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

ConocoPhillips Inc. (NYSE:COP)

Q2 2008 Earnings Call Transcript

July 23, 2008 11:00 am ET

Executives

Gary Russell – GM of IR

Jim Mulva – Chairman and CEO

John Carrig – EVP of Finance and CFO

Analysts

Michael LaMotte – J. P. Morgan

Paul Cheng – Lehman Brothers

Paul Sankey – Deutsche Bank

Kasey Raydon – Sanford Bernstein

Mark Gilman – Benchmark Company

Eric Milkie – Merrill Lynch

Jason Gamel [ph] – McCorey [ph]

Operator

Good day, ladies and gentlemen, and welcome to the ConocoPhillips second quarter 2008 earnings conference 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

Thank you, Jen and welcome to all who have joined us on the earnings conference call for ConocoPhillips for the second quarter of 2008. I have with me today Jim Mulva, our Chairman and CEO and John Carrig, our Executive Vice President of Finance and CFO.

Jim will be taking us through a slide presentation that’s been prepared to help you understand the financial and operating performances of the company during the second quarter of this year. This presentation along with other supplemental information can be found on our website, www.conocophilips.com.

If you turn to page two now, you’ll see our Safe Harbor statement and this statement simply says that there will be forward-looking statements made during our presentation today in the conference call and these forward-looking statements represent our management’s current expectations. Actual results may differ materially from these expectations. If you’ll take a look at our SEC filings, you’ll find information on items that could cause these material differences.

So at this point, I’ll turn the call over to Jim Mulva.

Jim Mulva

Okay, Gary, thank you, and I appreciate all those who are participating in our conference call. I’m going to start off on page three. See in the second quarter, our income was $5.4 billion, that’s $3.50 per share, and generated $5.4 billion in cash from operations. Our debt-to-cap ratio is 19%. It’s the same as it was at the end of the first quarter.

In our upstream business, we’ve produced 2.2 million BOE a day, and that includes an estimated 448,000 BOE a day from our LUKOIL Investment segment. On the downstream, crude processing capacity utilization was 93%, that’s up from the 89% during the first quarter.

As we have told the market, we purchased 2.5 billion of our stock in the second quarter, reducing average shares outstanding to 1.555 billion shares. It’s 103 million shares lower than the second quarter 2007 average.

Share repurchase programs had a favorable impact on our per share metrics and you can see that on the next slide, slide four. Seen in this slide from last quarter, on the left-hand side, you can see the 103 million share reduction I just referred to. On the right side of the chart, you can see second quarter 2008 earnings per share were $0.60 higher than the same quarter last year. Now, that’s after adjusting for the Venezuelan impairment last year. $0.22 of that improvement is directly attributable to our share repurchases.

Now, we will update you on our future share repurchase plans for 2009. We will do that most likely December when we come out and announce our capital spending program for 2009. So, you can expect us to be doing between 2 billion and 3 billion share repurchase in the third quarter and the fourth quarter.

I’m going now to page five, second quarter net income was $5.4 billion and this is $1.3 billion higher than the previous quarter of $4.1 billion shown on the left-hand side of the slide. As you move from the left to the right, you can see the contribution from our asset rationalization program. The first quarter was higher than the second quarter by $114 million. Prices margin, other impacts improved second quarter by $2.1 billion, it’s the green bar, or net sales volumes in our LUKOIL and E&P segments harshly offset by higher volumes in our downstream and midstream segments. We reduced income, $97 million

As a result of the current price environment, production taxes in the second quarter were $264 million higher than the last quarter and most of this relates to Alaska. Operating costs were about $276 million higher than the previous quarter and we’ll go into more detail on that in subsequent slides.

And there are other items that in the aggregate reduced income $85 million in the second quarter and most significant of that was a LUKOIL true up, which was outlined in our interim release earlier this month.

And moving to page six, total company cash flow, we start with gold bar on the left, you can see we generated $5.4 billion cash from our operations in the second quarter, then you combine that with our beginning cash balance. So we had $6.9 billion of cash available for the second quarter. So, as we move from left to right, you see we also had additional cash from asset sales of $362 million.

We used the cash to fund $3.6 billion of capital programs, $719 million of dividends and $2.5 billion in share repurchase. There is a slight increase, $432 million, in our debt balance and that has a lot to do with respect to the timing of substantial tax payments that we made in the U.S. as well as in Norway.

Moving to page seven, total company cash flow, pie chart in the left shows total cash available during the first half of the year of $13.6 billion, 88% or $12 billion comes from operations, the remaining 12% from asset sales and reduction in cash balances and small increase in debt. So, looking in the right, what did we do with the $13.6 billion? We spent $7.2 billion on our capital program. Repurchased $5 billion of our stock and paid $1.4 billion in dividends.

