ConocoPhillips 10-K 2009
Documents found in this filing:
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
For the fiscal year ended December 31, 2008
For the transition period from to
Commission file number 001-32395
(Exact name of registrant as specified in its charter)
600 North Dairy Ashford
Houston, TX 77079
(Address of principal executive offices)
Registrants telephone number, including area code: 281-293-1000
Securities registered pursuant to Section 12(b) of the Act:
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. þ Yes o No
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. o Yes þ No
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. þ Yes o No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. þ
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act. (Check one):
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). o Yes þ No
The aggregate market value of common stock held by non-affiliates of the registrant on June 30, 2008, the last business day of the registrants most recently completed second fiscal quarter, based on the closing price on that date of $94.39, was $143.4 billion. The registrant, solely for the purpose of this required presentation, had deemed its Board of Directors and grantor trusts to be affiliates, and deducted their stockholdings of 741,761 and 42,397,731 shares, respectively, in determining the aggregate market value.
The registrant had 1,480,240,553 shares of common stock outstanding at January 31, 2009.
Documents incorporated by reference:
Portions of the Proxy Statement for the Annual Meeting of Stockholders to be held on May 13, 2009 (Part III)
TABLE OF CONTENTS
Unless otherwise indicated, the company, we, our, us and ConocoPhillips are used in this report to refer to the businesses of ConocoPhillips and its consolidated subsidiaries. Items 1 and 2, Business and Properties, contain forward-looking statements including, without limitation, statements relating to our plans, strategies, objectives, expectations and intentions that are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. The words forecast, intend, believe, expect, plan, schedule, target, should, goal, may, anticipate, estimate and similar expressions identify forward-looking statements. The company does not undertake to update, revise or correct any forward-looking information. Readers are cautioned that such forward-looking statements should be read in conjunction with the companys disclosures under the heading CAUTIONARY STATEMENT FOR THE PURPOSES OF THE SAFE HARBOR PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995, beginning on page 72.
Items 1 and 2. BUSINESS AND PROPERTIES
ConocoPhillips is an international, integrated energy company. ConocoPhillips was incorporated in the state of Delaware on November 16, 2001, in connection with, and in anticipation of, the merger between Conoco Inc. and Phillips Petroleum Company. The merger between Conoco and Phillips was consummated on August 30, 2002.
Our business is organized into six operating segments:
At December 31, 2008, ConocoPhillips employed approximately 33,800 people.
SEGMENT AND GEOGRAPHIC INFORMATION
For operating segment and geographic information, see Note 26Segment Disclosures and Related Information, in the Notes to Consolidated Financial Statements, which is incorporated herein by reference.
EXPLORATION AND PRODUCTION (E&P)
At December 31, 2008, our E&P segment represented 67 percent of ConocoPhillips total assets. This segment explores for, produces, transports and markets crude oil, natural gas, and natural gas liquids on a worldwide basis. It also mines deposits of oil sands in Canada to extract bitumen and upgrade it into a synthetic crude oil. Operations to liquefy natural gas and transport the resulting liquefied natural gas (LNG) are also included in the E&P segment. At December 31, 2008, our E&P operations were producing in the United States, Norway, the United Kingdom, Canada, Ecuador, Australia, offshore Timor-Leste in the Timor Sea, Indonesia, China, Vietnam, Libya, Nigeria, Algeria and Russia.
In October 2008, we closed on a transaction with Origin Energy to further enhance our long-term Australasian natural gas business. The 50/50 joint venture, named Australia Pacific LNG, will focus on coalbed methane production from the Bowen and Surat basins in Queensland, Australia, and LNG processing and export sales.
The E&P segment does not include the financial results or statistics from our equity investment in the ordinary shares of LUKOIL, which are reported in our LUKOIL Investment segment. As a result, references to results, production, prices and other statistics throughout the E&P segment discussion exclude amounts related to our investment in LUKOIL. However, our share of LUKOIL is included in the supplemental oil and gas operations disclosures on pages 147 through 166, as well as in the net proved reserves table shown below.
The information listed below appears in the supplemental oil and gas operations disclosures and is incorporated herein by reference:
The following table is a summary of the proved reserves information included in the supplemental oil and gas operations disclosures. Natural gas reserves are converted to BOE based on a 6:1 ratio: six thousand cubic feet of natural gas converts to one BOE.
In 2008, E&Ps worldwide production, including its share of equity affiliates production other than LUKOIL, averaged 1,767,000 barrels of oil equivalent per day (BOED), compared with the 1,857,000 averaged in 2007. During 2008, 775,000 BOED were produced in the United States, a decrease from 843,000 in 2007. Production from our international E&P operations averaged 992,000 BOED in 2008, a decrease compared with 1,014,000 in 2007. In addition, our Canadian Syncrude mining operations had net production of 22,000 barrels per day in 2008, compared with 23,000 in 2007. The change in worldwide production was primarily due to field decline and the expropriation of our Venezuelan oil interests, partially offset by production from new developments primarily in the United Kingdom, Indonesia, Russia, Norway and Canada.
E&Ps worldwide annual average crude oil sales price increased 39 percent, from $67.11 per barrel in 2007 to $93.12 in 2008. E&Ps average annual worldwide natural gas sales price increased 32 percent, from $6.26 per thousand cubic feet in 2007 to $8.27 in 2008.
In 2008, U.S. E&P operations contributed 44 percent of E&Ps worldwide liquids production and 43 percent of natural gas production, compared with 46 percent and 45 percent in 2007, respectively.
Greater Prudhoe Area
The Greater Prudhoe Area is composed of the Prudhoe Bay field and five satellite fields, as well as the Greater Point McIntyre Area fields. Prudhoe Bay, the largest oil field on Alaskas North Slope, is the site of a large waterflood and enhanced oil recovery operation, as well as a gas processing plant that processes and re-injects natural gas into the reservoir. Prudhoe Bays satellites include Aurora, Borealis, Polaris, Midnight Sun and Orion, while the Point McIntyre, Niakuk, Raven and Lisburne fields are part of the Greater Point McIntyre Area. We have a 36.1 percent nonoperator interest in all fields within the Greater Prudhoe Area. Net oil production from the Greater Prudhoe Area averaged 106,000 barrels per day in 2008, compared with 107,000 in 2007, while natural gas liquids production averaged 17,000 barrels per day in 2008, compared with 19,000 in 2007.
Greater Kuparuk Area
We operate the Greater Kuparuk Area, composed of the Kuparuk field and four satellite fields: Tarn, Tabasco, Meltwater and West Sak. Kuparuk is located about 40 miles west of Prudhoe Bay. Our ownership interest in the area is approximately 55 percent. Field installations include three central production facilities that separate oil, natural gas and water. The natural gas is either used for fuel or compressed for re-injection. Net oil production from the area averaged 67,000 barrels per day in 2008, compared with 74,000 in 2007.
Western North Slope
The Alpine field and its satellite fields, located west of the Kuparuk field, produced at a net rate of 70,000 barrels of oil per day in 2008, compared with 80,000 in 2007. We operate and hold a 78 percent interest in Alpine and its three satellites, the Nanuq, Fiord and Qannik fields. The Qannik field began production in July 2008.
Cook Inlet Area
Our assets include the North Cook Inlet field, the Beluga River field, and the Kenai LNG facility, all of which we operate. We have a 100 percent interest in the North Cook Inlet field, while we own 33.3 percent of the Beluga River field. Net production in 2008 from the Cook Inlet Area averaged 88 million cubic feet per day of natural gas, compared with 101 million in 2007. Production from the North Cook Inlet field is used primarily to supply our share of gas to the Kenai LNG plant and also as a backup supply to local utilities, while gas from the Beluga River field is primarily sold to local utilities and is used as backup supply to the Kenai LNG plant.
We have a 70 percent interest in the Kenai LNG plant, which supplies LNG to two utility companies in Japan. We sold 27 net billion cubic feet in 2008, compared with 31 billion in 2007. In June 2008, the U.S.
Department of Energy announced its approval of a two-year extension of the plants export license, extending it through March 2011.
We were the successful bidder on 98 blocks totaling $506 million in the February 2008 Chukchi Sea lease sale. During 2008, our primary area of exploratory drilling activity was in the National Petroleum Reserve-Alaska on the Western North Slope. Three wells were drilled in the area, and all three encountered hydrocarbons. One of the wells was expensed as a dry hole, and we are evaluating the potential for future development of the other two discoveries.
We transport the petroleum liquids produced on the North Slope to south-central Alaska through an 800-mile pipeline that is part of the Trans-Alaska Pipeline System (TAPS). We have a 28.3 percent ownership interest in TAPS, and we also have ownership interests in the Alpine, Kuparuk and Oliktok pipelines on the North Slope.
Our wholly owned subsidiary Polar Tankers, Inc. manages the marine transportation of our North Slope production, using five company-owned double-hulled tankers in addition to chartering third-party vessels as necessary.
During the second quarter of 2008, ConocoPhillips and BP plc formed a limited liability company to progress the pipeline project named DenaliThe Alaska Gas Pipeline. The project, which would move approximately 4 billion cubic feet per day of Alaska natural gas to North American markets, would consist of a gas treatment plant on Alaskas North Slope and a large-diameter pipeline through Alaska to Alberta, Canada. Should a new pipeline be required to transport gas from Alberta, the project also could include a large-diameter pipeline from Alberta to the U.S. Lower 48.
Denali announced plans to reach the first major project milestone before year-end 2010. This milestone is an open season, a process during which the pipeline company seeks customers to make long-term firm transportation commitments to the project. We expect Denali would seek certification from the Federal Energy Regulatory Commission (FERC) and the Canadian National Energy Board if the open season is successful, and thereafter move forward with project construction. Summer fieldwork related to the project began in late May 2008, primarily in eastern Alaska, and involved route reconnaissance and environmental studies. In late June 2008, the Denali project was approved to use FERCs prefiling process. There is a pipeline project competing with Denali that is structured under the Alaska Gasline Inducement Act.
U.S. Lower 48
Gulf of Mexico
At year-end 2008, our portfolio of producing properties in the Gulf of Mexico mainly consisted of one operated field and three fields operated by co-venturers, including:
Net production from our Gulf of Mexico properties averaged 18,000 barrels per day of liquids and 24 million cubic feet per day of natural gas in 2008, compared with 25,000 barrels per day and 36 million cubic feet per day in 2007.
Our 2008 onshore production principally consisted of natural gas, with the majority of production located in the San Juan Basin, Permian Basin, Lobo Trend, Bossier Trend, and panhandles of Texas and Oklahoma. We also have operations in the Wind River, Anadarko and Fort Worth basins, as well as in East Texas and northern
and southern Louisiana. Other onshore ownership includes properties in the Williston Basin, the Piceance Basin and the Cedar Creek Anticline.
The San Juan Basin, located in northwestern New Mexico and southwestern Colorado, includes the majority of our coalbed methane (CBM) production. Additionally, we continue to pursue development opportunities in three conventional formations in the San Juan Basin. Net production from San Juan averaged 48,000 barrels per day of liquids and 863 million cubic feet per day of natural gas in 2008, compared with 50,000 barrels per day and 971 million cubic feet per day in 2007.
In addition to our CBM production from the San Juan Basin, we also hold CBM acreage positions in the Uinta Basin in Utah, the Black Warrior Basin in Alabama, and the Piceance Basin in Colorado.
Onshore activities in 2008 were mostly centered on continued optimization and development of existing assets. Combined production from all Lower 48 onshore fields in 2008 averaged a net 1,970 million cubic feet per day of natural gas and 147,000 barrels per day of liquids, compared with 2,146 million cubic feet per day and 157,000 barrels per day in 2007.
In 2006, we acquired a 24 percent interest in West2East Pipeline LLC, a company holding a 100 percent interest in Rockies Express Pipeline LLC. Rockies Express is completing construction of a 1,679-mile natural gas pipeline from Colorado to Ohio that is expected to have an approximate capacity of 1.8 billion cubic feet per day. A section of the pipeline extending from Colorado to Missouri was placed in service in May 2008, and construction continues on the remaining portion of the pipeline project. Full pipeline service extending to Lebanon, Ohio, is expected by June 2009, while service to the final destination of Clarington, Ohio, is scheduled to begin by year-end 2009.
During 2008, we completed 122 gross onshore exploration wells. Most of the wells were located in the Bakken play in the Williston Basin, the Bossier Trend, and the Fort Worth Basin Barnett play, all of which are company focus areas. Other areas with active exploration drilling programs included the Anadarko Basin, Wyoming, Colorado and South Texas.
