Financial Status and Policy of ConocoPhillips - Case Study Example

An Overview of the Financial Status and Policy of ConocoPhillips Introduction ConocoPhillips (NYSE:COP) in an international petroleum and energy company based in Houston, Texas. The third largest in terms of capitalization as well as oil and gas reserves of its kind in the US, it is the second largest refiner as well. Of non-government controlled entities in the world, ConocoPhillips ranks fifth and sixth in size based on crude oil refining capacity and reserves respectively. It is considered one of the foremost in deepwater exploration as well as 3-D seismic technology and reservoir management. Much of its investment is in emerging technologies such as alternative energy, carbons-to-liquids, power generation and technology solutions. Its refinement technology focuses on upgrading high-grade petroleum coke and removing sulfur. With approximately 32,700 employees in 40 countries, it has assets of $171 billion with core competencies in petroleum exploration, production, refining, supply, marketing and transportation as well as natural gas gathering and processing and chemicals and plastics production. The company has a 50 percent interest in Colorado-based natural gas liquid producer DCP Midstream, LLC and Texas-based petrochemical company Chevron Phillips Chemical Company LLC. This paper will provide an assessment of the existing company in terms of its current status, including stock trading and financial standing, and the issues that have significant effect on its performance. Brief History ConocoPhillips is actually the recent marriage between two pioneer oil companies in the US, Conoco Inc. and Phillips Petroleum Company. The two companies merged on August 30, 2002 amidst some speculation that the $15.5 Billion deal was a necessary move for the two contenders to avoid being out-competed by bigger petroleum companies. At the time of the merger, oil prices had taken a disastrous turn downward that threatened the survival of smaller gas companies. The merger was expected to save about $750 million in overhead costs, mostly based on planned downsizing of some of the combined roster of 58,000 employees. ("Analysts: Phillips-Conoco merge to survive," 2001) Isaac Elder Blake founded Conoco in November 25, 1875 as the Continental Oil and Transportation Co. that would bring in petroleum in bulk to the pioneers of Ogden, Utah, making it more affordable and convenient for individual use. In the course of operations, Blake developed new uses for petroleum including benzene, ready mixed paints, birthday candles and paraffin chewing wax, but the focus was more on gasoline for use in automobiles. Continental built the first filling station in the West in 1909. By 1913, Continental was the top petroleum marketer in the Rocky Mountain region and an attempt by Standard Oil to take over the company was rebuffed by order of the Supreme Court. In 1929, Continental Oil merged with Oklahoma-based Marland Oil because each company could benefit from each other's strengths, marketing know how from the former and supply of crude oil for the latter and was named Continental Oil Company, assets including 3,000 wells and retail outlets in 30 states. Conoco stock began trading in the New York Stock Exchange in September 15, 1929, just in time for the stock market crash. The company survived only by drastically cutting overhead costs and expanding refinery capacity under the direction of Dan Moran. He was succeeded by Leonard F. McCollum who led Conoco overseas, acquiring oil fields in Dubai and retail acquisitions in Europe. He diversified the company to such an extent that by 1972 Conoco was worth more that $2.3 Billion in assets. On September 30, 1981, in the midst of political and economic ups and downs and a threatened hostile takeover, Conoco merged with DuPont, which resulted in the former becoming a wholly owned-subsidiary of the latter, until Conoco separated from Dupont in 1997 to become an independent oil company. ("Conoco History," 2005) It was in 1905 that the Philips brothers hit their first oil well, eventually discovering 81 viable ones. In 1917, Philips Petroleum Company was formed and the first gas liquid plant was opened. By 1920, research and development in gas processing plan techniques began and the first patent for recovering natural gasoline from natural gas was won, which lead tot the Research and Development Group formed. By 1927, Philips was marketing gasoline to service stations, eventually supplying 10,000. Philips pioneered