Now we go to page eight, starting on the left-hand side of the slide, we grew our equity to $94 billion. Our debt balance, shown in the middle is $21.9 billion and you could see on the right, our debt-to-capital ratio remains at 19%.

So moving to slide nine, talk about E&P quarter to quarter. Realized price for both crude oil and natural gas were higher in this quarter. Our realized crude oil price was $118.01, that's $25.13 per barrel higher than the previous quarter and our realized natural gas price was $9.87 per MCF, that’s $1.84 per MCF higher than the first quarter.

As we indicated in our interim, E&P’s production volumes were lower than the previous quarter and we’ll talk more about this on the other slide, and we had higher production taxes mainly in Alaska and that had a negative impact on earnings.

So I go to page ten to talk about our production sequentially quarter to quarter. Production in the second quarter from our E&P segment, now that excludes LUKOIL, was 1.75 million BOE a day, that’s 44,000 BOE a day lower than the first quarter, which was 1.79 million BOE a day, that’s shown on the left-hand side of the slide.

So you move across from left to right, you can see that production was lower in Norway, Canada, United Kingdom and Alaska, and all of that totaled 61,000 BOE a day.

Now, the vast majority of this reduction is due to planned maintenance and seasonality. Production in the Lower 48 was 17,000 BOE a day higher as we had reduced production due to planning maintenance in the second quarter. That was more than offset by the impact of restoring the production in the San Juan Basin that had quite a negative impact on us in the first quarter. And that related to the non-operated natural gas processing plant in the San Juan Basin.

Then you add our equity share of LUKOIL production and that takes you up to 2.2 million BOE a day, shown on the right-hand side of the slide.

Moving to page 11, E&P net income for the second quarter was $4 billion, that compares to $2.9 billion in the first quarter. So we start with the green bar in the left, prices and other market impacts improved income $1.5 billion. As you move to the right, you could see that sales volumes negatively impacted income $47 million in the second quarter.

Now this includes an adverse impact from inventory changes that does reflect the regional mix and the divergence of effective tax rates, rather complicated, but all in this $47 million.

As mentioned earlier, production taxes were $264 million higher in the second quarter primarily in Alaska. Operating costs were higher primarily due to increased plant maintenance and we had also a higher olefin cost and this reduced our income to $107 million compared to first quarter. There are some other items in the aggregate that improved income $32 million; that's how you get to the $4 billion.

Moving to page 12, downstream, our realized worldwide refinery margins were higher than the first quarter. Our U.S. margins were $10.29 a barrel and that’s $2.29 a barrel higher and then the international margins were $6.70 a barrel and that’s higher by $0.28 a barrel in the second quarter compared to the first.

As we outlined in our interim update earlier this month, we do not fully realize the improvement in refinery margins in the second quarter and this is due to the significant negative impact from secondary products such as fuel oil, natural gas liquids and petroleum coke. These secondary products represent about 20% of overall refined product production in the second quarter.

Our global capacity utilization was 93%, that's up 4% from the 89% in the first quarter. In the U.S., utilization was 94%, that’s 4% higher than the first quarter as our Gulf Coast refineries ran much better. International utilization was 88%. It was 2% higher than our first quarter, but we really move our hydroskimming margins (inaudible) impact with the Wilhelmshaven refinery. So, we have pretty good hydroskimming margins. We have run it and when we don’t, we shut it back in terms of production, and this impacts the utilization rate.

If we look now to page 13, you can see downstream second quarter income was $664 million, $144 million higher than the first quarter income of $520 million shown on the left-hand side of the slide. You move from left to right, you could see the contribution from asset rationalization was $114 million lower in the second quarter than the first. Prices, margin and other market impacts increased income in the second quarter by $249 million, primarily driven by higher realized margins, partially offset by the impact of foreign exchange and higher utility prices.

Overall, our downstream, we improved our volumes, which is the result of the higher U.S. utilization and that improved income to $84 million. We had higher operating cost mainly due to turnaround activity in the second quarter and that reduced income $102 million. There were other items in the aggregate improved income $27 million, the largest of that $27 million was higher equity earnings from affiliates.

So now I go to slide 14, all the other segments we cover in this slide. Our estimate of second quarter equity earnings from LUKOIL is $774 million. It’s higher than the $710 million in the first quarter primarily due to higher realized prices for crude and refined products, partially offset by the true up that we previously reported.