Gulf of Mexico deepwater leasehold acreage was expanded by successful bidding at federal offshore lease sales in March and August 2008, with high bids totaling $334 million, adding 22 new blocks. At year end we had interests in 267 lease blocks totaling 1.1 million net acres. During 2008, we completed two successful appraisal wells and participated in four deepwater exploration wells. Three of the exploration wells were expensed as dry holes, and operations on one well continued into 2009.
In 2008, E&P operations in Europe contributed 24 percent of E&Ps worldwide liquids production, compared with 22 percent in 2007. European operations contributed 20 percent of natural gas production in 2008, compared with 19 percent in 2007. Our European assets are principally located in the Norwegian and U.K. sectors of the North Sea.
We operate and hold a 35.1 percent interest in the Greater Ekofisk Area, located approximately 200 miles offshore Norway in the center of the North Sea. The Greater Ekofisk Area is composed of four producing fields: Ekofisk, Eldfisk, Embla and Tor. Net production in 2008 from the Greater Ekofisk Area was 99,000 barrels of liquids per day and 100 million cubic feet of natural gas per day, compared with 103,000 barrels per day and 103 million cubic feet per day in 2007.
We also have varying ownership interests in other producing fields in the Norwegian sector of the North Sea and in the Norwegian Sea, including:
Net production from these and other fields in the Norwegian sector of the North Sea and the Norwegian Sea averaged 68,000 barrels of liquids per day and 139 million cubic feet of natural gas per day in 2008, compared with 67,000 barrels per day and 133 million cubic feet per day in 2007.
The Alvheim North Sea development achieved first production in June 2008 through a floating production, storage and offloading (FPSO) vessel and subsea installations. At year-end 2008, Alvheim was producing at a net rate of 16,000 barrels per day of liquids and 7 million cubic feet per day of natural gas. Net peak production of 18,000 barrels per day of liquids and 9 million cubic feet per day of natural gas is expected in the second quarter of 2009.
We have interests in the transportation and processing infrastructure in the Norwegian sector of the North Sea, including interests in the Norpipe Oil Pipeline System and in Gassled, which owns most of the Norwegian gas transportation system.
We participated in seven exploration wells during 2008, with five of the wells encountering hydrocarbons. Two gas discoveries were made in the PL218 license, and two others were made in the Oseberg area. A discovery was also made on the East Flank of the Visund field, and operations in this well continued into 2009. In late 2008, we were awarded two Norway exploration licenses, both in the central North Sea.
In addition to our 58.7 percent interest in the Britannia natural gas and condensate field, we own 50 percent of Britannia Operator Limited, the operator of the field. Net production from Britannia and its satellite fields averaged 277 million cubic feet of natural gas per day and 24,000 barrels of liquids per day in 2008, compared with 252 million cubic feet per day and 10,000 barrels per day in 2007. We achieved first production from two Britannia satellites, Callanish and Brodgar, in June and July 2008, respectively. We have a respective 83.5 percent interest and a 75 percent interest in these satellite fields.
We operate and hold a 36.5 percent interest in the Judy/Joanne fields, which together make up J-Block. Additionally, our operated Jade field, in which we hold a 32.5 percent interest, produces from a wellhead platform and pipeline tied to J-Block facilities. Together, these fields produced a net 13,000 barrels of liquids per day and 88 million cubic feet of natural gas per day in 2008, compared with 14,000 barrels per day and 94 million cubic feet per day in 2007.
Our various ownership interests in 18 producing gas fields in the Rotliegendes and Carboniferous areas of the southern North Sea yielded average net production in 2008 of 241 million cubic feet per day of natural gas, compared with 276 million in 2007.
We also have ownership interests in several other producing fields in the U.K. sector of the North Sea, including:
Production from these and other remaining fields in the U.K. sector of the North Sea averaged a net 17,000 barrels of liquids per day and 14 million cubic feet of natural gas per day in 2008, compared with 20,000 barrels per day and 15 million cubic feet per day in 2007.
In the Atlantic Margin, we have a 24 percent interest in the Clair field. Net production in 2008 averaged 11,000 barrels of liquids per day, compared with 7,000 in 2007.
The Millom, Dalton and Calder fields in the East Irish Sea, in which we have a 100 percent ownership interest, are operated on our behalf by a third party. Net production in 2008 averaged 43 million cubic feet of natural gas per day, compared with 36 million in 2007.
The Interconnector pipeline, linking the United Kingdom and Belgium, facilitates marketing natural gas produced in the United Kingdom throughout Europe. Our 10 percent equity share allows us to ship approximately 200 million cubic feet of natural gas per day to markets in continental Europe, and our reverse-flow rights provide an 85 million cubic feet per day import capability into the United Kingdom.
We operate the Teesside oil and Theddlethorpe gas terminals, in which we have 29.3 percent and 50 percent ownerships, respectively. We also have a 100 percent ownership interest in the Rivers Gas Terminal, operated by a third party, in the United Kingdom.
During 2008 we were awarded interests in three exploration licenses: two in the central North Sea and one in the West of Shetland region. We also participated in three appraisal wells and three exploration wells in the Southern Gas Basin, central North Sea and the West of Shetland region, with four of the wells encountering hydrocarbons. Three of these six wells were drilled in the proximity of the Jasmine discovery and confirmed the viability of that project.
Our varying nonoperator production interests in the Dutch sector of the North Sea, as well as interests in offshore pipelines and an onshore gas plant and terminal at Den Helder, were sold in December 2008. Net production in 2008 averaged 50 million cubic feet of natural gas per day, compared with 52 million in 2007.
In 2008, E&P operations in Canada contributed 8 percent of E&Ps worldwide liquids production (excluding Syncrude production), compared with 7 percent in 2007. Canadian operations contributed 22 percent of E&Ps worldwide natural gas production in 2008 and 2007.
Oil and Gas Operations
Operations in western Canada encompass properties throughout Alberta, northeastern British Columbia, and southern Saskatchewan. Net production from these oil and gas operations in western Canada averaged 44,000 barrels per day of liquids and 1,054 million cubic feet per day of natural gas in 2008, compared with 46,000 barrels per day and 1,106 million cubic feet per day in 2007.
We operate and have a 50 percent interest in the Surmont oil sands lease, located approximately 35 miles south of Fort McMurray, Alberta. The Surmont project uses an enhanced thermal oil recovery method called steam-assisted gravity drainage (SAGD). Steam injection began in the second quarter of 2007, and first production was achieved in the fourth quarter of 2007. Average net production of bitumen from Surmont during 2008 was 6,000 barrels per day, and the 2008 average sales price was $46.85 per barrel. Net peak production of 13,000 barrels per day is expected in 2013.
On January 3, 2007, we closed on a business venture with EnCana Corporation to create an integrated North American heavy oil business. The venture consists of two 50/50 business ventures: a Canadian upstream general partnership, the FCCL Oil Sands Partnership, and a U.S. downstream limited liability company, WRB Refining LLC. FCCLs operating assets consist of the Foster Creek and Christina Lake SAGD bitumen projects, both located in the eastern flank of the Athabasca oil sands in northeastern Alberta. EnCana is the operator and managing partner of FCCL. With Christina Lake phase 1B becoming operational in mid-2008 and the continuing ramp-up of Foster Creek phase C, our share of FCCLs production increased to 30,000 barrels per day in 2008, compared with 27,000 in 2007. Foster Creek phases D and E are expected to add additional production of more than 20,000 net barrels per day combined and are expected to become operational in early 2009. The average sales price realized on FCCLs 2008 production was $58.54 per barrel. See the Refining and Marketing (R&M) section for information on WRB.
Parsons Lake/Mackenzie Gas Project
We are working with three other energy companies, as members of the Mackenzie Delta Producers Group, on the development of the Mackenzie Valley pipeline and gathering system, which is proposed to transport onshore gas production from the Mackenzie Delta in northern Canada to established markets in North America. We have a 75 percent interest in the Parsons Lake gas field, one of the primary fields in the Mackenzie Delta that would anchor the pipeline development. The Joint Review Panel (JRP), an independent body appointed by the Minister of Environment to evaluate the potential impacts of the project on the environment and lives of the people in the project area, completed public hearings in November 2007. The JRP issued a press release in December 2008, indicating a report assessing the environmental and socio-economic impact of the proposed project would be released in December 2009. The pipeline project awaits the JRP report and will continue to progress toward regulatory authorizations, but it has deferred detailed engineering work pending resolution with the federal government on the fiscal and commercial framework.
We hold exploration acreage in four areas of Canada: western Canada, offshore eastern Canada, the Mackenzie Delta/Beaufort Sea region, and the Arctic Islands. In 2008, the company added 62,000 acres in the Horn River play in western Canada and acquired two additional Beaufort licenses. Within western Canada, we participated in 43 exploratory wells.
Syncrude Canada Ltd.
We own a 9 percent interest in the Syncrude Canada Ltd. (SCL) joint venture, created for the purpose of mining shallow deposits of oil sands, extracting the bitumen, and upgrading it into a light sweet crude oil called Syncrude. The primary plant and facilities are located at Mildred Lake, about 25 miles north of Fort McMurray, Alberta. SCL, as operator of the joint venture, holds eight oil sands leases and the associated surface rights, of which our share is approximately 22,400 net acres. Net production averaged 22,000 barrels per day in 2008, compared with 23,000 in 2007.
U.S. Securities and Exchange Commission regulations currently in effect define the Syncrude project as mining-related and not part of conventional oil and gas operations. As such, Syncrude operations are not included in our proved oil and gas reserves or production as reported in our supplemental oil and gas information.
In 2008, E&P operations in South America contributed 1 percent of E&Ps worldwide liquids production, compared with 5 percent in 2007.
Petrozuata, Hamaca and Corocoro
On June 26, 2007, we announced we had been unable to reach agreement with respect to our migration to an empresa mixta structure mandated by the Venezuelan governments Nationalization Decree. In response, Venezuelas national oil company, Petróleos de Venezuela S.A. (PDVSA), or its affiliates directly assumed the activities associated with and control over ConocoPhillips interests in the Petrozuata and Hamaca heavy oil ventures and the offshore Corocoro development project.
Plataforma Deltana Block 2
We have a 40 percent nonoperated interest in Plataforma Deltana Block 2 which holds a gas discovery made by PDVSA. Several critical components required to progress an investment decision have not yet been defined by the govenment.
At year-end 2008, we held ownership interests in five exploration blocks in Peru. Two 2D seismic programs were carried out during the year in Blocks 39 and 104, and the sale of Block 57 was completed in the second quarter of the year. In the fourth quarter of 2008, we completed an appraisal well in Block 39, but the well did not confirm a stand-alone commercial hydrocarbon accumulation. The appraisal well and suspended discovery well were expensed as dry holes.
In Ecuador, we own a 42.5 percent interest in Block 7 and a 46.3 percent interest in Block 21. Net production in 2008 averaged 9,000 barrels of crude oil per day, compared with 10,000 in 2007.
We sold our assets in Argentina in September 2008.
In 2008, E&P operations in the Asia Pacific region contributed 11 percent of E&Ps worldwide liquids production and 13 percent of natural gas production, compared with 10 percent and 11 percent in 2007, respectively.
Australia and Timor Sea
Australia Pacific LNG
In October 2008, we closed on a transaction with Origin Energy, an integrated Australian energy company, to further enhance our long-term Australasian natural gas business. The 50/50 joint venture, named Australia Pacific LNG, will focus on coalbed methane (CBM) production from the Bowen and Surat basins in Queensland, Australia, and LNG processing and export sales. With this transaction, we gained access to CBM resources in Australia and will enhance our LNG position with the expected creation of an additional LNG hub targeting Asia Pacific markets. Four LNG trains are anticipated, each currently expected to process an estimated 3.5 million gross tons of LNG per year. An estimated 20,500 gross wells are ultimately envisioned to supply both the domestic gas market and the LNG development. Drilling and production operations will be supported by gas gathering systems and centralized gas processing and compression stations, as well as by dewatering and water treatment facilities.
Our share of the joint ventures year-end production rate was 68 million cubic feet per day. Current production is sold into the Australian domestic market. CBM field development work is ongoing in parallel with front-end engineering associated with the planned LNG processing facilities.