several technologies, including lighter, more efficient aviation fuels, first aviation refueling trucks, the first propane for home use, seasonal gasoline, first long-distance multi-product pipeline, polyethylene plastics and the first synthetic rubber better than natural rubber. Philips was the first oil company to install electrostatic precipitators to limit air pollution. In 1969, Phillips discovers oil in the North Sea and oil production began in 1975. By 2000, after warding off hostile takeover attempts, Phillips' GPM operations with Duke Energy's midstream operations were combined to create Duke Energy Field Services. In the same year, Phillips purchased ARCO Alaska Inc, and a joint venture between Phillips and Chevron Corp. created the Chevron Phillips Chemical Company. In 2001, Philips acquires one of the largest US refiners and marketers Tosco Corporation. ("Conoco History," 2005) Overview of Core Businesses "Exploration and Production (E&P) produces crude oil, natural gas and natural gas liquids (NGL) in 18 countries in 2006, with proved reserves in two others. The addition of Burlington Resources, re-entry in Libya's Waha concessions and the Bayu-Undan field in the Timor Sea significantly increased the company's production and presence in North America". ("Conoco History," 2005) Refining and Marketing (R&M) operations in 12 refineries in the US, as well as Europe and Asia had a 2006 processing capacity of 2,208,000 barrels per day (BD). "A Memorandum of Understanding was signed with Saudi Aramco to develop a 400,000 BD refinery in Yanbu, Saudi Arabia". ("Conoco History," 2005) Gasoline, distillates and aviation fuels were distributed through 13,000 outlets worldwide, selling 3.5 million BD in 2006. Thirty thousand miles of pipeline systems in the US was owned and operated by ConocoPhillips or its affiliates by the end of 2006. Midstream operations, as part of DCP Midstream, LLC included about 56,000 miles of transmission system pipelines in 2006. DCP had 52 NGL extraction plants and 10 NGL fractionation plants, with raw natural gas throughput of 6 billion cubic feet per day (BCFD) and NGL extraction at 360,000 BD in 2006. The Chemicals sector, as part of Chevron Phillips Chemical Company LLC (CPChem) includes Olefins and Polyolefins. "In 2006, it had 11 U.S. facilities, a petrochemical complex in Puerto Rico and nine fitting plants. It has major production facilities in Belgium, Singapore, South Korea, China, Saudi Arabia and Qatar". ("Conoco History," 2005) In 2006, the company increased its shares in LUKOIL to 20 percent. An international, integrated oil and gas company based in Russia, it had operations in 30 countries, and the estimated net share of ConocoPhillips in 2006 was equivalent to 401,000 BD. Emerging Businesses include the development of new technologies and consequently of new businesses and has been a primary motivation for both Conoco and Phillips when they were independent companies, In 2006, the development of production technology for renewable diesel fuel was applied in a refinery in Europe which is projected to be integrated into more refineries in the future. "The technology converts vegetable oils and animal fats into diesel fuel. There is also a projected capacity expansion by 450 megawatts of the Immingham Combined Heat and Power plant in the United Kingdom". ("Conoco History," 2005) Financial Survey The net income for ConocoPhillips in 2006 was $15.6 billion, translating to $9.66 per share. As the table shows, this was a significant increase over 2005, attributed to: 1. Increased production and profit from E&P due to higher crude oil prices and inclusion of Burlington Resources 2. Improved refining margins for R&M in the US 3. Increased earnings from LUKOIL 4. Business interruption insurance claims for hurricanes in 2005 The company continues to increase annual dividend rates, increasing 16% per quarter for 2006, and a 2007 first quarter increase of 14%. Share repurchases almost reached $1 billion in 2006 compared to $1.9 billion in 2005. A projected $4 billion repurchase plan for 2007 was announced. Seventy-five percent of the resultant operating cash flow was expended on capital expenditures, investments and loans, the remaining 25% used to reduce debt, dividends and share repurchases. Capital expenditures The purchase of additional authorized and issued shares of LUKOIL accounted for a considerable portion of the $16.3 billion capital program for 2006 at $2.7 billion. Over the last three years, a total of 58% went to E&P spending, a total of $9.513 billion for 2006 in both the US and internationally. For 2007, the company plans to allocate just $13.5 billion for the capital program, lower than in 2006 because equity investments in LUKOIL had been completed. The program includes loans to affiliates and an oil-sands joint venture with EnCana Corporation, and an estimated $11.4 billion is budgeted for E&P investments. Approximately $1.7 billion is earmarked for R&M and about $0.4 billion will go to Emerging businesses. Executive vice president and CFO John Carrig explains the more conservative approach in 2007 to capital expenditure is a reaction to cost pressures within the industry which makes capital and investment spending less attractive. Stock trading ConocoPhillips (COP) is an international, integrated company that is subject to fluctuations in the prices of worldwide natural gas, natural gas liquids, crude oil, refined products, and electric power markets as well as foreign currency risk. The company's policy is therefore to allow this exposure but hedged for the price risk of crude oil and natural gas production, as well as refinery margins with the use of derivative instruments. The company makes use of futures, forwards, swaps, and options in various markets to optimize the value of the supply chain and reduce commodity price risk through the physical delivery of the commodity prior to contract expiration. Swap contracts that convert fixed-price sales contracts to the floating market price for the benefit of natural gas and refined product consumers. The cash flow risk for crude oil, natural gas, refined product and electric power transactions is managed through limited trading outside the physical side of the business, using the VaR model to estimate for loss of fair value. ("ConocoPhillips 2006 Annual Report," 2007) Projected stock performance for COP Based on an analysis of COP compared to nearest competitors Chevron Corp. (CVX) and Exxon Mobil (XOM), it was suggested that as COP is heavily reliant on the US market for revenue, this would translate to the maintenance of natural gas prices above $6.55. Despite some concerns regarding the effect of geopolitical factors on revenues for LUKOIL, it is considered likely that the risk is minimal at this point, as collateral damage from any political risk has already been factored in. In essence, COP stock is ideal for long-term investment over CVX and XOM. (CrossProfit, 2007) An analysis on the oil and fuel industry has conceded that the volatility of the market has made speculation risky business. The Investment U Research Team (2007) however, has singled out ConocoPhillips (COP) as one of the stock market's most reliable in terms of increasing shareholder value. One of the so-called "Oil's Top 5," COP among others had posted strong performance in 2006, up 22% from 2005. A caveat was included with regard to the potential of some of the bigger oil companies to a repeat performance. For example, while BP PLC (BP) posted a 7.9% increase in 2006, the trend is downwards and Chevron Corp, up 29% in 2006 was beleaguered by falling oil prices and maintenance costs in its refineries and the Gulf of Mexico platforms in the last two quarters of 2006, showing no signs of any quick recovery. COP, on the other hand, is considered to have successfully managed its resources and is the best cash-generator over five years among in the group, with the most improved balance sheets. The analysis continues to consider the capital program of the company to be efficient and potentially productive, whittling down long-term debts from 46.2% in 1998 to 14.1% of its market capitalization. Over the last 10 years, the company has increased the value for shareholders with an average of 17.2% a year. The consistency and level of revenue growth has ranked it third among the top oil companies, with an average of 37.78% over the last nine years. COP shares trade at about $10.10 in 2006, seven times higher than estimated, and have the lowest price-to-earnings (PE) ratio among the Dow Jones Global Titans. This makes the stock relatively cheap and attractive to investors looking to put money into quality stock that has consistently managed to weather fluctuations and price increases without seriously affecting shareholder value. As if to illustrate the volatility of the market, a press release on the interim performance of COP in the first half of 2007 showed that the company show a considerable decline in net income for the same period in 2006. The 2007 income was $301 million, or $0.18 per share compared