Now, the downstream income was $162 million compared to $137 million in the first quarter, mainly due to higher realized NGO prices. Our Chemicals joint venture, the income was $18 million, that’s lower than the previous quarter and the first quarter was $52 million and this is mainly due to benzene and polyethylene margins, which were negatively impacted by the higher of feedstock cost. And further, in the Chemical business, we had utility and turnaround costs were higher in the second quarter.

Emerging businesses contributed $8 million in the second quarter compared to $12 million in the first, which reflects lower U.S. spot [ph] spreads and then we also had some plant maintenance.

And our corporate costs were $186 million and that’s $7 million higher than the first quarter, primarily as a result of lower interest income on cash balances.

Let’s move to slide 15, if we look at the E&P metrics, you could see the chart shows our E&P income and cash per BOE go back to year 2003 and then through the first two quarters of 2008. While we don’t have the period, the data obviously for the second quarter for the peer group, we would expect the effect of purchase accounting to continue to impact our earnings per BOE when compared to our peers, but when you look at our cash contribution per BOE, we continue to be very competitive and we expect to be in the second quarter.

Go to the next slide, page 16, which is the downstream and you could see both on an income per barrel and a cash contribution per barrel, we continue to be competitive and expect to be in the second quarter.

Then I go to page 17, which is return on capital employed. By the way, the shaded area on the peer group there is made up with the largest integrated public utility companies – that’s Exxon, Mobil, BP, Shell, Chevron and Total.

This pie chart reflects the company’s return on capital employed with no adjustments for purchase accounting but we do make adjustments for peer group reflect purchase accounting for them, for their transactions that they’ve done in prior years and that’s shown in table three, which is attached to the presentation.

Our annualized return on capital employed for the second quarter of 2008 was 20%, that’s 6% higher than the year of 2007, 5% higher than the first quarter of 2008.

And I go to the last slide 18, the outlook. See now, we recently signed interim agreement with Abu Dhabi National Oil Company (ADNOC) to develop the Shah gas field in Abu Dhabi and elsewhere in the Middle East, we approved the continued funding, moving forward for the development of the Yanbu Export Refinery project with Saudi Aramco.

We’re pleased to be working with both ADNOC and Saudi Aramco on these world-class projects. It helps meet the growing demand for energy not only in the old Middle East but also around the world.

We recently signed a MoU with Petrobras, as you know the largest to Brazilian Energy company, and with this agreement we hope to sort through opportunities to work together in our core businesses, upstream and downstream, as well as energy opportunities such as ethanol in Brazil.

In North America, our joint venture with TransCanada, we plan to expand the Keystone crude oil pipeline system, providing additional capacity of 500,000 barrels per day from Western Canada to the U.S. Gulf Coast. Then we look ahead in the third quarter, we expect our E&P segment production will be similar to the second quarter. We expect full-year 2008 production will be consistent with our operating plan, which we announced at the beginning of the year and that is 1.8 million BOE a day excluding the LUKOIL segment.

We expect exploration expenses to be about $375 million in the third quarter. In our downstream refining business, we expect continued negative impacts on market cash due to the secondary product margins that I covered when going through the downstream part of the company.

We anticipate our worldwide crude oil capacity utilization will be similar to the second quarter, reflecting continued lower utilization at our Wilhelmshaven refinery due to the weak hydroskimming margins.

Turnaround costs in the downstream are expected to be $100 million before tax in the third quarter and then we expect our share repurchases in the third quarter to be between $2 billion and $3 billion, which supports our objective of doing $10 billion in share repurchases for 2008.

So that completes going through the prepared comments and so we are ready to take whatever questions that those who are participating in the call may have of us.

Gary Russell

Okay. Jen, could we go ahead and line up our questions please?

Question-and-Answer Session

Operator

Yes, sir. (Operator instructions) Our first question will come from Michael LaMotte of J.P. Morgan.

Michael LaMotte – J.P. Morgan

Thanks, good morning. Jim, I was hoping you could elaborate a little bit on the Memorandum of Understanding with Petrobras? How that came to pass and I’m sure ultimately where you think it can go?

Jim Mulva

Well, obviously, we are quite pleased with starting to work with Petrobras. We’ve worked a little bit with them in the past. We very much respect what they’ve done around the world and certainly in Brazil.

We’re merely looking at the opportunities on how we can participate in exploration and production both in Brazil as well as outside Brazil and then we also, with our large refining segment in North America, we kind of explore and ultimately, we’re having more crude oil production when there is an opportunities for us to be working with each other in the downstream part of the company and then for both companies.