We operate and hold a 57.2 percent ownership interest in the Bayu-Undan field located in the Timor Sea. The field averaged a net production rate of 36,000 barrels of liquids per day in 2008, compared with 34,000 in 2007. Our share of natural gas production was 210 million cubic feet per day in 2008, compared with 189 million in 2007. Produced natural gas is used to supply the Darwin LNG plant, of which we own a 57.2 percent interest. In 2008, we sold 159 billion gross cubic feet of LNG to utility customers in Japan, compared with 140 billion in 2007.
We have a 30 percent interest in the Greater Sunrise gas and condensate field located in the Timor Sea. Although agreement has been reached between the governments of Australia and Timor-Leste concerning sharing of revenues from the anticipated development of Greater Sunrise, key challenges to be resolved before significant funding commitments can be made include ensuring the reservoir is adequately appraised, gaining co-venturer and government alignment on the development concept, and establishing fiscal stability arrangements. Immediate activity is focused on reprocessing seismic data and integrating the results of an appraisal well to define the remaining appraisal program, as well as advancing the development concept screening phase.
In 2008, our share of production from the Athena/Perseus (WA-17-L) gas field, located offshore Western Australia, was 35 million cubic feet of natural gas per day, compared with 34 million in 2007.
In November 2008, we acquired 50 percent interests in two permits in the Arafura Basin, offshore Northern Territory. In the Bonaparte Basin, we drilled one successful appraisal well at the Sunrise field. Additionally, seismic processing from the NT/P69 and the NT/P61 permits was completed, and interpretation of this data is currently under way to further evaluate the Caldita and Barossa discoveries.
The company also operates the WA-314-P, WA-315-P and WA-398-P permits in the Browse Basin. During 2008, acquisition and processing of seismic data in WA-398-P was completed. An exploration drilling campaign will be conducted in these permits during 2009.
We operate seven production sharing contracts (PSCs) in Indonesia. Production from Indonesia in 2008 averaged a net 343 million cubic feet per day of natural gas and 15,000 barrels per day of oil, compared with 330 million cubic feet per day and 12,000 barrels per day in 2007. Our assets are concentrated in two core areas: the West Natuna Sea and onshore South Sumatra.
We operate four offshore PSCs: South Natuna Sea Block B, Amborip VI, Kuma and Arafura Sea. The South Natuna Sea Block B PSC, in which we have a 40 percent interest, has two producing oil fields and 16 gas fields in various stages of development.
We operate three onshore PSCs. Corridor and South Jambi B are in South Sumatra, and Warim is in Papua. As part of the Corridor PSC, in which we have a 54 percent interest, we operate six oil fields and six natural gas fields, and supply natural gas from the Grissik and Suban gas processing plants to the Duri steamflood in central Sumatra and to markets in Singapore, Batam and West Java. We have a 45 percent interest in the South Jambi B PSC, a shallow gas project that supplies natural gas to Singapore.
We are a 35 percent owner of a consortium company that has a 40 percent ownership in PT Transportasi Gas Indonesia, which owns and operates the Grissik to Duri and Grissik to Singapore natural gas pipelines.
In November 2008, we acquired the Arafura Sea Block, and a 2D seismic survey was completed on the block by year end. One appraisal well was drilled at the South Belut field, and one appraisal well and one exploration well were drilled at the North Belut field.
Production related to our 49 percent share of the Peng Lai 19-3 field in Bohai Bay Block 11-05 averaged 14,000 barrels of oil per day in 2008, compared with 10,000 in 2007. We also hold a 49 percent interest in the nearby Peng Lai 25-6 field. An FPSO vessel to accommodate production from both fields is expected to be installed in early 2009. Concurrent development of both fields continues.
The Xijiang development consists of two fields located approximately 80 miles south of Hong Kong in the South China Sea. Our ownership in these fields ranges from 12.3 percent to 24.5 percent. Facilities include two manned platforms and an FPSO vessel. Combined net production of oil from the Xijiang fields averaged 7,000 barrels per day in 2008, compared with 8,000 in 2007.
We have a 24.5 percent interest in the offshore Panyu field, also located in the South China Sea, which produced 12,000 net barrels of oil per day in 2008 and 13,000 in 2007. In July 2008, we sold our 100 percent interest in the onshore Ba Jiao Chang natural gas field.
Our ownership interest in Vietnam is centered around the Cuu Long Basin in the South China Sea and consists of two primarily oil-producing blocks, four exploration blocks, and one gas pipeline transportation system.
We have a 23.3 percent interest in Block 15-1 in the Cuu Long Basin. Net production in 2008 was 13,000 barrels of oil per day, compared with 14,000 in 2007. The oil is processed through a 1-million-barrel FPSO vessel and through the Su Tu Vang central processing platform and new floating storage and offloading (FSO) vessel. First oil production from the Su Tu Vang satellite field was achieved in October 2008.
Also in the Cuu Long Basin, we have a 36 percent interest in the Rang Dong field in Block 15-2. All wellhead platforms produce into an FSO vessel. Net production in 2008 was 9,000 barrels per day of liquids and 16 million cubic feet per day of natural gas, compared with 8,000 barrels per day and 15 million cubic feet per day in 2007.
We own a 16.3 percent interest in the Nam Con Son natural gas pipeline. This 244-mile transportation system links gas supplies from the Nam Con Son Basin to gas markets in southern Vietnam.
In 2008, we drilled one exploration well in Block 15-1 that was expensed as a dry hole.
We have interests in three deepwater PSCs located off the eastern Malaysian state of Sabah: Block G, Block J, and the Kebabangan Cluster. Development of the Gumusut discovery in Block J continues.
In 2008, we completed two successful appraisal wells in Block G to evaluate the prior Ubah and Petai discoveries. Kebabangan and Malikai, a Block G discovery, are moving toward field development.
E&PMIDDLE EAST AND AFRICA
During 2008, E&P operations in the Middle East and Africa contributed 8 percent of E&Ps worldwide liquids production and 2 percent of natural gas production, the same as in 2007.
Qatargas 3 is an integrated project jointly owned by Qatar Petroleum (68.5 percent), ConocoPhillips (30 percent) and Mitsui & Co., Ltd. (1.5 percent). The project comprises upstream natural gas production facilities to produce approximately 1.4 billion gross cubic feet per day of natural gas from Qatars North field. The project also includes a 7.8-million-gross-ton-per-year LNG facility, from which LNG will be shipped in
new LNG carriers destined for sale in the United States and other markets. The first LNG cargoes are expected to be loaded in the fourth quarter of 2010.
In order to capture cost savings, Qatargas 3 is executing the development of the onshore and offshore assets as a single integrated project with Qatargas 4, a joint venture between Qatar Petroleum and Royal Dutch Shell plc. This includes the joint development of offshore facilities situated in a common offshore block in the North field, as well as the construction of two identical LNG process trains and associated gas treating facilities for both the Qatargas 3 and Qatargas 4 joint ventures. Upon completion of the Qatargas 3 and Qatargas 4 projects, production from the LNG plant and associated facilities will be combined and shared.
We have a 12.4 percent ownership interest in the Golden Pass LNG regasification facility and associated pipeline. The facilities are currently being constructed on the Sabine-Neches Industrial Ship Channel northwest of Sabine Pass, Texas. Subject to the negotiation of definitive agreements, ConocoPhillips will also secure capacity rights in the regasification terminal and pipeline to manage the LNG we will purchase from Qatargas 3. In addition to the United States, other market alternatives for Qatargas 3 LNG production are being pursued. Despite sustaining some damage during Hurricane Ike, the Golden Pass LNG terminal is expected to be operational in time to receive the first cargoes of Qatargas 3 production.
ConocoPhillips holds a 16.3 percent interest in the Waha concessions in Libya, which encompass nearly 13 million gross acres. Net oil production averaged 47,000 barrels per day in 2008 and 2007.
During 2008, we produced from four onshore Oil Mining Leases (OMLs), in which we have a 20 percent nonoperator interest. Net production from these leases was 21,000 barrels of liquids per day and 105 million cubic feet of natural gas per day in 2008, compared with 19,000 barrels per day and 117 million cubic feet per day in 2007.
We have a 20 percent interest in a 480-megawatt gas-fired power plant in Kwale, Nigeria, which supplies electricity to Nigerias national electricity supplier. In 2008, the plant consumed 11 million net cubic feet per day of natural gas sourced from our proved reserves in the OMLs.
We have a 17 percent equity interest in Brass LNG Limited, which plans to construct an LNG facility in the Niger Delta.
We drilled an exploration well in block OPL214 that did not confirm commercial quantities of hydrocarbons and was expensed as a dry hole. Development planning activities for the prior Uge discovery in the same block continue. In the fourth quarter of 2007, we assigned our interest in OPL248 to a co-venturer. This assignment was formally acknowledged by the Nigerian government in the third quarter of 2008.
In July 2008, we signed an Interim Agreement with the Abu Dhabi National Oil Company (ADNOC) to develop the Shah gas field in Abu Dhabi. This large-scale project involves the development of natural gas condensate reservoirs within the onshore Shah gas field, the construction of a new 1-billion-cubic-feet-per-day natural gas processing plant at Shah, new natural gas and liquid pipelines, and sulfur-exporting facilities at Ruwais. ADNOC would have a 60 percent interest and we would have a 40 percent interest in the project. We are currently working on final project agreements with ADNOC.
We have interests in three fields in Block 405a: the Menzel Lejmat North field, the Ourhoud field, and the development stage El Merk (EMK) oil field unit. Net production from these fields averaged 13,000 barrels of oil per day in 2008, compared with 11,000 in 2007.
E&PRUSSIA AND CASPIAN
We have a 50 percent equity interest in Polar Lights Company, an entity created to develop fields in the Timan-Pechora Basin in northern Russia. Net production averaged 11,000 barrels of oil per day in 2008, compared with 12,000 in 2007.
We have a 30 percent ownership interest with a 50 percent governance interest in OOO Naryanmarneftegaz (NMNG), a joint venture with LUKOIL. NMNG is working to develop resources in the northern part of Russias Timan-Pechora province, including the Yuzhno Khylchuyu (YK) field. Initial production from YK was achieved in June 2008, with the field producing at a net rate of 24,000 barrels of oil per day at year end. Net peak production of 45,000 barrels per day is expected to be reached in the second quarter of 2009. Production from the NMNG joint venture fields is transported via pipeline to LUKOILs terminal at Varandey Bay on the Barents Sea and then shipped via tanker to international markets. Late in the second quarter of 2008, LUKOIL completed an expansion of the terminals gross oil-throughput capacity from 30,000 barrels per day to 240,000 barrels per day to accommodate production from the YK field.
In the Caspian Sea, we have an interest in the Republic of Kazakhstans North Caspian Sea Production Sharing Agreement (NCSPSA), which includes the Kashagan field. The first phase of field development currently being executed includes construction of artificial drilling islands with processing facilities and living quarters, and pipelines to carry production onshore. First production is expected in the latter part of 2012. The initial production phase of the contract is for 20 years, with options to extend the agreement an additional 20 years.
In 2004, the Republic of Kazakhstan approved the submitted development plan and budget relating to the Kashagan oil field development and, in 2007, triggered dispute proceedings under the NCSPSA following submission of a revised development plan and budget reflecting Kashagan cost increases and schedule delays. Definitive agreements were signed October 31, 2008, resolving the Kashagan field development dispute and allowing Kazakhstans state-owned energy company, JSC National Company KazMunayGas, to increase its ownership interest from 8.33 percent to 16.81 percent. As a result, our interest in the NCSPSA was reduced from 9.26 percent to 8.40 percent, effective January 1, 2008. We will receive our share of the purchase price plus accrued interest in three annual installments beginning from the date of first commercial production. In addition, a new joint operating company, with significant involvement from the owners, was established and will operate future phases of Kashagan. We will have seconded employees in the joint operating company.
We have a 2.5 percent interest in the Baku-Tbilisi-Ceyhan (BTC) pipeline, which transports crude oil from the Caspian region through Azerbaijan, Georgia and Turkey for tanker loadings at the port of Ceyhan.
In October 2008, we signed a Memorandum of Understanding to negotiate terms for the exploration and development of the N Block, located offshore Kazakhstan, under a new subsoil use contract. Subsequently, in December 2008, we signed a Heads of Agreement that would give us a 24.5 percent interest in the exploration and development of the N Block. In addition, development studies continue for the next phase of Kashagan and the satellite fields of Kalamkas, Kairan and Aktote.
