IHS Global Insight Perspective | |
Significance | ConocoPhillips, the third largest oil company in the United States, has demonstrated with its second-quarter results that its asset divestment strategy is paying off with higher returns, recording a sharp increase in earnings to US$4.2 billion. |
Implications | The U.S. supermajor is focused on delivering shareholders greater returns, and in that vein ConocoPhillips announced a deal to divest of its remaining stake in LUKoil, effectively conceding that their alliance and ConocoPhillips's investment in the Russian oil company was—if not an outright failure—hardly the success it was expected to be. |
Outlook | ConocoPhillips said that it will use money from the sale of its remaining shares in LUKoil to buy back its own shares, part of ongoing efforts to strengthen ConocoPhillips's balance sheet and pull back from its earlier expansion to refocus on its core operations. |
Strong Results, But…
U.S. supermajor ConocoPhillips said yesterday that its reported income in the second quarter jumped to US$4.16 billion, more than quadruple its US$859 million in reported earnings in the same time period in 2009. Excluding a net benefit of US$1.7 billion from dispositions and an impairment, the company's April–June adjusted earnings still rose to US$2.5 billion, or US$1.67/share, up from US$980 million in adjusted earnings in the second quarter of 2009. Higher oil prices certainly boosted the company's financial performance, with revenues climbing from US$35.45 billion in the second quarter of 2009 to US$45.69 billion in the most recent quarter, but a greater focus on cost-cutting and efficiency was also of benefit.
ConocoPhillips: Q2 Financial and Operational Performance at a Glance | |||
Q2 2010 | Q2 2009 | % Change | |
Earnings | US$4.16 bil. | US$859 mil. | +484% |
Revenues | US$45.69 bil. | US$35.45 bil. | +28.9% |
Production* | 1.73 mil. boe/d | 1.87 mil. boe/d | -7.5% |
The company made more from less in the second quarter as well, as the firm's total hydrocarbon production dropped nearly 8% year-on-year (y/y), to 1.73 million barrels of oil equivalent per day (boe/d) in the second quarter (see table). Around 140,000 boe/d of this decrease was the result of normal field decline in North America, Norway, and the United Kingdom, while another 50,000 boe/d was offline due to planned maintenance at the Greater Ekofisk area in Norway and the full shutdown of Bayu-Undan and the Darwin LNG plant in Australia. New production of 75,000 boe/d from China, Canada, and Indonesia partially offset these decreases, however. Furthermore, the average price ConocoPhillips received for its oil production was 37% higher y/y, at US$71.09/b, while its average sale price for its gas production rose 22% y/y, to US$4.50 per 1,000 cf.
On the refining front, ConocoPhillips benefited in the second quarter from improved margins. The company noted that global refining market crack spreads improved by more than 15% y/y, adding that its refinery utilisation rate in the United States was 96% during the quarter, up from 93% during the April–June 2009 period. ConocoPhillips's international refinery utilisation rate dropped to 54% from 72%, primarily as a result of reduced runs at its Wilhelmshaven refinery in Germany, where the company also cancelled a planned upgrade and took a US$1.1-billion impairment. Nevertheless, ConocoPhillips's adjusted earnings for its refining and marketing segment stood at US$736 million for the quarter, up from a paltry US$20 million in adjusted earnings from the second quarter of 2009.
…Not Such a Great Return on Investment
Despite the strong financial quarter, there is surely a sense of regret at ConocoPhillips, as the company's results were inflated by sales of assets that the firm had previously acquired as part of its rapid expansion strategy. After announcing a dramatic shift in strategy last year to pull back by divesting some US$10 billion in assets, that strategy gained pace in the second quarter, as ConocoPhillips completed its disposition of CFJ and its stake in Syncrude, for which it garnered US$4.65 billion in a deal with China's Sinopec (see "Related Articles").
In another "glass half empty" example for ConocoPhillips, yesterday the company announced that it is indeed divesting its entire remaining stake in LUKoil. The U.S. firm said that it has reached a deal to sell LUKoil a 7.6% stake for US$3.44 billion, representing 40% of ConocoPhillips's stake in the Russian company, and that it plans to sell the remaining 60% of its stake in LUKoil on the open market or back to LUKoil itself by the end of 2011. The Russian oil company said that it plans to buy the 7.6% stake—equivalent to the shares of LUKoil that ConocoPhillips bought from the Russian government at a privatisation auction in September 2004 for US$1.98 billion—by 16 August. LUKoil, which is lining up a loan of at least US$600 million to supplement its own funds to repurchase its own shares, said that it also has the right to buy the remaining 11.6% stake of its own shares from ConocoPhillips by 26 September.