And then we also are working at – we need a lot of ethanol ultimately to blend into our gasoline and so we’re looking to opportunities of being such large ethanol producer in Brazil and how Petrobras participates in that where there’s opportunities for us to be working with each other. So to go any further than that, we are really in initial phases of this study work of the MoU but we‘re really pleased to be working with Petrobras.

Michael LaMotte – J.P. Morgan

Is it possible that, and I know its early days, but is it possible that the relationship would even evolve JV-ing on hard assets or do you think at this point it would be left to project specific?

Jim Mulva

We really don’t know. I mean we’re going to explore all the different opportunities but it’s just too early to come out and furthermore, this is always a sensitive area, so we just have to wait and see how this develops with time.

Michael LaMotte – J.P. Morgan

Okay. And if I can ask you to sort of, I know you have good access and contacts in D.C. and if I could ask you on two issues kicking around Washington now, the windfall profits on the super majors and also the UCS [ph], if you have any comments on those?

Jim Mulva

Well, first of all, we know that the public opinion has really been moving here in just the last few months, certainly understanding the challenge and issues with respect to energy and the high cost of oil and gas and so to the extent that the Washington and the states are looking at opening up more acreage, we think that’s something that the industry has always been looking for and we know there’s a lot of resources that are indigenous to the United States that we can develop without any compromise to the environment and so that’s very, very encouraging. So hopefully we’re going to see continued movement on that.

With respect to windfall profits tax, we know that that's – with the high prices and all and the financial performance that companies, that’s an easy one to talk about, but on the other hand, the companies are reinvesting their income back into development of energy and that’s upstream and downstream, and we really need this cash to reinvest, to fund our opportunities and everything that we do would cost a lot more than the barrels that we produced in the past, so we really all think windfall profits tax is warranted given the huge cost, the capital cost and operating cost that we have to continue to replace what we produced.

And furthermore, as a company or as an industry, we know that windfall profits tax in past has been tried. It really hasn’t to work. It’s actually led less supply and then actually higher impact on cost of energy. So, it’s really important for us to get that message out. We continue to do that. We just don’t think it’s warranted but we understand that it is talked about.

Michael LaMotte – J.P. Morgan

Do you sense that the swing in public opinion towards more drilling, etc., sort of zaps the momentum for windfall profits?

Jim Mulva

Well, it’s difficult to say on that. They’re really in some ways, (inaudible) but it is encouraged that I think the American public, it’s such an important issue to them and we recognize the hardship it has, the cost of energy, on everyone particularly those with less income. And so to the extent that we can be adding supply and moderating the impact on energy is something, and price of energy is something we really need to do to the American public. I think the media is becoming more balanced in all of this. The American public understands this although it’s such a challenge and it’s difficult. We need to add supply and I think that’s what’s happening with public opinion.

Michael LaMotte – J.P. Morgan

That’s great. Thanks, Jim.

Operator

Our next question will come from Paul Cheng with Lehman Brothers.

Paul Cheng – Lehman Brothers

Hey, gentlemen, good morning.

Jim Mulva

Good morning.

Paul Cheng – Lehman Brothers

Jim, on the Shah gas project, any kind of preliminary production schedule or development plan you can share and what kind of reserve booking that we may be looking at in 2008?

Jim Mulva

Well, I think it’s pretty mature to be getting into production levels or anything on Shah project. Obviously, we’ve been working as pretty closely with ADNOC for quite some period of time and we’re very pleased that we have come forward with our agreement. We’ve dedicated teams from both ADNOC and ourselves. We’re working well together. It’s a challenging project.

We’ve taken quite an innovative approach toward how to do this one with ADNOC and I know there’s quite a number of issues with respect to value creation from the gas production, value creation from the liquids, since we had pretty innovatively put together and it’s just premature for us to get into reserve bookings or expected production levels. I think that will come probably more likely when we meet with the analyst in the early part of next year. But I will say that is in reasonable expectations on values of cost and values for oil and natural gas prices or whatever, we see that in no way have we compromised in going forward with the Shah project, have we compromised our hurdle rates of what we expect for returns on investment.

Paul Cheng – Lehman Brothers

Sure. Jim, I know signed on any day [ph], should we assumed that you will be able to book some reserve this year and also do you have a percentage of what is the H2S gas as a percent?

Jim Mulva

No, I don’t think that you can expect us to be looking at booking reserves in 2008. I think in subsequent years, we will be doing that.

Paul Cheng – Lehman Brothers

And do you have a rough idea, is it 30% H2S gas or that is less?

Jim Mulva

Well, why don’t we come back to you on that, but yes, it’s pretty sour gas and that’s why it is challenging and we’ve got really make sure we do our technical work and all in a way that this is done in no way and I know ADNOC feels very strongly about this and no way do we comprise environmental safety performance.