We have a long-term agreement with Freeport LNG Development, L.P. to use 0.9 billion cubic feet per day of regasification capacity at Freeports 1.5-billion-cubic-feet-per-day LNG receiving terminal in Quintana, Texas. The terminal became operational late in the second quarter of 2008. In order to deliver natural gas from the Freeport terminal to market, we constructed a 32-mile, 42-inch pipeline from the Freeport terminal to a point near Iowa Colony, Texas. Construction was completed in the second quarter of 2008 to coincide with the
Freeport terminal startup. Due to present market conditions, which favor the flow of LNG to European and Asian markets, our near-to-mid-term utilization of the Freeport terminal is expected to be limited. We are responsible for monthly process-or-pay payments to Freeport irrespective of whether we utilize the terminal for regasification. The financial impact of this capacity underutilization is not expected to be material to our future earnings or cash flows.
We received planning permission in 2008 for an LNG regasification facility and combined heat and power plant at the existing Norsea Pipeline Limited oil terminal site at Teesside, United Kingdom.
Our Commercial organization optimizes the commodity flows of our E&P segment. This group markets our crude oil and natural gas production, using commodity buyers, traders and marketers in offices in the United States, the United Kingdom, Singapore, Canada and Dubai.
We have not filed any information with any other federal authority or agency with respect to our estimated total proved reserves at December 31, 2008. No difference exists between our estimated total proved reserves for year-end 2007 and year-end 2006, which are shown in this filing, and estimates of these reserves shown in a filing with another federal agency in 2008.
We sell crude oil and natural gas from our E&P producing operations under a variety of contractual arrangements, some of which specify the delivery of a fixed and determinable quantity. Our Commercial organization also enters into natural gas sales contracts where the source of the natural gas used to fulfill the contract can be the spot market or a combination of our reserves and the spot market. Worldwide, we are contractually committed to deliver approximately 6 trillion cubic feet of natural gas and 119 million barrels of crude oil in the future, including approximately 800 billion cubic feet related to the minority interests of consolidated subsidiaries. These contracts have various expiration dates through the year 2025. We expect to fulfill the majority of these delivery commitments with proved developed reserves. In addition, we anticipate using proved undeveloped reserves and spot market purchases to fulfill these commitments. See the disclosure on Proved Undeveloped Reserves in Managements Discussion and Analysis of Financial Condition and Results of Operations, for information on the development of proved undeveloped reserves.
At December 31, 2008, our Midstream segment represented 1 percent of ConocoPhillips total assets. Our Midstream business is primarily conducted through our 50 percent equity investment in DCP Midstream, LLC, a joint venture with Spectra Energy.
The Midstream business purchases raw natural gas from producers and gathers natural gas through extensive pipeline gathering systems. The gathered natural gas is then processed to extract natural gas liquids. The remaining residue gas is marketed to electrical utilities, industrial users and gas marketing companies. Most of the natural gas liquids are fractionatedseparated into individual components like ethane, butane and propaneand marketed as chemical feedstock, fuel or blendstock. Total natural gas liquids extracted in 2008, including our share of DCP Midstream, were 188,000 barrels per day, compared with 211,000 in 2007.
DCP Midstream markets a portion of its natural gas liquids to ConocoPhillips and Chevron Phillips Chemical Company LLC under a supply agreement that continues until December 31, 2014. This purchase commitment is on an if-produced, will-purchase basis and so has no fixed production schedule, but has had, and is expected over the remaining term of the contract to have, a relatively stable purchase pattern. Under the agreement, natural gas liquids are purchased at various published market index prices, less transportation and fractionation fees.
DCP Midstream is headquartered in Denver, Colorado. At December 31, 2008, DCP Midstream owned or operated 53 natural gas liquids extraction and 10 natural gas liquids fractionation plants, and its gathering and transmission systems included approximately 60,000 miles of pipeline. In 2008, DCP Midstreams raw natural gas throughput averaged 6.2 billion cubic feet per day, and natural gas liquids extraction averaged 360,000 barrels per day, compared with 5.9 billion cubic feet per day and 363,000 barrels per day in 2007. DCP Midstreams assets are primarily located in the following producing regions of the United States: Rocky Mountains, Midcontinent, Permian, East Texas/North Louisiana, South Texas, Central Texas, and Gulf Coast.
Outside of DCP Midstream, our U.S. natural gas liquids business included the following as of year-end 2008:
We also own a 39 percent equity interest in Phoenix Park Gas Processors Limited, a joint venture principally with the National Gas Company of Trinidad and Tobago Limited. Phoenix Park processes natural gas in Trinidad and markets natural gas liquids in the Caribbean, Central America and the U.S. Gulf Coast. Its facilities include a 1.35-billion-cubic-feet-per-day gas processing plant and a 70,000-barrel-per-day natural gas liquids fractionator. A third gas processing train is currently under construction and, when complete in 2009, will bring Phoenix Parks total processing capacity to 2 billion cubic feet per day. Our share of natural gas liquids extracted averaged 8,000 barrels per day in 2008 and 2007. Our share of fractionated liquids averaged 14,000 barrels per day in 2008, compared with 13,000 in 2007.
REFINING AND MARKETING (R&M)
At December 31, 2008, our R&M segment represented 24 percent of ConocoPhillips total assets. R&M operations encompass refining crude oil and other feedstocks into petroleum products (such as gasolines, distillates and aviation fuels); buying, selling and transporting crude oil; and buying, transporting, distributing and marketing petroleum products. R&M has operations in the United States, Europe and the Asia Pacific region. The R&M segment does not include the results or statistics from our equity investment in LUKOIL, which are reported in our LUKOIL Investment segment.
Our Commercial organization optimizes the commodity flows of our R&M segment. This organization procures feedstocks for R&Ms refineries, facilitates supplying a portion of the gas and power needs of the R&M facilities, supplies petroleum products to our marketing operations, and markets petroleum products directly to third parties. Commercial has buyers, traders and marketers in offices in the United States, the United Kingdom, Singapore, Canada and Dubai.
At December 31, 2008, we owned or had an interest in 12 operated refineries in the United States.
Primary crude oil characteristics and sources of crude oil for our U.S. refineries are as follows:
Capacities for and yields of clean products, as well as other products produced, relating to our U.S. refineries are as follows:
ConocoPhillips has a 50 percent interest in Merey Sweeny, L.P. (MSLP), a limited partnership that owns a 70,000-barrel-per-day delayed coker and related facilities at the Sweeny refinery that produce fuel-grade petroleum coke. Petróleos de Venezuela S.A. (PDVSA), which owns the other 50 percent interest, supplies the refinery with heavy, high-sulfur crude oil. We are the operator and managing partner. Late in 2008, PDVSA notified us that January 2009 nominated crude oil supplies for MSLP would not be delivered due to Venezuelan government-ordered production reductions. Similar notifications have been received for nominated supplies for February and March. We processed alternative crude oils at MSLP during January. Late in January, MSLP entered into a planned turnaround, which will continue into March 2009.
On January 3, 2007, we closed on a business venture with EnCana Corporation to create an integrated North American heavy oil business. The venture consists of two 50/50 business ventures: a Canadian upstream general partnership, the FCCL Oil Sands Partnership, and a U.S. downstream limited liability company, WRB Refining LLC. WRB consists of the Wood River and Borger refineries, located in Roxana, Illinois, and Borger, Texas, respectively. We are the operator and managing partner of WRB. For the Wood River refinery, operating results are shared 50/50. For the Borger refinery, we were entitled to 65 percent of the operating results in 2008, with our share decreasing to 50 percent in all years thereafter. See the Exploration and Production (E&P) section for additional information on FCCL.
Since formation, the joint venture has expanded the processing capability of heavy Canadian crude to 95,000 barrels per day from 60,000 barrels per day with the startup of a coker at Borger in 2007. In addition, during 2008, the final permit was received and plans were progressed to expand the Wood River refinery, including the installation of a coker. With the completion of this project, anticipated in 2011, total processing capability of heavy Canadian or similar crudes at Wood River will increase to 225,000 barrels per day, and existing asphalt production at the refinery will be replaced with production of upgraded products.
In 2008, capital was directed toward projects to meet environmental and air emission standards and to further improve the operating reliability, safety and energy efficiency of processing units. In addition, capital was spent for small projects that are expected to yield an incremental return through providing improvements in overall transportation fuel yields and product mix.
Significant projects during 2008 included progressing an expansion of a hydrocracker at the Rodeo facility of our San Francisco refinery. When complete in 2009, this project is expected to increase clean product yield at the refinery. We also installed wet gas scrubbers at our Los Angeles and Ponca City refineries in order to improve air emissions from those plants. Another project completed during the year was a coker upgrade at our Los Angeles refinery, which improved the yield of transportation fuels.
In the United States as of December 31, 2008, R&M marketed gasoline, diesel and aviation fuel through approximately 8,340 outlets in 49 states. The majority of these sites utilize the Phillips 66, Conoco or 76 brands.
At December 31, 2008, our wholesale operations utilized a network of marketers operating approximately 7,270 outlets that provided refined product offtake from our refineries, including Borger and Wood River. A strong emphasis is placed on the wholesale channel of trade because of its lower capital requirements. We also buy and sell petroleum products in the spot market. Our refined products are marketed on both a branded and unbranded basis.
In addition to automotive gasoline and diesel, we produce and market aviation gasoline, which is used by smaller, piston engine aircraft. At December 31, 2008, aviation gasoline and jet fuel were sold through independent marketers at approximately 630 Phillips 66-branded locations in the United States.
At December 31, 2008, our retail operations consisted of approximately 330 owned and operated sites under the Conoco, Phillips 66 and 76 brands. Company-operated retail operations were focused in 10 states, mainly in the Midcontinent, Rocky Mountain and West Coast regions. Most of these outlets marketed merchandise through the Kicks or Circle K brand convenience stores.
At December 31, 2008, CFJ Properties, our 50/50 joint venture with Flying J, owned and operated approximately 110 truck travel plazas that carry the Conoco, Flying J or both brands. Flying J filed for Chapter 11 bankruptcy protection in December 2008. Flying J continues to operate the CFJ properties jointly owned with ConocoPhillips.
In December 2006, we announced our U.S. company-owned and company-operated retail outlets and our U.S. company-owned and dealer-operated retail outlets would be divested to new or existing wholesale marketers. Approximately 830 sites were included in the held for sale plans. About 620 sites have been sold, including approximately 390 outlets sold in January 2009. The remaining sites included in the original disposition plan are also expected to be sold in 2009.
We distribute refined products to our customers via company-owned and common-carrier pipeline, barge, railcar and truck.
Pipelines and Terminals
At December 31, 2008, R&M had approximately 28,000 miles of common-carrier crude oil, raw natural gas liquids, and petroleum products pipeline systems in the United States, including those partially owned or operated by affiliates. We also owned or operated 48 finished product terminals, seven liquefied petroleum gas terminals, five crude oil terminals and one coke exporting facility.
In December 2007, we acquired a 50 percent equity interest in four Keystone pipeline entities (Keystone), to create a joint venture with TransCanada Corporation. In October 2008, we elected to exercise an option to reduce our equity interest from 50 percent to 20.01 percent. The change in equity will occur through a dilution mechanism, which is expected to gradually lower our ownership interest until it reaches 20.01 percent by the third quarter of 2009. At December 31, 2008, our ownership interest was 38.7 percent. Keystones first phase, a 2,148-mile, 590,000-barrel-per-day crude oil pipeline from Alberta to delivery points in Illinois and Oklahoma, is expected to be mechanically complete in late 2009. A second phase is expected to carry up to 700,000 barrels per day to refineries on the Gulf Coast. We anticipate utilizing the Keystone pipeline to transport our Canadian crude oil production to market, including as a source of supply to our U.S. refineries.
During 2008, we disposed of our international marine operations consisting of leasehold interests in six double-hulled crude oil tankers and replaced the disposed operations with long-term charter agreements. At December 31, 2008, we had 17 double-hulled crude oil tankers, with capacities ranging in size from 700,000 to 2,100,000 barrels, which are under charter primarily to transport feedstocks to certain of our U.S. refineries. In addition, we had under charter five double-hulled product tankers utilized to transport our heavy and clean products. The tankers discussed here exclude the operations of the companys subsidiary, Polar Tankers, Inc., which are discussed in the E&P segment, as well as an owned tanker on lease to a third party for use in the North Sea.
We manufacture and sell a variety of specialty products including petroleum cokes, lubes (such as automotive and industrial lubricants), solvents and pipeline flow improvers. Our lubes are marketed under the Phillips 66, Conoco, 76 and Kendall brands. We also manufacture and market high-quality graphite and anode-grade petroleum cokes in the United States and Europe for use in the global steel and aluminum industries.
