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ConocoPhillips' Flat Reserve Additions Concern Analysts

ConocoPhillips bolstered its oil and natural gas output last year by 300% with the addition of 2.6 billion boe in new reserves, the company said in a preliminary 2006 estimate. However, energy analysts criticized the Houston-based producer, noting that Conoco's proved reserves rose almost entirely on its $35.6 billion cash-and-stock acquisition of Burlington Resources Inc. and its increased stake in Russia's LUKOIL.

Conoco, the third-largest U.S.-based producer, bought Burlington in late 2005 and completed the acquisition last year (see Daily GPI, April 3, 2006; Dec. 14, 2005). At year-end 2004, Burlington estimated its total reserves were 2.001 billion boe. When the merger was completed, Conoco said that based on estimates at Dec. 31, 2005, net proved reserves of the combined companies would be around 11.5 billion boe, including Conoco's interest in LUKOIL, but excluding its Canadian Syncrude.

In a statement on Wednesday, ConocoPhillips said it expects to end 2006 with approximately 11.1 billion boe in reserves. A joint venture with EnCana Corp. to swap refining capacity for Canadian oilsands production will be counted in 2007 reserve additions, according to Conoco. Production in 2006 is expected to total around 880 MMboe.

"This announcement, along with the company's dependence on acquisitions and joint ventures, further suggests that ConocoPhillips' future organic growth opportunities remain somewhat limited," wrote A.G. Edwards & Son energy analyst Bruce Lanni in a research note. "Moreover, it brings into question the quality of ConocoPhillips' project backlog." Lanni wrote that Conoco was "producing more than they're finding," and it has "limited -- if any -- growth potential." If commodity prices continue to decline, "Conoco is in a world of hurt. They'll have to cut their capital budget or take on additional debt."

Conoco estimated its organic reserve replacement at 10-15% for 2006, which is the third consecutive year it has been below 100%, Lanni noted.

Deutsche Bank energy analysts noted the producer had "shocked" them with its reserves guidance for 2006. "That, by the company's own admission, is a weak number," they wrote in a research note.

On Friday, Standard & Poor's Ratings Services (S&P) said the "poor internal reserve additions" would not immediately affect the company's ratings or outlook. However, "the unfavorable news substantially reduces ConocoPhillips' upward rating momentum." S&P noted that the company had made "meaningful progress" to reduce its large acquisition debt, and it said the positive outlook "reflects sufficient confidence that the company will be able to generate adequate cash flow under near-term commodity prices to continue to reduce debt while simultaneously pursuing an ambitious capital spending program..."

Earlier this month, Conoco stated that its refining margins and upstream revenues will be lower in 4Q2006 because of weak commodity prices (see Daily GPI, Jan. 5). On Friday, the company said it plans to repurchase up to $1 billion worth of its common stock, with $750,000 in purchases expected to be made in 1Q2007.

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