Paul Cheng – Lehman Brothers

Okay. I think that the next two questions, one is, BP and Shell recently have moved into the pipe gas in North America through acquisition. I’m wondering, Jim, when you’re looking at your portfolio, what’s your appetite on those non-conventional gas play in the U.S.? You already have some in your portfolio, any appetite to substantially increase it fixing the path [ph] as the other two guys did?

Jim Mulva

Well, we’ve got a nice portfolio, both conventional and unconventional. What we need to do is really exploit it, which we certainly intend to do over the next number of years as we said in all of our conference calls and presentations. We spread this out in a way so that we make sure we do it well. We don’t give up any opportunity of drilling the wells ultimately.

It is not a question of how fast we go but we’ve got a really great portfolio, conventional and unconventional. And when we look at getting more aggressive, it’s exploitation but it’s also – we do continue to pick up acreage. And so, our approach really is picking up acreage. And so, we quietly do that and we are always working for – not only in the existing areas but what we think will become the new areas and new know how we place in the future. So, that’s really our strategy and where it is directed.

Paul Cheng – Lehman Brothers

So, Jim, based on what you just say, I suppose that we should not assume you’re going to make any multi-billion dollar acquisition, they are trying to (inaudible) expenditures. It is going to be more of a solution gradually, I think.

Jim Mulva

Your assessment is correct. Making large acquisitions of assets is – we have done that in the past but we just don't think the environment is right to do that in creating value for our shareholders. So, what we were doing – our growth is really directed towards organic growth as I just outlined.

Paul Cheng – Lehman Brothers

Great. Two final questions, one, Alaskan gas pipeline, the Alaskan legislation just get approval to one of your competitive proposal. Wondering if you can give us an update what exactly that mean. Does that mean that you guys go with that one, or that does not really mean anything to your current proposal? And then last question is for John. Looking at the international, I’m not sure why do we have 140% tax credit and it is not in your special items. So, can you just give us some idea about what is that?

Jim Mulva

Okay, first on the gas pipeline in Alaska. We know that in the state of Alaska, the legislators is considering approving the process of state working with TransCanada. We will have to see how that sorts out. With respect to the Denali project they were doing with BP, irrespective of what takes place with the approval or not by the state legislature, we continue to go forward with BP and the Denali Project doing our fieldwork this summer and moving right through a process of open season that we expect here in the next few years. So, it does not change at all, the aggressiveness in the plan that we’ve announced with respect to Denali and our work between ConocoPhillips and BP.

Paul Cheng – Lehman Brothers

Jim, on that, did Exxon have indicated whether they are going to join you guys or not?

Jim Mulva

Well, ultimately, we would like to see everyone participating in the pipeline, all the producers, and whether pipeline company participates, and all that remains to be seen. I really shouldn’t be speculating or indicating for another company like Exxon. I think that is really appropriate for them to answer. Now with respect – as I said ultimately, I think everyone needs to participate. The question you had on the downstream for John, I will let John answer.

John Carrig

The negative international tax rate primarily is due to outperformance by equity companies, which don’t record any tax on the equity earnings, because that is just by nature of the structure. And then, there were losses in some of the marketing and other businesses that we have internationally that produced a tax benefit in the consolidated accounts, and that resulted in a negative tax rate.

Paul Cheng – Lehman Brothers

So, there is no tax adjustment or anything, that is why you didn’t put it all as a special item.

John Carrig

That is correct.

Paul Cheng – Lehman Brothers

I see. Very good. Thank you.

Operator

The next question is from Paul Sankey with Deutsche Bank.

Paul Sankey – Deutsche Bank

Hi guys, good morning. It feels like a couple of the big ticket if you like guidance items are back in line here. Obviously you’re absolutely in line on buyback and we are looking at I guess levels of CapEx, if could confirm that they are exactly in line with what you have guided. The one area that you seem to be falling a bit short or at least based on what you’re saying seems to be falling short is on volume. I guess the previous guidance was for full year 1.8 million barrel per day ex LUKOIL. You talked about flat in Q3. I guess we can reasonably expect a bounce back in Q4, but could you just talk a little bit about where we can expect volumes to pan out at the end of the year?

Jim Mulva

Okay, thanks. On share repurchase, I did comment on and so, market can expect we are going do $10 billion share repurchase in 2008 and going at a rate of $2.5 billion a quarter. Capital spending is going to be around $15 billion, maybe a little bit more, but $15 billion, $16 billion. But what we said, we are going to spend this year is about where we are going to be. On volumes, we said 1.8 million BOE a day ex LUKOIL. So, we are a little bit below that so you can expect with a flat second quarter or third quarter, that the fourth quarter comes up, and we still stand behind the 1.8 million BOE a day for 2008.