The companys 50-percent-owned Excel Paralubes joint venture owns a hydrocracked lubricant base oil manufacturing plant located adjacent to the Lake Charles refinery. The facility produces approximately 20,000 barrels per day of high-quality, clear hydrocracked base oils.
In January 2008, we sold our 50 percent interest in Penreco, which manufactured and marketed highly refined specialty petroleum products.
At December 31, 2008, R&M owned or had an interest in five refineries outside the United States.
Primary crude oil characteristics and sources of crude oil for our international refineries are as follows:
Capacities for and yields of clean products, as well as other products produced, relating to our international refineries are as follows:
We operate a crude oil and products storage complex consisting of 7.5 million barrels of storage capacity and an offshore mooring buoy, located about 80 miles southwest of the Whitegate refinery in Bantry Bay, Ireland.
During 2008, we continued to progress our plans to upgrade the Wilhelmshaven refinery in Germany. Our future capital budget incorporates funds to economically improve the operation of the refinery, enabling it to process heavier, higher-sulfur crude oil and produce predominantly low-sulfur diesel.
In late 2007, we and our co-venturers sanctioned a project for the expansion of the Melaka refinery to be completed during 2010. This project is intended to increase crude oil, conversion and treating unit capacities.
In May 2006, we signed a Memorandum of Understanding with Saudi Aramco to conduct a detailed evaluation of the proposed development of a 400,000-barrel-per-day, full-conversion refinery in Yanbu, Saudi Arabia. The refinery would be designed to process Arabian heavy crude oil and produce high-quality, ultra-low-sulfur refined products. In November 2008, we agreed to delay the bidding process associated with the refinerys construction due to uncertainties in the contracting and financial markets. The originally scheduled bidding process requested bids be submitted in December 2008. Instead, project bidding is now scheduled to begin in 2009.
At December 31, 2008, R&M had marketing operations in five European countries. R&Ms European marketing strategy is to sell primarily through owned, leased or joint venture retail sites using a low-cost, high-volume strategy. We use the JET brand name to market retail and wholesale products in Austria, Germany and the United Kingdom. In addition, a joint venture in which we have an equity interest markets products in Switzerland under the Coop brand name. We also market aviation fuels, liquid petroleum gases, heating oils, transportation fuels and marine bunkers to commercial customers and into the bulk or spot market in the aforementioned countries and Ireland.
As of December 31, 2008, R&M had approximately 1,260 marketing outlets in its European operations, of which approximately 860 were company-owned and 400 were dealer-owned. Through our joint venture operations in Switzerland, we also have interests in 200 additional sites. In October 2008, we sold our 274 fueling stations in Norway, Sweden and Denmark to Statoil.
At December 31, 2008, our LUKOIL Investment segment represented 4 percent of ConocoPhillips total assets. In 2004, we became a strategic equity investor in OAO LUKOIL, an international, integrated oil and gas company headquartered in Russia. Under the Shareholder Agreement between the two companies, we have representation on the LUKOIL Board of Directors, and LUKOILs corporate charter requires unanimous Board consent for certain key decisions. At year-end 2008, we had a 20 percent ownership interest in LUKOIL based on authorized and issued shares. Based on estimated shares outstanding at year end, our ownership was 20.06 percent. We use the equity method of accounting for our investment in LUKOIL. See Note 7Investments, Loans and Long-Term Receivables, in the Notes to Consolidated Financial Statements, for additional information.
As reported in LUKOILs publicly available 2007 annual report, the majority of its 2007 upstream oil production was sourced within Russia, with 62 percent from the western Siberia region, 15 percent from the Timan-Pechora province and 12 percent from the Urals region. Outside of Russia, LUKOIL had 2007 oil production in Kazakhstan, Egypt and Azerbaijan, and gas production in Uzbekistan. Eighty-eight percent of LUKOILs natural gas production was sourced within Russia. In addition, LUKOIL has an active exploration program focused in Russia but also encompassing several international countries. Downstream, LUKOIL has seven refineries with a net crude oil throughput capacity of approximately 1.2 million barrels per day. LUKOIL also has a marketing network extending to 24 countries, with the majority of wholesale and retail sales in Russia, the United States and Europe.
At December 31, 2008, our Chemicals segment represented 2 percent of ConocoPhillips total assets. The Chemicals segment consists of our 50 percent equity investment in Chevron Phillips Chemical Company LLC (CPChem), a joint venture with Chevron Corporation, headquartered in The Woodlands, Texas.
CPChems business is structured around two primary operating segments: Olefins & Polyolefins and Specialties, Aromatics & Styrenics. The Olefins & Polyolefins segment produces and markets ethylene, propylene, and other olefin products, which are primarily consumed within CPChem for the production of polyethylene, normal alpha olefins, polypropylene, and polyethylene pipe. The Specialties, Aromatics & Styrenics segment manufactures and markets aromatics products, such as benzene, styrene, paraxylene and cyclohexane. This segment also manufactures and markets polystyrene, as well as styrene-butadiene copolymers. Furthermore, this segment manufactures and markets a variety of specialty chemical products including organosulfur chemicals, solvents, catalysts, drilling chemicals, mining chemicals and high-performance engineering plastics and compounds.
CPChems domestic facilities are located in California, Connecticut, Illinois, Louisiana, Mississippi, Ohio and Texas. International facilities are located in Belgium, Brazil, China, Columbia, Qatar, Saudi Arabia, Singapore and South Korea.
CPChem owns a 49 percent interest in Qatar Chemical Company Ltd. (Q-Chem), a joint venture that owns a major olefins and polyolefins complex in Mesaieed, Qatar. CPChem also owns a 49 percent interest in Qatar Chemical Company II Ltd. (Q-Chem II), a joint venture that began construction of a second complex in Mesaieed in 2005. This Q-Chem II facility is designed to produce polyethylene and normal alpha olefins on a site adjacent to the Q-Chem complex. In connection with this project, CPChem entered into a separate agreement establishing a joint venture to develop an ethylene cracker in Ras Laffan Industrial City, Qatar. Operational startup of the Q-Chem II project is anticipated in late 2009.
In 2003, CPChem formed a 50-percent-owned joint venture company to develop an integrated styrene facility in Al Jubail, Saudi Arabia. The facility is being built adjacent to the existing aromatics complex owned by Saudi Chevron Phillips Company (SCP), another 50-percent-owned CPChem joint venture. Construction of the facility, which began in the fourth quarter of 2004, is in conjunction with an expansion of SCPs existing benzene plant, together called the JCP Project. Operational startup occurred in the third quarter of 2008, while project completion is anticipated during the first quarter of 2009.
In 2007, CPChem formed a 50-percent-owned joint venture, Saudi Polymers Company (SPC), to construct and operate an integrated petrochemicals complex at Al Jubail, Saudi Arabia. Construction began in January 2008, and commercial production is scheduled to begin in late 2011. Prior to project completion, based on a planned initial public offering of shares in CPChems joint venture partners company and a corresponding increase in the partners ownership interest in SPC, CPChems ownership is expected to decline to 35 percent.
In 2007, CPChem and the Dow Chemical Company signed a nonbinding Memorandum of Understanding relating to the formation of a joint venture involving assets from their polystyrene and styrene monomer businesses. Joint venture operations commenced in May 2008, with CPChem contributing two domestic plants and Dow contributing four domestic and two international plants.
At December 31, 2008, our Emerging Businesses segment represented 1 percent of ConocoPhillips total assets. The segment encompasses the development of new technologies and businesses outside our normal scope of operations. Activities within this segment are currently focused on power generation and innovation of new technologies, such as those related to conventional and nonconventional hydrocarbon recovery (including heavy oil), refining, alternative energy, biofuels and the environment.
The focus of our power business is on developing projects to support our E&P and R&M strategies. While projects primarily in place to enable these strategies are included within their respective segments, projects with a significant merchant component are included in the Emerging Businesses segment.
The Immingham combined heat and power plant (CHP), a wholly owned 730-megawatt facility in the United Kingdom, provides steam and electricity to the Humber refinery and steam to a neighboring refinery, as well as merchant power into the U.K. market. In October 2006, we announced we would expand capacity at Immingham to 1,180 megawatts. Development work on Immingham phase 2 began with the award of a contract for front-end engineering and securing of additional connection availability to the U.K. grid. Commercial operation of the expansion is expected to start in mid-2009.
We also own a gas-fired cogeneration plant in Orange, Texas, as well as a 50 percent operating interest in Sweeny Cogeneration LP, a joint venture near the Sweeny refinery complex.
Our Technology group focuses on developing new business opportunities designed to provide future growth prospects for ConocoPhillips. Areas of interest include advanced hydrocarbon processes, energy conversion technologies, new petroleum-based products, renewable fuels and carbon capture technology. We have commercialized production of renewable diesel, a new type of renewable fuel that utilizes existing infrastructure. In 2007, we formed a research relationship with Iowa State University to develop new methods for producing second-generation biofuels. In addition, we have formed alliances with Tyson Foods and Archer Daniels Midland to produce and market the next generation of renewable transportation fuels. We have also formed an internal group that is evaluating wind, solar and geothermal investment opportunities.
We are working with General Electric Company to develop a technology center in Qatar to research water sustainability solutions for petroleum, petrochemical, municipal and agricultural applications. The Qatar center will examine ways of treating and using by-product water from oil production and refining operations, as well as other projects relating to industrial and municipal water sustainability. In conjunction with the Interim Agreement to develop the Shah field with the Abu Dhabi National Oil Company, we are planning to develop a technology center in Abu Dhabi that will conduct research and provide technical service in areas including reservoir management and development of sour gas fields; safe and efficient processing of gas with high hydrogen sulfide and carbon dioxide concentrations; and sour gas sequestration. Both centers are expected to open in 2009.
We offer a gasification technology (E-Gas) that uses petroleum coke, coal, and other low-value hydrocarbons as feedstock, resulting in high-value synthesis gas used for a slate of products, including power, hydrogen and chemicals. In 2008, we completed a feasibility study and submitted applications for all required environmental permits related to a proposed coal-to-substitute natural gas (SNG) facility, which would have a capacity of 60 billion to 70 billion cubic feet per year and be located in Muhlenberg County, Kentucky. We also became a founding member of the Western Kentucky Carbon Storage Foundation, which is funding evaluation of carbon storage in deep underground formations through a test well project directed by the Kentucky Geologic Survey.
A conceptual engineering study was completed in 2008 for a project at our Sweeny refinery in Texas that would utilize E-Gas technology to convert petroleum coke to low-carbon power or SNG and hydrogen. To minimize carbon dioxide (CO2) emissions from the facility, the proposed design allows CO2 to be captured, transported and safely stored in nearby geological formations. This project would increase clean energy supply while establishing critical carbon capture and storage infrastructure in the Texas Gulf Coast region. A more detailed feasibility study is expected in 2009.
We compete with private, public and state-owned companies in all facets of the petroleum and chemicals businesses. Some of our competitors are larger and have greater resources. Each of our segments is highly competitive. No single competitor, or small group of competitors, dominates any of our business lines.
Upstream, our E&P segment competes with numerous other companies in the industry to locate and obtain new sources of supply and to produce oil and natural gas in an efficient, cost-effective manner. Based on publicly available year-end 2007 reserves statistics, we had the sixth-largest total of worldwide proved reserves of nongovernment-controlled companies. We deliver our oil and natural gas production into the worldwide oil and natural gas commodity markets. Principal methods of competing include geological, geophysical and engineering research and technology; experience and expertise; economic analysis in connection with property acquisitions; and operating efficient oil and gas producing properties.
The Midstream segment, through our equity investment in DCP Midstream and our consolidated operations, competes with numerous other integrated petroleum companies, as well as natural gas transmission and distribution companies, to deliver components of natural gas to end users in the commodity natural gas markets. DCP Midstream is a large producer of natural gas liquids in the United States. Principal methods of competing include economically securing the right to purchase raw natural gas into gathering systems, managing the pressure of those systems, operating efficient natural gas liquids processing plants, and securing markets for the products produced.
