CONOCOPHILLIPS quarterly report, Q3 FY2011

Business context and reporting period

ConocoPhillips’ unaudited Form 10-Q covers the quarter and nine months ended September 30, 2011, compared with the corresponding 2010 periods. The integrated energy company’s earnings are driven chiefly by oil and gas prices and refining margins. Figures below are in millions of dollars unless noted.

Financial performance and position

• Revenue rose 33% in Q3 and 34% year to date, primarily reflecting higher petroleum, crude oil and NGL prices. Attributable earnings fell 14% in Q3 and 3% for nine months; 2010 comparisons included significant disposition gains and 2011 results included asset-sale losses and the Trainer refinery impairment.
• Operating cash flow was $13,834 for nine months, up from $10,854. Capital expenditures and investments were $9,394, versus $6,371; investing cash flow was a use of $8,139. Financing cash use was $11,618, including $7,984 in share repurchases and $2,761 in dividends. Cash and equivalents declined $6,017 to $3,437; the decline included $1,623 shifted into short-term investments.
• At September 30, cash and equivalents were $3,437, short-term investments $2,589, current assets $32,391 and current liabilities $28,936. Total debt was $23,150, down $442 from year-end 2010; debt-to-capital was 26%, versus 25%. The company had $1,127 of commercial paper outstanding and $6.8 billion of available revolving-credit capacity.
• Effective tax rates were 49% for Q3 and 47% for nine months, compared with 42% and 39%. A UK tax-law change added $234 of Q3 tax expense. Interest and debt expense for nine months declined 19%, primarily due to lower debt levels.

Material changes and operating results

• Q3 E&P earnings were $1,762, up 13%; nine-month E&P earnings were $6,638, down 12%. E&P production averaged 1.538 million BOE/day in Q3, compared with 1.717 million, and 1.626 million for nine months, compared with 1.758 million.
• Q3 R&M earnings were $789, compared with $268; nine-month earnings were $2,037, compared with a $15 loss. Improved refining margins drove results, partly offset by the Trainer impairment. The U.S. 3:2:1 crack spread rose 186% year over year in Q3; the filing also reports improved international refining margins.
• Q3 Midstream earnings were $137, versus $77; Chemicals earnings were $197, versus $132. Higher NGL prices supported Midstream, while stronger margins and volumes supported Chemicals.
• ConocoPhillips completed its LUKOIL divestiture in Q1 2011. The 2010 comparison includes LUKOIL earnings and gains, as well as a large Syncrude sale gain; these make reported year-over-year earnings comparisons less representative of underlying operations.

Outlook, commentary, risks and unusual items

• Management forecast 2011 E&P production of 1.61–1.62 million BOE/day and Q4 production of 1.56–1.58 million BOE/day. It planned an additional $7–12 billion in non-strategic asset sales through the end of 2012.
• The company planned a tax-free separation of downstream operations, including most Midstream and Chemicals businesses, targeted for Q2 2012. Completion depended on market conditions, regulatory approvals, an affirmative IRS ruling, agreements and final Board approval. The proposed distribution was one new-company share per two ConocoPhillips shares.
• The 185,000-barrel/day Trainer refinery was idled and offered for sale; if no sale succeeds, the company expected to close it by the end of Q1 2012. The Q3 income statement recorded $486 of impairments, primarily the $484 Trainer charge. The Wilhelmshaven refinery sale generated a $228 pretax loss.
• Production at China’s Peng Lai 19-3 field was suspended following seepage incidents; management expected the shutdown and related constraints to reduce Q4 production by about 40,000 net barrels/day compared with 2010 field production. Libya operations and exports also remained temporarily suspended. Future impacts were uncertain.
• Environmental accruals were $926 at September 30, with substantial spending expected over the next 30 years. The company disclosed ongoing Venezuela and Ecuador arbitration proceedings, an APLNG delivery-related guarantee with estimated potential payments of $1,282 (or $2,824 in specified breach circumstances), and a QG3 construction-completion guarantee with estimated maximum payments of $850. Management said it believed material adverse effects from known contingencies were remote, while noting estimates could change.
• Key sensitivities include commodity prices, refining and chemicals margins, production levels and interruptions, environmental and climate regulation, taxes, political developments, litigation, and execution of planned asset sales and the downstream separation.

Important facts for investors to verify

• Progress and conditions for the planned downstream separation, including the IRS ruling, approvals, registration statement and targeted Q2 2012 timing.
• Whether Trainer is sold or closed, and the operational, financial and environmental consequences of the Peng Lai suspension and Libya disruptions.
• Delivery against production guidance and planned asset-sale proceeds, and the effect of those proceeds on debt, buybacks and liquidity.
• The sustainability of refining-margin-driven R&M earnings and the impact of lower production on E&P results and cash generation.
• Developments in environmental accruals, guarantees and Venezuela and Ecuador arbitrations; the filing does not provide a clear estimate of maximum exposure for certain indemnifications.