Paul Sankey – Deutsche Bank

Great, that is good. Good news. The second thing I had, Jim, was on Saudi. You said that you have agreed to spend more or rather continued funding for the development. Could you just clarify firstly what that means in terms of capital commitment? And secondly, could you give us a date around which you expect that maybe we might see some volumes out of that project? Thanks.

Jim Mulva

Well, it’s a foreign [ph] project and I think we would come back here, I will say, I think it’s about 2012 when we really get going somewhere in there but we are in the process of actually going into the marketplace with the bids for the large units of that refinery. We expect to have a lot of interest and hopefully they will be within our ballpark guidelines of what we think the bid should be. And then, assuming that is all in place, then we announce we go forward with the project. So, that is where we are. We are working really well with Saudi Aramco. It is a challenging project, but once it is done and built, it creates a lot of value for both Saudi Aramco and ourselves. So, that is where we are right now in a marketplace with our bid packages, and we don't see big surprises, any real big negative surprises and it fits the guidelines and we will be going forward announcing.

Paul Sankey – Deutsche Bank

That’s good on the date. Jim, any hints you can give us about what kind of prices you are looking out for that refinery of that scale?

Jim Mulva

We will tell you once we have confirmed the bids and so that is probably going to be something that we talk to the marketplace in the first quarter next year.

Paul Sankey – Deutsche Bank

Very good. Thanks very much, indeed.

Operator

The next question is from Neil McMahon with Sanford Bernstein.

Kasey Raydon – Sanford Bernstein

Hi, this is actually Kasey Raydon [ph] on behalf of Neil McMahon at Sanford Bernstein. We just wanted to ask you what your latest fees on Arctic exploration and what your drilling sands were there in the next year or so?

Jim Mulva

Okay. Is this related to the Arctic?

Kasey Raydon – Sanford Bernstein

Yes.

Jim Mulva

I think you’re probably – most of your question is really related to Chukchi Shale, is that correct?

Kasey Raydon – Sanford Bernstein

Yes.

Jim Mulva

Yes, well, we are quite pleased that we’ve won the acreage and we are working through. It is a tough area that we have to do a lot of planning, but we know that we’ve got ten years I believe on these licenses, and so we have to get going pretty quickly. I don’t have right at hand. I don’t think you are going to see drilling anytime real soon because we got to do a lot of planning and get a lot of permits and approvals to do this. But we are working the schedule pretty aggressively and this is one that I just going to have to get a little more time before we give you more substance to just how this is going to be done.

John Carrig

Yes, my guess would be you’re going to hear a lot more about it in the analyst meeting next year, but probably not a lot between now and then.

Kasey Raydon – Sanford Bernstein

Okay. Thank you.

Operator

The next question is from Mark Gilman with Benchmark Company.

Mark Gilman – Benchmark Company

Guys, good morning. First question by the way of clarification, these adverse inventory effects, Jim, I believe you referred to one in the upstream, the press release were first to one in the downstream. Could you quantify these effects and explain a little bit more what gave rise to it? I think the downstream one internationally was associated with an inventory build, but would still love some clarification.

Jim Mulva

Okay, John, maybe you can –

John Carrig

The downstream inventory build, I don’t have a precise number at hand, but it relates to just an inventory cost and that resulted in an inventory charge in the second quarter. With respect to the upstream, that’s more of a mixed issue where it has to do with under list and over list quarter to quarter. And a mix of those between high – relatively high tax rate jurisdictions and less high tax rate jurisdictions and that mix resulted in an impact to the sales volume.

Gary Russell

Mark, I would say further that when we look at the downstream inventory impacts, we would expect that to be a temporary impact because it is related to an inventory build in the second quarter and we would expect that to be liquidated before the end of the year.

Mark Gilman – Benchmark Company

Gary, that is why I was asking for the quantification. I expect it is temporary also.

Gary Russell

Yes.

Mark Gilman – Benchmark Company

If I could ask another one, this one is for John Carrig a little bit off the wall. Your first quarter 10-Q indicated that you chose to defer the implementation of SAF 57 fair value accounting with respect to business combinations, John. Can you tell me why you exercised your option to defer that?

John Carrig

Just to get more time. We don’t have any large business combinations that we are dealing with. So, there is no sense of urgency to get that in place.

Mark Gilman – Benchmark Company

Doesn’t that relate to BR in particular and others?