to the 2006 income of $5,186 million, or $3.09 per share. This is attributed to an after-tax impairment of $4,512 million in E&P activities in Venezuela, as well as overall lower sales volumes and higher taxes. Adjusted earnings were $2.90 per share, which is still lower than that for 2006. There was also a decline in E&P daily production, excluding LUKOIL, from 2.1 million barrels of oil equivalent (BOE) per day in 2006 to an average of 1.9 million BOE per day in 2007 to date. This in turn it attributed to scheduled North Sea maintenance, exit from Dubai and seasonal production in Alaska. Other factors include OPEC reductions, Nigerian pipeline sabotage and asset dispositions. Net loss for the E&P was $75 million for the first half of 2007. Midstream reported a decrease as well in net income for the second quarter in 2007 of $29 million due to lower sales volumes. R&M posted, on the other hand, posted an increase of $650 million due to higher refining and marketing profit margins, lower costs for turnarounds and impact of Hurricane Katrina impact. LUKOIL also posted increased net income of $139 million while Chemicals posted a decline of $35 million, due to after-tax asset retirement and lower olefins and polyolefins profit margins. Emerging Businesses posted a net loss of $12 million, same as for the previous year, attributed to lower power generation. To increase shareholder value in the face of these performance declines, COP instituted a share repurchase program of a maximum of $15 billion until the end of 2008 and the anticipated repurchases for 2007 is between $2 to $3 billion. In the meantime, negotiations with Venezuela as well as technical improvements in operations in Timor Sea and Alaska are ongoing, and successful issues are expected to improve turnaround and profitability, although not in the near future. "It was also announced that an agreement has been hatched between COP and Peabody Energy to develop commercial scale coal-to-substitute natural gas facility using the proprietary ConocoPhillips E-GAStechnology within the US which will effectively produce up to 70 billion cubic feet of natural gas". ("ConocoPhillips reports second-quarter net income of $301 million or $0.18 per diluted share," 2007) Conclusion Conoco and Phillips have both recorded a roller coaster history as individual companies and as the merged company ConocoPhillips (COP), this has not changed much due mainly to the fact that the same forces are in place that conspire to keep the status quo. However, because of the company's policy of prioritizing research and development of new products and technologies and the possible dividends that have resulted from successful deployment, has inspired significant confidence in long-term investors. In the long-term, financial management has been consistently shrewd and careful, keeping an eye on maintaining shareholder value. This primary stock trading policy of COP of maintaining this confidence is illustrated by the offer of share-repurchasing programs as well as the continued practice of hedging risks with limited speculations in futures and swap options. Overall, COP is considered a good choice for long-term investment in spite of the risks associated with worldwide natural gas production and oil industry. References Analysts: Phillips-Conoco merge to survive. (2001, November 19). USA Today. Retrieved August 23, 2007 from http://www.usatoday.com/money/energy/2001-11-19-merger.htm ConocoPhillips 2006 annual report. (2007, March 6) ConocoPhillips.com. Retrieved August 23, 2007 from http://www.conocophillips.com/NR/rdonlyres/ACAB5A80-1887-4061-8AB9-FE4CDCC44BAA/0/2006_annualreport.pdf ConocoPhillips history. (2005, February 17) ConocoPhillips.com. Retrieved August 23, 2007 from http://www.conocophillips.com/about/Company+History/ ConocoPhillips reports second-quarter net income of $301 million or $0.18 per diluted share. (2007, July 25) ConocoPhillips.com. Retrieved August 23, 2007 from http://www.conocophillips.com/newsroom/news_releases/2007+News+Releases/072507.htm CrossProfit. (2007, March 16) COP - ConocoPhillips: 2007 Integrated Oil & Gas Outlook Part I. CrossProfit.com. Retrieved August 23, 2007 from http://www.crossprofit.com/article.aspid=12 The Investment U Research Team. (2007, August 23) Conoco Phillips. The Oxford Club. Retrieved August 23, 2007 from http://www.investmentu.com/research/conoco-phillips.html Who we are. (2005, February 17) ConocoPhillips.com. Retrieved August 23, 2007 from http://www.conocophillips.com/about/Who+We+Are/index.htm Read More