Downstream, our R&M segment competes primarily in the United States, Europe and the Asia Pacific region. Based on the statistics published in the December 22, 2008, issue of the Oil & Gas Journal, our R&M segment had the second-largest U.S. refining capacity of 18 large refiners of petroleum products. Worldwide, our refining capacity ranked fourth among nongovernment-controlled companies. In the Chemicals segment, CPChem generally ranked within the top 10 producers of many of its major product lines, based on average 2008 production capacity, as published by industry sources. Petroleum products, petrochemicals and plastics are delivered into the worldwide commodity markets. Elements of competition for both our R&M and Chemicals segments include product improvement, new product development, low-cost structures, and improved manufacturing and distribution systems. In the marketing portion of the business, competitive factors include product properties and processibility, reliability of supply, customer service, price and credit terms, advertising and sales promotion, and development of customer loyalty to ConocoPhillips or CPChems branded products.
At the end of 2008, we held a total of 1,464 active patents in 81 countries worldwide, including 556 active U.S. patents. During 2008, we received 39 patents in the United States and 58 foreign patents. Our products and processes generated licensing revenues of $38 million in 2008. The overall profitability of any business segment is not dependent on any single patent, trademark, license, franchise or concession.
Company-sponsored research and development activities charged against earnings were $209 million, $160 million, and $117 million in 2008, 2007, and 2006, respectively.
The environmental information contained in Managements Discussion and Analysis of Financial Condition and Results of Operations on pages 63 through 65 under the caption Environmental is incorporated herein by reference. It includes information on expensed and capitalized environmental costs for 2008 and those expected for 2009 and 2010.
Web Site Access to SEC Reports
Our Internet Web site address is http://www.conocophillips.com. Information contained on our Internet Web site is not part of this report on Form 10-K.
Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and any amendments to these reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 are available on our Web site, free of charge, as soon as reasonably practicable after such reports are filed with, or furnished to, the U.S. Securities and Exchange Commission (SEC). Alternatively, you may access these reports at the SECs Web site at http://www.sec.gov.
Item 1A. RISK FACTORS
You should carefully consider the following risk factors in addition to the other information included in this Annual Report on Form 10-K. Each of these risk factors could adversely affect our business, operating results and financial condition, as well as adversely affect the value of an investment in our common stock.
Our operating results, our future rate of growth and the carrying value of our assets are exposed to the effects of changing commodity prices and refining margins.
Our revenues, operating results and future rate of growth are highly dependent on the prices we receive for our crude oil, natural gas, natural gas liquids and refined products. The factors influencing the prices of crude oil, natural gas, natural gas liquids and refined products are beyond our control. Lower crude oil, natural gas, natural gas liquids and refined products prices may reduce the amount of these commodities we can produce economically, which may have a material adverse effect on our revenues, operating income and cash flows.
Unless we successfully add to our existing proved reserves, our future crude oil and natural gas production will decline, resulting in harm to our business.
The rate of production from crude oil and natural gas properties generally declines as reserves are depleted. Except to the extent that we conduct successful exploration and development activities, or, through engineering studies, identify additional or secondary recovery reserves, our proved reserves will decline materially as we produce crude oil and natural gas. Accordingly, to the extent we are unsuccessful in replacing the crude oil and natural gas we produce with good prospects for future production, our business will suffer reduced cash flows and results of operations.
Any material change in the factors and assumptions underlying our estimates of crude oil and natural gas reserves could impair the quantity and value of those reserves.
Our proved crude oil and natural gas reserve information included in this annual report has been derived from engineering estimates prepared or reviewed by our personnel. Any significant future price changes will have a material effect on the quantity and present value of our proved reserves. Future reserve revisions could also result from changes in, among other things, governmental regulation. Reserve estimation is a subjective process that involves estimating volumes to be recovered from underground accumulations of crude oil and natural gas that cannot be directly measured. As a result, different petroleum engineers, each using industry-accepted geologic and engineering practices and scientific methods, may produce different estimates of reserves and future net cash flows based on the same available data. Any changes in the factors and assumptions underlying our estimates of these items could result in a material negative impact to the volume of reserves reported.
We expect to continue to incur substantial capital expenditures and operating costs as a result of our compliance with existing and future environmental laws and regulations. Likewise, future environmental laws and regulations may impact or limit our current business plans and reduce demand for our products.
Our businesses are subject to numerous laws and regulations relating to the protection of the environment. These laws and regulations continue to increase in both number and complexity and affect our operations with respect to, among other things:
We have incurred and will continue to incur substantial capital, operating and maintenance, and remediation expenditures as a result of these laws and regulations. To the extent these expenditures, as with all costs, are not ultimately reflected in the prices of our products and services, our business, financial condition, results of operations and cash flows in future periods could be materially adversely affected.
Domestic and worldwide political and economic developments could damage our operations and materially reduce our profitability and cash flows.
Actions of the U.S., state and local governments through tax and other legislation, executive order and commercial restrictions could reduce our operating profitability both in the United States and abroad. The U.S. government can prevent or restrict us from doing business in foreign countries. These restrictions and those of foreign governments have in the past limited our ability to operate in, or gain access to, opportunities in various countries. Actions by both the United States and host governments have affected operations significantly in the past, such as the expropriation of our oil assets by the Venezuelan government, and will continue to do so in the future.
Local political and economic factors in international markets could have a material adverse effect on us. Approximately 56 percent of our crude oil, natural gas and natural gas liquids production in 2008 was derived from production outside the United States, and 62 percent of our proved reserves, as of December 31, 2008, were located outside the United States. We are subject to risks associated with operations in international markets, including changes in foreign governmental policies relating to crude oil, natural gas, natural gas liquids or refined product pricing and taxation, other political, economic or diplomatic developments, changing political conditions and international monetary fluctuations.
The current financial crisis could have a material adverse affect on our financial strength and that of our business co-venturers.
Recent disruptions in the credit markets and concerns about global economic growth have had a significant adverse impact on global financial markets and commodity prices, both of which have contributed to a decline in our stock price and corresponding market capitalization. A lower level of economic activity could result in a decline in energy consumption, which could cause our revenues and margins to decline and limit our future growth prospects. Decreased returns on pension fund assets may also materially increase our pension funding requirements. Likewise, the capital and credit markets have become increasingly volatile as a result of adverse conditions. If the capital and credit markets continue to experience volatility and the availability of funds remains limited, we, and third parties with whom we do business, may incur increased costs associated with issuing commercial paper and/or other debt instruments and this, in turn, could adversely affect our ability to advance our strategic plans as currently contemplated. In this context, changes in our debt rating could have a material adverse effect on our interest costs and financing sources.
Changes in governmental regulations may impose price controls and limitations on production of crude oil and natural gas.
Our operations are subject to extensive governmental regulations. From time to time, regulatory agencies have imposed price controls and limitations on production by restricting the rate of flow of crude oil and natural gas wells below actual production capacity in order to conserve supplies of crude oil and natural gas. Because legal requirements are frequently changed and subject to interpretation, we cannot predict the effect of these requirements.
Our investments in joint ventures decrease our ability to manage risk.
We conduct many of our operations through joint ventures in which we may share control with our joint venture participants. There is a risk that our joint venture participants may at any time have economic, business or legal interests or goals that are inconsistent with those of the joint venture or us, or that our joint venture participants may be unable to meet their economic or other obligations and we may be required to fulfill those obligations alone. Failure by us, or an entity in which we have a joint venture interest, to adequately manage the risks associated with any acquisitions or joint ventures could have a material adverse effect on the financial condition or results of operations of our joint ventures and, in turn, our business and operations.
Our operations are inherently dangerous and require significant and continuous oversight.
The scope and nature of our operations present a variety of operational hazards and risks that must be managed through continual oversight and control. These risks are present throughout the process of extraction, transportation, refinement and storage of the hydrocarbons we produce. Failure to manage these risks could result in injury or loss of life, environmental damage, loss of revenues and damage to our reputation.
Item 1B. UNRESOLVED STAFF COMMENTS
Item 3. LEGAL PROCEEDINGS
The following is a description of reportable legal proceedings, including those involving governmental authorities under federal, state and local laws regulating the discharge of materials into the environment for this reporting period. The following proceedings include those matters that arose during the fourth quarter of 2008, as well as matters previously reported in our 2007 Form 10-K and our first-, second- and third-quarter 2008 Form 10-Qs that were not resolved prior to the fourth quarter of 2008. Material developments to the previously-reported matters have been included in the descriptions below. While it is not possible to accurately predict the final outcome of these pending proceedings, if any one or more of such proceedings was decided adversely to ConocoPhillips, we expect there would be no material effect on our consolidated financial position. Nevertheless, such proceedings are reported pursuant to the U.S. Securities and Exchange Commissions regulations.
Our U.S. refineries are implementing two separate consent decrees, regarding alleged violations of the Federal Clean Air Act, with the U.S. Environmental Protection Agency (EPA), six states and one local air pollution agency. Some of the requirements and limitations contained in the decree provide for stipulated penalties for violations. Stipulated penalties under the decrees are not automatic, but must be requested by one of the agency signatories. As part of periodic reports under the decree and/or other reports required by permits or regulations, we occasionally report matters which could be subject to a request for stipulated penalties. If a specific request for stipulated penalties meeting the reporting threshold set forth in U.S. Securities and Exchange Commission rules is made pursuant to these decrees based on a given reported exceedance, we will separately report that matter and the amount of the proposed penalty.
On October 23, 2008, ConocoPhillips received a demand from the Los Angeles Regional Water Quality Control Board (LARWQCB) to settle multiple alleged exceedances of National Pollutant Discharge Elimination System Permit effluent limits at its Los Angeles Lubricants plant dating back to 2000. The amount of the demand is $174,000. We will work with the LARWQCB to resolve these allegations.
On December 15, 2008, the Trainer refinery received Citations and a Notification of Penalty (Citation) from the Occupational Safety and Health Administration (OSHA) for 26 alleged violations noted during the OSHA National Emphasis Program review of the refinery. The Citation seeks $115,500 in penalties for a variety of alleged Process Safety Management violations. We are working with OSHA to resolve this matter.
Matters Previously Reported
The South Coast Air Quality Management District (SCAQMD) conducted an audit of the Los Angeles refinery in 2007 to assess compliance with applicable local, state, and federal regulations related to fugitive emissions. As a result of the audit, SCAQMD issued three Notices of Violations (NOVs) alleging multiple counts of noncompliance. We resolved two of the three NOVs for a total payment of $42,500 in the third quarter of 2008 and reached an agreement with SCAQMD to resolve the third NOV for $12,500 in the fourth quarter of 2008.
SCAQMD conducted an audit of the Los Angeles refinery in August 2008 to assess compliance with applicable local, state and federal regulations related to fugitive emissions. As a result of the audit, on August 28, 2008, SCAQMD issued five NOVs alleging noncompliance. SCAQMD has not yet specified a penalty for these alleged violations. We are working with SCAQMD to resolve these NOVs.
On July 16, 2008, ConocoPhillips received a demand from the Bay Area Air Quality Management District (BAAQMD) to settle 24 NOVs issued in late 2006 and 2007 for alleged violations of air pollution-control regulations at the San Francisco refinery. The amount of the settlement demand is $304,500. On December 29, 2008, BAAQMD added an additional seven NOVs issued in 2008 and a corresponding additional $340,500 to its settlement demand. We are working with BAAQMD to resolve these NOVs.
On June 2, 2008, the Billings refinery received a Violation Letter from the Montana Department of Environmental Quality (MDEQ) for opacity and nickel emissions, which occurred during startup of the catalytic cracker in April 2007. The letter also alleged certain monitoring quality assurance/quality control violations. The letter requests a penalty of $604,000. We intend to work with the MDEQ to resolve this matter.
On March 27, 2008, the Trainer refinery received a proposed Consent Assessment of Civil Penalty from the Pennsylvania Department of Environmental Protection (PADEP) for alleged air quality violations that occurred from 2002 to 2007. The assessment covers several categories of alleged air quality violations including emission events, air emissions inventory reporting, and violation of permit conditions. We paid $129,424 in the fourth quarter of 2008 to resolve this matter.
On March 27, 2008, the Sweeny refinery received a Notice of Enforcement (NOE) from the Texas Commission on Environmental Quality (TCEQ) for an emissions event related to flaring that occurred on January 28, 2008. A penalty of $32,000 was submitted to the TCEQ in September 2008. This matter is subject to formal approval by the TCEQ Commissioners. We expect consideration of approval to occur in the first quarter of 2009.
On February 11, 2008, ConocoPhillips Alaska, Inc. (CPAI) received an NOV from the North Slope Borough (NSB) in relation to its Alpine facility on the North Slope of Alaska. The NOV alleges that three fuel tanks at the Alpine facility lacked adequate containment and/or setbacks from water bodies. There was no environmental impact due to these alleged violations. The NOV proposed penalties of $207,000, which was later reduced to $128,000. CPAI paid the reduced penalty under protest in accordance with the payment demands in the NOV. On March 11, 2008, CPAI filed an appeal with the NSB Planning Commission challenging the alleged violations and penalties in the NOV. We will continue to work with the NSB to resolve this matter.