John Carrig

Not materially. There is some residual impact that you might have like some impacts related possibly to taxes, but those were not the drivers in that decision.

Mark Gilman – Benchmark Company

Okay. One more if I could just, are you yet incurring take or pay obligations with respect to your commitments on free port and can you give us an idea of what that might be? If you were unable to utilize the capacity which you contracted for?

John Carrig

Well, we will incur take or pay charges related to free port. As you may recall, we signed up for a term to process LNG and then we are also – because we funded that, we will receive some amount of that back. So, the net impact – I don’t have an annual number. That’s something that we can work to try to provide, if not in the next quarter, certainly at our analyst meeting

Jim Mulva

But isn’t it something that's rolled in every month. It’s not something that’s expected to be at one time.

John Carrig

Right. Yes, that’s right. It’s going to be a – it’s an executory obligation and if we have the volumes, they will offset the transportation or the processing charges. If we don’t, then we’ll have the typical take or pay arrangement where you have an expense in the month where you don’t utilize the capacity.

Mark Gilman – Benchmark Company

Will it show up in U.S. E&P?

John Carrig

Likely, yes.

Operator

Our next question is from Eric Milkie with Merrill Lynch.

Eric Milkie – Merrill Lynch

Good Morning. A couple of quick questions on the – firstly, on the proposed Keystone expansion, can you elaborate what exactly it would mean for Conoco? Do you expect to have any shipping volumes toward the receiving end and if that (inaudible) near term impact on CapEx as well?

Jim Mulva

Well, on Keystone, the expansion, yes, we expect to use it by taking Canadian crude all the way down to the Gulf Coast because there's good optionality to be in our refineries in Mid-Continent and Gulf Coast, both from Canada as well as from say Venezuela and other crudes that we can get from Mexico and other places around the world. So, we expect to do that.

In terms of capital spending, it’s already been geared into our capital spending for this year and for subsequent years, but it’s going to be an equity investment but all of the cost and all of the capital will be just part of our capital program.

Eric Milkie – Merrill Lynch

Okay. Thanks. Can I ask about your joint venture with EnCana and with any change to that joint venture from the corporate changes at EnCana, and in the event that there were to be a change of ultimate control of the EnCana part of the joint venture, would you have preemption rights?

Jim Mulva

We don’t see any change in our EnCana joint venture. Obviously, EnCana is splitting into two companies but the joint venture will be not in the pure gas company. We are working to know the management well and they were part of the formation, obviously as a joint venture. In terms of – once it’s completed, which is going to take some time, we don’t have preemptive rights on things with respect to this joint venture.

Eric Milkie – Merrill Lynch

Can I ask quickly on refining modes that you mentioned there was an asset rationalization with the net costs of I think it was $140 million. Would you elaborate exactly what that rationalization was?

John Carrig

Well, that rationalization related to the sequential difference. So there was a gain in the first quarter that didn’t show up in the second quarter because we didn’t have any asset –material asset sales from the second quarter. And so that variance is reflected in that $114 million dollar difference in the R&M chart.

Eric Milkie – Merrill Lynch

Okay. Thank you.

Operator

The next question is from Jason Gamel [ph] with McCorey [ph].

Jason Gamel – McCorey

Thank you. Jim, you made reference earlier to your strong position in non-conventional resource in North America. There’s something you might be able to expand a little bit about, what your activity levels look like currently in the Bakken Shale and the Montney Shale, and then possibly even rank where you see the best prospectivity between those two plays and maybe put the Piceance and Barnett into that as well?

Jim Mulva

Well, I think it’s probably better we’ve come in the back to you (inaudible) on that because really I don’t have right at hand just what our position is in terms of to date and what we expect to do. So maybe Gary, you could do that. In terms of whether how we rank them, what’s more perspective than others, that’s more of a competitive issue and I don’t think we’d like to share that with others but in terms of precision and all, maybe Gary, you can do that all fine.

Gary Russell

Yes, I’ll get back with you Jason.

Jason Gamel – McCorey

Okay, great and then one more if I could. A lot of the macrostatistics are indicating sort of a 2.5%, 3% decline in U.S. demand for refined products. With your own experience as a marketer tend to confirm those numbers? Do you think they’re too high, too low?

Jim Mulva

Oh, we’re seeing demand down in all the markets particularly in the West Coast. So, we have to configure our operations and all the – to make sure that we run the right – have the right inventories. It’s – don’t want to have too much and certainly want to have the inventories you need to supply the marketplace and yet, on the other hand, the way we operate, we continue to expect that we’re going to operate our refineries with the exception of Wilhelmshaven because it’s a relatively unsophisticated refinery in the bid 90% level all in probably the whole 90s. So, yes, we’re seeing the demand falling off more on the West Coast than the other paths.

