satellite and the Timan-Pechora project with YK project in Timan-Pechora with LUKOIL?

Jim Mulva

YK project, I think we're getting close to the first, we have the first production or a small amount of production, so that's going right as we scheduled and outlined at the analyst meeting.

What was the other project? BritSat. Well, we've got quite a schedule in terms of how we're getting ready to bring them on stream, and I think we're looking at no difference in what we said. Production in the John or Gary, it's the third quarter, isn't it? Third quarter of this year is production from BritSat.

Gary Russell

That's the expectation.

John Carrig

So no change.

Jim Mulva

No change.

Erik Mielke - Merrill Lynch

The LUKOIL number that you reported for 1Q, is that a clean number? Was their a first quarter catch-up involved as well?

John Carrig

There was a modest what we call true-up, but not overall significant.

Erik Mielke - Merrill Lynch

And on the Shaw field that you're negotiating in Abu Dhabi and obviously you can't comment on the economics given that you haven't signed anything yet can you perhaps give us some guidance on where you see the economics in the project, gas versus liquids versus sulfur, particularly in light of some of the stories that have been in the industry press.

Jim Mulva

Well, as we've indicated, we felt that what would distinguish our company and how we competed, hopefully, for this opportunity was a rather unique bid, both in terms of technical bid as well as a commercial bid. And it's not appropriate first, we have not been formally awarded this project and I think for other reasons it's not appropriate at this time for us to get into how that would be done.

But I think, assuming that it goes forward, we're named. And for the formal announcement in the next month or two, you could expect there in the next quarter conference call, if we follow that schedule, we'll talk quite a bit more about the project and what are the drivers and what we see in it.

Erik Mielke - Merrill Lynch

Very good. And final one from me is on share buybacks, where you were pretty explicit about if you have additional free cash during the course of 2008 you'll be more likely to be handing that back in the form of share buybacks. Would that be a fourth quarter event? Would you wait until the end of the year before seeing where cash flows are? Could you conceivably accelerate buybacks during Q2 and Q3?

Jim Mulva

Well, I don't think you're going to see it in the second quarter, probably not even in the third quarter. But that's something that's very tactical we have to address and see. What we've really set up for the company is we come out in the fourth quarter in December and we say okay, we've pretty well finished the year. Here's what we expect or what we're going to approve, and go to our Board for approval on the capital program for 2009. And with that, we will be making an announcement to what we see the share repurchase is for 2009.

We like the idea of doing this on an annual basis. Now, we recognize that a question came from Arjun Murti, what would happen if you have a little bit more cash flow, what would you do? It's really the timing. You know, we'll look at our capital program and if we have more cash for a share repurchase, this is a tactic question and when would we do it.

But we like the idea of making an annual announcement on share repurchase because that's pretty finite. Instead of saying something for three to five years, we say, here's what we're going to do next year. And then it's pretty clear, with discipline, that's what we are going to do. And the marketplace and the shareholders look at it and say that's what we expect you to do.

So that's really the plan of what we'll probably do.

Operator

There are no more questions in queue.

Gary Russell

We do appreciate everybody's interest and participation on the call this morning. We'd remind you that, again, the presentation that we went through this morning is available on our website, and soon we will also include a transcript of the conference call there as well. Again, the website is ConocoPhillips.com. And we appreciate your participation and wish you good day.

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Source: ConocoPhillips Q1 2008 Earnings Call Transcript

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