Divesting of its full stake in LUKoil is a smart financial move for ConocoPhillips, even if it highlights the overall failure of the strategic alliance between the two companies. The U.S. supermajor bought the initial block of shares in LUKoil from the Russian government, striking a concurrent deal with LUKoil to increase that shareholding to 20% and create a strategic alliance, but the hoped-for benefits of that partnership never really materialised. Certainly, ConocoPhillips benefited from around US$1 billion in dividends from the investment, and will probably reap net gains of around US$1.5–2 billion simply from the rise in the Russian company's market valuation from the time ConocoPhillips bought in until the time it sells its last shares, but overall it is a somewhat meagre return on its investment. Financially speaking, the deal is not exactly a failure, but it is hardly an outstanding success either.
Outlook and Implications
Strategically, however, the LUKoil experiment must be categorised as a failure for ConocoPhillips. The U.S. company joined the Russian frenzy already somewhat late, as—by September 2004—the door had already slammed shut on foreign investors after the formation of TNK-BP. Chevron and ExxonMobil had already been rebuffed in their negotiations to buy Yukos, and the destruction of the then-leading Russian oil producer had already been set in motion. ConocoPhillips opted to join the fray at the tail end of the party, but unlike BP, the U.S. company only managed to secure approval from Russian authorities (and from LUKoil's core shareholders) for a minority 20% stake in LUKoil.
What is more, ConocoPhillips failed to read the tea leaves in the changing dynamics of the Russian oil sector in the 2004–08 period. While other foreign oil companies were getting out, reducing their exposure in Russia, the U.S. company was busy increasing its investments, albeit via buying additional shares in LUKoil to raise its stake to 20%. ConocoPhillips made the assumption that it was protected from the wrath of Russian authorities via LUKoil, but where it fell down was in failing to understand that the rise of state-run Rosneft and Gazprom (and its oil division, Gazprom Neft) meant that LUKoil itself was effectively sidelined. The government's moves to tilt the playing fields in favour of state players not only left foreign companies on the outside looking in, but also put privately owned Russian companies like LUKoil (and TNK-BP, for that matter) at a disadvantage in bidding for new projects.
Hence, the strategic alliance envisioned when ConocoPhillips first partnered with LUKoil never really came into being. The Russian firm largely went its own way, focusing on its own international expansion as domestic projects in Russia became off-limits. LUKoil even ended up partnering with Norway's Statoil rather than ConocoPhillips in its winning bid earlier this year for the West Qurna-2 field in Iraq. The writing was on the wall well before ConocoPhillips committed to selling its LUKoil stake, and by divesting its shares in the Russian company, both ConocoPhillips and LUKoil may be better off; LUKoil may, ironically, have a better chance at securing new licences in Russia (partly because it will not have the awkward strategic U.S. investor onboard, but also because the Russian government is now moving to reduce the state role in the economy as the pendulum swings back). For ConocoPhillips, selling off its remaining LUKoil stake is not so much cutting its losses as it is enhancing its return on investment by putting its money to better use elsewhere—and recognising when a strategic alliance is not really an alliance at all.
Related Articles
- Australia: 11 June 2010: ConocoPhillips Considers Expansion of Darwin LNG Terminal in Australia
- Azerbaijan: 4 June 2010: SOCAR Signs New PSA; Azerbaijani Firm Readies for Talks with ConocoPhillips
- Indonesia: 12 May 2010: ConocoPhillips, Chevron Settle Gas Sales and Purchase Agreement in Indonesia
- World: 30 April 2010: ConocoPhillips Sees Profits Up in Q1, Asset Divestment Gathers Pace
- United Arab Emirates: 29 April 2010: ConocoPhillips Withdraws from Abu Dhabi's Shah Project in Blow to Emirate's Gas Strategy
- Vietnam: 22 April 2010: ConocoPhillips Withdraws from Block 133/134 Offshore Vietnam
- Canada - China: 13 April 2010: Sinopec Makes US$4.65-bil. Deal for Stake in Syncrude Canada
- World: 8 October 2009: ConocoPhillips Announces Dramatic Shift in Strategy
- Russia: 4 July 2005: LUKoil, ConocoPhillips Kick Off JV in Russian Arctic
- Russia: 30 September 2004: ConocoPhillips, LUKoil Announce Formation of Strategic Alliance