Jason Gamel – McCorey

Okay and then maybe if I could just ask one last question on the strategic level. You have taken ownership in pipeline infrastructure that would generally have attracted utility rates return. Can you expand a little more on the optionality you see in ownership of assets like Rex and Keystone and I think you’ve only touched on Keystone a little bit.

Jim Mulva

Well, first of all we can see in terms of the capital invested. Obviously there’s some external financing in most of those and so the return on capital investment is pretty good and acceptable but doesn’t take (inaudible) flexibility over time to do something else but if we would like to, we can always do that but when you make a commitment– your economic commitment, then why pay someone else to do some of the financing for it on the basis of your commitment to use pipelines.

So, we look at that and say unless we see something that’s really attractive in terms of use someone else’s funds or financing. Then we might as well do it ourselves but yet not give up the option or flexibility refinance it differently in the future.

Jason Gamel – McCorey

Okay. That’s very helpful. Thank you.

Operator

Next question is from Paul Cheng with Lehman Brothers.

Paul Cheng – Lehman Brothers

Hi. Thank you. Jim, can you give us an update about the EnCana joint venture. I mean, how well is the progression ramp up. And also I think you were having some difficulty receiving the permit for it would there be any update on there. And also, where are we in the Surmont and also the YK production [method].

Jim Mulva

Okay, a number of questions. First EnCana, this joint venture both upstream and downstream is very integrated. We work upstream and downstream well separately as well, but really has worked well. From the top down to all the operating people, it’s a joint venture that’s going as well as any. We’re pleased with that.

In terms of the production, we had some issues on our production with some mechanical problems in the first quarter but yet we seem to be doing a lot better. And so, for the year, we might be down 1,000 or 2,000 barrels a day net on this but we seem to be doing pretty much better than we did in the first quarter in terms of volumes coming from the EnCana joint venture.

The permit for whatever cost, we’re working that because it’s pretty costly with EPA as well as the state of Illinois and I think, we’d like to think– I’m always an optimist– try to think we’re going to get this sorted out here in the next few months. We’re working very aggressively on it. We’re working with all the right people. So hopefully, we’ll have some use on that sooner than you might think. It is important for us to get sorted up. We think we’ll get there.

On the YK field, we did start our production and maybe John or Gary could tell you that it has come on pretty smoothly. And we’re quite pleased with what’s going on with respect to YK and hopefully, we’ll see some different fiscal. Some of the impact of the Russian fiscal tax changes will have some beneficial impact on the return for that project but in terms of volume, it’s already starting to ramp up.

Paul Cheng – Lehman Brothers

What’s the current production, I’m sorry, with YK?

Jim Mulva

I don’t have the precise number on the current production. I know that we’re – it’s early production and continues to ramp up in line with our expectations but I don’t have the –

John Carrig

Tell me (inaudible), with you Paul.

Paul Cheng – Lehman Brothers

Okay, thank you.

Jim Mulva

It’s just actually starting up with its first (inaudible) and so, it changes from day to day as we sort this out but Gary we certainly have more info on our conference call next quarter.

Paul Cheng – Lehman Brothers

How about Surmont. Are we still looking at just 20,000 debt per day at this point.

Jim Mulva

Where?

Paul Cheng – Lehman Brothers

The Surmont Oilsands Project.

John Carrig

Surmont

John Carrig

Surmont

Jim Mulva

Surmont is actually running quite well and Gary, maybe you have the numbers. I don’t have them in front of me for Surmont –

Gary Russell

Well, we were looking at it as gross – about 100,000 barrels a day at peak and so the ramp up is going really well. We just started production early this year so you wouldn’t expect it to be at peak yet but it’s certainly within 15,000 or 20,000 barrels a day net pass we think it’s what we’re looking at. So I’ll get back with the actual numbers but–

Jim Mulva

It’s important to get the actual numbers on this.

Gary Russell

I do know it’s in line – slightly ahead of the line to slightly ahead of expectations.

Operator

Thank you, gentlemen. I will now hand the call over to management for closing remarks.

Gary Russell

Yes, thanks, Jim. Again, we appreciate it – by participating on the call today and I would remind you that presentation material that we went through today along with the supplemental schedules are available for your use and viewing on our website, www.conocophilips.com. Thank you and have a good day.

Operator

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

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

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

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

Source: ConocoPhillips Inc. Q2 2008 Earnings Call Transcript
This Transcript
All Transcripts