In October 2003, the District Attorneys Office in Sacramento, California, filed a complaint in Superior Court for alleged methyl tertiary-butyl ether (MTBE) contamination in groundwater. On April 4, 2008, the District Attorneys Office filed an amended complaint that included alleged violations of state regulations relating to operation or maintenance of underground storage tanks. There are numerous defendants named in the suit in addition to ConocoPhillips. We intend to continue to contest this lawsuit.
In October 2007, we received a Complaint from the U.S. EPA alleging violations of the Clean Water Act related to a 2006 oil spill at our Bayway refinery and proposing a penalty of $156,000. We are working with the EPA and the U.S. Coast Guard to resolve this matter.
On December 16, 2005, the Bayway refinery experienced a hydrocarbon spill to the Rahway River and Arthur Kill. On August 26, 2006, we signed an Order on Consent with the state of New York pursuant to which we paid a penalty of $50,000 and conducted a beach cleanup. Also in December 2008, we paid a total of $106,578 for natural resource damages and other costs to the New Jersey Department of Environmental Protection, the U.S. Department of the Interior and the U.S. Department of Commerce. This matter is resolved.
In March 2005, ConocoPhillips Pipe Line Company (CPPL) received a Notice of Probable Violation and Proposed Civil Penalty from the U.S. Department of Transportations Pipeline and Hazardous Materials Safety Administration (DOT) alleging violation of DOT operation and safety regulations at certain facilities in Kansas, Missouri, Illinois, Indiana, Wyoming and Nebraska. DOT is proposing penalties in the amount of $184,500. An information hearing was held on September 24, 2007. CPPL has provided additional information in support of its position. We are currently awaiting a ruling from DOT.
The U.S. Coast Guard and Washington State Department of Ecology investigated the possible sources of an oil spill in Puget Sound. In November 2004, the U.S. Attorney and the U.S. Coast Guard offices in Seattle, Washington, issued subpoenas to Polar Tankers, Inc., a subsidiary of ConocoPhillips Company, for records related to the vessel Polar Texas. On December 23, 2004, the governor of the state of Washington and the U.S. Coast Guard publicly announced they believed the Polar Texas was the source of the spill. The company fully cooperated with the investigations. The U.S. Attorneys Office in Seattle declined prosecution of the company. As previously reported, Polar Tankers, ConocoPhillips and the state of Washington settled the matter, with payment of civil penalties and response costs. The settlement did not include any admission of liability. The company and the authorities remain in settlement negotiations regarding the natural resource damage assessment.
In April 2004, in response to several historical spills at the Albuquerque Products Terminal, we received an Administrative Compliance Order from the New Mexico Environment Department. The order does not propose a penalty assessment, but rather attempts to impose specific design, construction and operational changes. We have been in negotiations with the agency and in June 2007 proposed a settlement offer of $100,000. We will continue to work with the agency to resolve this matter.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
EXECUTIVE OFFICERS OF THE REGISTRANT
There is no family relationship among the officers named above. Each officer of the company is elected by the Board of Directors at its first meeting after the Annual Meeting of Stockholders and thereafter as appropriate. Each officer of the company holds office from date of election until the first meeting of the directors held after the next Annual Meeting of Stockholders or until a successor is elected. The date of the next annual meeting is May 13, 2009. Set forth below is information about the executive officers.
Rand C. Berney was appointed Vice President and Controller upon completion of the merger in 2002.
John A. Carrig was appointed President and Chief Operating Officer in October 2008, having previously served as Executive Vice President, Finance, and Chief Financial Officer since the merger in 2002.
W. C. W. Chiang was appointed Senior Vice President, Refining, Marketing and Transportation in October 2008. He previously served as Senior Vice President, Commercial since 2007. Prior to that, he served as President, Americas Supply & Trading, Commercial, from 2005 through 2007 and as President, Downstream Strategy, Integration and Specialty Businesses from 2003 through 2005.
Sigmund L. Cornelius was appointed Senior Vice President, Finance, and Chief Financial Officer in October 2008. Prior to that, he served as Senior Vice President, Planning, Strategy and Corporate Affairs since September 2007, having previously served as President, Exploration and ProductionLower 48 since 2006. He served as President, Global Gas since 2004, and prior to that served as President, Lower 48, Latin America and Midstream since 2003.
James L. Gallogly was appointed Executive Vice President, Exploration and Production in October 2008, and prior to that served as Executive Vice President, Refining, Marketing and Transportation from April 2006. He previously served as President and Chief Executive Officer of Chevron Phillips Chemical Company LLC since 2000.
Janet L. Kelly was appointed Senior Vice President, Legal, General Counsel and Corporate Secretary effective September 1, 2007, having previously served as Deputy General Counsel since 2006. Prior to joining ConocoPhillips in 2006, she was a partner at Zelle, Hoffman, Voelbel, Mason and Gette during 2005 and 2006. She previously served as Senior Vice President, Chief Administrative Officer and Chief Compliance Officer of Kmart Corporation during 2003 and 2004.
James J. Mulva has served as Chairman of the Board of Directors and Chief Executive Officer since October 2008, having previously served as Chairman of the Board of Directors, President and Chief Executive Officer since October 2004. Prior to that, he served as President and Chief Executive Officer since completion of the merger in 2002.
Jeff W. Sheets was appointed Senior Vice President, Planning and Strategy in October 2008, having previously served as Vice President and Treasurer since the merger in 2002.
Quarterly Common Stock Prices and Cash Dividends Per Share
ConocoPhillips common stock is traded on the New York Stock Exchange, under the symbol COP.
Issuer Purchases of Equity Securities
Item 6. SELECTED FINANCIAL DATA
See Managements Discussion and Analysis of Financial Condition and Results of Operations for a discussion of factors that will enhance an understanding of this data.
The financial data for 2008 includes the impact of impairments relating to goodwill and to our LUKOIL investment that together amount to $32,853 million before- and after-tax. For additional information, see the Goodwill Impairment section of Note 9Goodwill and Intangibles and the LUKOIL section of Note 7Investments, Loans and Long-Term Receivables, in the Notes to Consolidated Financial Statements.
The financial data for 2007 includes the impact of a $4,588 million before-tax ($4,512 million after-tax) impairment related to the expropriation of our oil interests in Venezuela. For additional information, see the Expropriated Assets section of Note 10Impairments, in the Notes to Consolidated Financial Statements.
Additionally, the acquisition of Burlington Resources in 2006 affects the comparability of the amounts included in the table above. See Note 3Acquisition of Burlington Resources Inc., in the Notes to Consolidated Financial Statements, for additional information. See Note 2Changes in Accounting Principles, in the Notes to Consolidated Financial Statements, for information on changes in accounting principles affecting the comparability of amounts included in the table above.
Item 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
February 25, 2009
Managements Discussion and Analysis is the companys analysis of its financial performance and of significant trends that may affect future performance. It should be read in conjunction with the financial statements and notes, and supplemental oil and gas disclosures. It contains forward-looking statements including, without limitation, statements relating to the companys plans, strategies, objectives, expectations and intentions, that are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. The words intends, believes, expects, plans, scheduled, should, anticipates, estimates and similar expressions identify forward-looking statements. The company does not undertake to update, revise or correct any of the forward-looking information unless required to do so under the federal securities laws. Readers are cautioned that such forward-looking statements should be read in conjunction with the companys disclosures under the heading: CAUTIONARY STATEMENT FOR THE PURPOSES OF THE SAFE HARBOR PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995, beginning on page 72.
BUSINESS ENVIRONMENT AND EXECUTIVE OVERVIEW
ConocoPhillips is an international, integrated energy company. We are the third-largest integrated energy company in the United States, based on market capitalization. We have approximately 33,800 employees worldwide, and at year-end 2008 had assets of $143 billion. Our stock is listed on the New York Stock Exchange under the symbol COP.
Our business is organized into six operating segments:
In 2008, the energy industry was characterized by extreme volatility. Forecasts of worldwide economic growth and increasingly scarce supply, a weakening U.S. dollar, and other factors helped drive crude oil prices to record highs. This was followed by an abrupt shift into a severe global financial recession, which reduced current and forecasted demand for petroleum products. Because of this, crude oil prices fell rapidly and refining margins also significantly weakened.
As a result of the significant drop in global equity markets during the fourth quarter of 2008, we recorded two individually significant impairments in 2008 that were primarily linked to market capitalizationsa $25.4 billion write-down of our E&P segments recorded goodwill, and a $7.4 billion reduction in the carrying value of our LUKOIL investment. These impairments contributed to a net loss in 2008 of $17.0 billion, compared with net income in 2007 of $11.9 billion, which includes the impact of a $4.5 billion impairment due to expropriation of our Venezuelan assets. Since these 2008 and 2007 impairment charges were noncash, they did not impact our cash provided by operating activities, which was $22.7 billion in 2008, compared with $24.6 billion in 2007.
Crude oil and natural gas prices, along with refining margins, are the most significant factors in our profitability, and are driven by market factors over which we have no control. However, from a competitive perspective, there are other important factors we must manage well to be successful, including:
Through a combination of all three methods listed above, we have been successful in the past in maintaining or adding to our production and proved reserve base. Although it cannot be assured, we anticipate being able to do so in the future. In the three years ending December 31, 2008, our reserve replacement was 124 percent, including the impacts of the Burlington Resources acquisition, additional equity investments in LUKOIL, the FCCL Oil Sands Partnership with EnCana, the Australia Pacific LNG joint venture with Origin Energy, and the expropriation of our Venezuelan oil assets.
Access to additional resources has become increasingly difficult as direct investment is prohibited in some nations, while fiscal and other terms in other countries can make projects uneconomic or unattractive. In addition, political instability, competition from national oil companies, and lack of access to high-potential areas due to environmental or other regulation may negatively impact our ability to increase our reserve base. As such, the timing and level at which we add to our reserve base may, or may not, allow us to replace our production over subsequent years.
industries, cost control is a component of our variable compensation programs. In response to the current depressed market environment, we expect to reduce our work force in 2009, reduce the headcount of contractors, and continue to emphasize cost discipline throughout our operations.
With the rise in commodity prices over the last several years and through the first half of 2008, and the subsequent increase in industry-wide spending on capital and major maintenance programs, we and other energy companies experienced inflation for the costs of certain goods and services in excess of general worldwide inflationary trends. Such costs included rates for drilling rigs, steel and other raw materials, as well as costs for skilled labor. With the weakening of the economy and the decline in commodity prices, our industry began to see some relief from this upward cost pressure in late 2008 and into early 2009.
In October 2008, we formed Australia Pacific LNG, a 50/50 joint venture with Origin Energy for the development of coalbed natural gas in Australia, and the subsequent liquefaction and transport of the liquefied natural gas targeting Asia Pacific markets. In January 2007, we entered into two 50/50 business ventures with EnCana to create an integrated North American heavy oil business, consisting of the upstream FCCL Oil Sands Partnership in Canada and the downstream WRB Refining LLC in the United States.
Our capital expenditures and investments in 2008 totaled $19.1 billion, and we anticipate capital expenditures and investments to be approximately $11.7 billion in 2009. The reduced capital budget in 2009 reflects the impact of the Origin transaction on the 2008 totals, and a planned reduction in response to current market conditions. In addition to our capital program, we paid dividends on our common stock of $2.9 billion in 2008, and repurchased $8.2 billion of our common stock.
Our key performance indicators are shown in the statistical tables provided at the beginning of the operating segment sections that follow. These include crude oil, natural gas and natural gas liquids prices and production, refining capacity utilization, and refinery output.
Other significant factors that can affect our profitability include:
The E&P segments results are most closely linked to crude oil and natural gas prices. These are commodity products, the prices of which are subject to factors external to our company and over which we have no control. Industry crude oil prices for West Texas Intermediate (WTI) were higher in 2008, compared with 2007, averaging $99.56 per barrel in 2008, an increase of 38 percent. The increase was driven by concerns during the first half of 2008 of adequate supplies given the strong oil demand growth in developing Asia and the Middle East. The average annual price for WTI moderated due to the economic crisis in the second half of 2008 that impacted demand from all regions of the world. Industry natural gas prices for Henry Hub increased 32 percent during 2008 to an average price of $9.04 per million British thermal units (MMBTU), primarily due to increased demand from the industrial and electric power sector during the first half of 2008 and higher oil prices. These factors were moderated by higher domestic production and lower demand, which led to higher storage in the second half of 2008.
The Midstream segments results are most closely linked to natural gas liquids prices. The most important factor on the profitability of this segment is the results from our 50 percent equity investment in DCP Midstream. DCP Midstreams natural gas liquids prices increased 11 percent in 2008.
Refining margins, refinery utilization, cost control and marketing margins primarily drive the R&M segments results. Refining margins are subject to movements in the cost of crude oil and other feedstocks, and the sales prices for refined products, both of which are subject to market factors over which we have no control. Industry refining margins in the United States were lower overall in comparison with 2007. The primary factor contributing to the reduced refining margins in 2008 was a decrease in gasoline demand.
The LUKOIL Investment segment consists of our investment in the ordinary shares of LUKOIL. At December 31, 2008, our ownership interest in LUKOIL was 20 percent based on issued shares and 20.06 percent based on estimated shares outstanding. LUKOILs results are subject to factors similar to those of our E&P and R&M segments. LUKOILs upstream results are closely linked to Russian (Urals) crude oil prices and are heavily impacted by extraction tax rates. Refining margins are significant factors on LUKOILs downstream results. Export tariff rates for crude oil and refined products also have a significant impact on both upstream and downstream results.
The Chemicals segment consists of our 50 percent interest in CPChem. The chemicals and plastics industry is mainly a commodity-based industry where the margins for key products are based on market factors over which CPChem has little or no control. CPChem is investing in feedstock-advantaged areas in the Middle East with access to large, growing markets, such as Asia.
The Emerging Businesses segment represents our investment in new technologies or businesses outside our normal scope of operations. Activities within this segment are currently focused on power generation and innovation of new technologies, such as those related to conventional and nonconventional hydrocarbon recovery (including heavy oil), refining, alternative energy, biofuels and the environment. Some of these technologies have the potential to become important drivers of profitability in future years.
RESULTS OF OPERATIONS
A summary of the companys net income (loss) by business segment follows:
2008 vs. 2007
The lower results in 2008 were primarily the result of:
These items were partially offset by:
2007 vs. 2006
The lower results in 2007 were primarily the result of:
These items were partially offset by:
Statement of Operations Analysis
2008 vs. 2007
Sales and other operating revenues increased 28 percent in 2008, while purchased crude oil, natural gas and products increased 37 percent. These increases were mainly the result of higher petroleum product prices and higher prices for crude oil, natural gas and natural gas liquids.
Equity in earnings of affiliates decreased 16 percent in 2008, reflecting:
These negative results were somewhat offset by improved results from the FCCL Oil Sands Partnership, DCP Midstream, LUKOIL (excluding the investment impairment), and CFJ Properties.
Other income decreased 45 percent during 2008, mainly due to a lower net benefit from asset rationalization efforts, the release in 2007 of escrowed funds associated with our Hamaca joint venture in Venezuela, and the settlement of retroactive adjustments for crude oil quality differentials on Trans-Alaska Pipeline System shipments (Quality Bank) in 2007.
Exploration expenses increased 33 percent during 2008, reflecting increased dry hole costs and higher expenses for post-discovery feasibility and development planning studies.
Impairments increased from $5,030 million in 2007 to $34,539 million in 2008. This increase reflects a $25,443 million goodwill impairment recorded during 2008 in our E&P segment. Also contributing to the increase was a $7,410 million impairment of our LUKOIL investment taken during 2008. These 2008 impairments were partially offset by a 2007 impairment of $4,588 million related to the expropriation of our oil interests in Venezuela.
Other impairments increased $1,244 million during 2008 primarily due to property impairments taken in response to a significantly diminished outlook for crude oil and natural gas prices, refining margins and power spreads, as well as in response to revised capital spending plans. For additional information, see Note 7Investments, Loans, and Long-Term Receivables, Note 9Goodwill and Intangibles, and Note 10Impairments, in the Notes to Consolidated Financial Statements.
Interest and debt expense decreased 25 percent in 2008, primarily due to lower average interest rates, as well as the absence of 2007 interest expense related to the Alaska Quality Bank settlements.
Foreign currency transaction losses incurred during 2008 totaled $117 million, compared with foreign currency transaction gains of $201 million in 2007. This change occurred as the Canadian dollar, Russian rouble, British pound, and euro all weakened against the U.S. dollar during 2008, compared with the strengthening of these currencies against the U.S. dollar in 2007.
See Note 21Income Taxes, in the Notes to Consolidated Financial Statements, for information regarding our income tax expense and effective tax rate.
2007 vs. 2006
Equity in earnings of affiliates increased 21 percent in 2007. The increase reflects earnings from WRB and FCCL, our downstream and upstream business ventures with EnCana, formed in January 2007. Also, we had improved results from LUKOIL, reflecting higher estimated commodity prices and volumes, and an increase in our average equity ownership percentage. These increases were partially offset by lower earnings from Hamaca and Petrozuata, our heavy oil joint ventures expropriated by Venezuela in the second quarter of 2007. Additionally, CPChem reported lower earnings, primarily due to lower olefins and polyolefins margins.
Other income increased 188 percent during 2007, primarily due to:
These increases were partially offset by the recognition in 2006 of recoveries on business interruption insurance claims attributable to losses sustained from hurricanes in 2005.
Exploration expenses increased 21 percent during 2007, primarily reflecting the amortization of unproved North American leaseholds obtained in the Burlington Resources acquisition and the impairment of an international exploration license. The increase also reflects higher geological and geophysical expenses and higher dry hole costs.
Depreciation, depletion and amortization increased 14 percent during 2007, primarily resulting from the addition of Burlington Resources assets in the E&P segments depreciable asset base for a full year in 2007 versus only nine months in 2006.
Impairments reflects an impairment of $4,588 million related to the expropriation of our oil interests in Venezuela recorded in the second quarter of 2007. Impairments unrelated to the expropriation decreased 35 percent during 2007, primarily due to impairments recorded in 2006 of certain assets held for sale in the R&M segment, comprised of properties, plants and equipment, trademark intangibles and goodwill.
Interest and debt expense increased 15 percent during 2007, primarily due to the interest expense component of the Alaska Quality Bank settlements, as well as higher expense associated with the funding requirements for the business venture with EnCana.
Foreign currency transaction gains during 2007 primarily reflect the strengthening of the Canadian dollar against the U.S. dollar.
The E&P segment explores for, produces, transports and markets crude oil, natural gas and natural gas liquids on a worldwide basis. It also mines deposits of oil sands in Canada to extract the bitumen and upgrade it into a synthetic crude oil. At December 31, 2008, our E&P operations were producing in the United States, Norway, the United Kingdom, Canada, Ecuador, Australia, offshore Timor-Leste in the Timor Sea, Indonesia, China, Vietnam, Libya, Nigeria, Algeria and Russia.
2008 vs. 2007
The E&P segment recorded a net loss of $13,479 million during 2008. This amount includes a $25,443 million before- and after-tax complete impairment of E&P segment goodwill. In 2007, the E&P segment had net income of $4,615 million, which includes the impact of a $4,588 million before-tax impairment ($4,512 million after-tax) related to the expropriation of our oil interests in Venezuela. For additional information, see the Goodwill Impairment section of Note 9Goodwill and Intangibles, and the Expropriated Assets section of Note 10Impairments, in the Notes to Consolidated Financial Statements, which are incorporated herein by reference.
The decrease in net income was attributed to the goodwill impairment, higher taxes other than income (mainly in Alaska), lower production volumes, higher operating and exploration costs, increased impairments and depreciation expense, and the absence of a 2007 benefit related to release of escrowed funds associated with our Hamaca joint venture in Venezuela. The decrease was partially offset by the absence of the 2007 Venezuela impairment, as well as higher crude oil, natural gas and natural gas liquids prices. During 2008, our E&P segment recognized property impairment charges totaling $511 million after-tax, mostly due to revised capital spending plans as a result of current project economics, as well as a significantly diminished outlook for commodity prices. A large portion of these impairments relate to fields in the U.S. Lower 48 and Canada.
E&Ps results for 2008 reflect an average realized worldwide selling price of $93.12 per barrel of crude oil. In contrast, our average realized worldwide crude oil price per barrel in December 2008 was $37.23. If average crude oil prices in 2009 do not increase appreciably from the low levels at year-end 2008, we would expect E&Ps 2009 results to be negatively impacted.
Proved reserves at year-end 2008 were 8.08 billion barrels of oil equivalent (BOE), compared with 8.72 billion at year-end 2007. This excludes the estimated 1,893 million BOE and 1,838 million BOE included in the LUKOIL Investment segment at year-end 2008 and 2007, respectively. Also excluded is our share of Canadian Syncrude, which was 249 million barrels at year-end 2008, compared with 221 million at year-end 2007.
Net income from our U.S. E&P operations increased 17 percent, primarily due to higher crude oil, natural gas and natural gas liquids prices. The increase was partially offset by higher production taxes (mainly in Alaska), lower volumes, an increase in impairments of properties in the Lower 48, and higher operating costs.
E&P production on a BOE basis averaged 775,000 per day in 2008, a decrease of 8 percent from 843,000 in 2007. The production decrease was primarily due to field decline and unplanned downtime in the Lower 48 reflecting the impact of hurricane disruptions.
Net income from our international E&P operations increased from $367 million in 2007 to $6,976 million in 2008. The increase was attributed to the impact of the Venezuelan impairment on our prior-year results and higher crude oil, natural gas and natural gas liquids prices. The increase was partially offset by higher depreciation expense due to increased rates and new assets being placed in service, increased taxes other than income, higher operating costs, and the absence of a 2007 benefit related to release of escrowed funds associated with our Hamaca joint venture in Venezuela.
International E&P production averaged 992,000 BOE per day in 2008, a decrease of 2 percent from 1,014,000 in 2007. Decreases in production were caused by field decline and the expropriation of our Venezuelan oil interests. These decreases were mostly offset by increased production from new developments
in the United Kingdom, Indonesia, Russia, Norway and Canada. Our Syncrude mining operations produced 22,000 barrels per day in 2008, compared with 23,000 barrels per day in 2007.
In regards to our Venezuelan assets expropriated during 2007, we filed a request for international arbitration on November 2, 2007, with the International Centre for Settlement of Investment Disputes (ICSID), an arm of the World Bank. The request was registered by ICSID on December 13, 2007. The tribunal of three arbitrators is constituted, and the arbitration proceeding is under way.
In October 2007, the government of Ecuador increased the tax rate of the Windfall Profits Tax Law implemented in 2006, increasing the amount of government royalty entitlement on crude oil production to 99 percent of any increase in the price of crude oil above a contractual reference price. In April 2008, we initiated arbitration with ICSID against The Republic of Ecuador and PetroEcuador as a result of the governments confiscatory fiscal measures enacted in 2006 and 2007, as well as the government-mandated renegotiation of our production sharing contracts into service agreements with inferior fiscal and legal terms. The arbitration has been registered by ICSID, the arbitration tribunal is fully constituted and the case is proceeding.
In Canada, the Alberta provincial government changed the royalty structure for Crown lands, effective January 1, 2009. A component of the new royalty rate calculation for each well will be based on prevailing prices, and therefore we expect that our reported production and reserve volumes will move inversely with changes in commodity prices. This change will impact both our conventional western Canada natural gas and oil business and our oil sands operations.
2007 vs. 2006
Net income from the E&P segment decreased 53 percent in 2007. In the second quarter of 2007, we recorded a noncash impairment of $4,588 million before-tax ($4,512 million after-tax) related to the expropriation of our oil interests in Venezuela. The decrease in net income during 2007 reflects this impairment, as well as lower crude oil production, higher production taxes and operating costs, and higher DD&A expense. These decreases were partially offset by:
Proved reserves at year-end 2007 were 8.72 billion BOE, compared with 9.36 billion at year-end 2006. This excludes the estimated 1,838 million BOE and 1,805 million BOE included in the LUKOIL Investment segment at year-end 2007 and 2006, respectively. Also excluded is our share of Canadian Syncrude, which was 221 million barrels at year-end 2007, compared with 243 million at year-end 2006.
Net income from our U.S. E&P operations decreased 2 percent, primarily due to higher production taxes in Alaska, higher operating costs and DD&A expense, and lower crude oil production. These decreases were mostly offset by:
In December 2007, the state of Alaska enacted new production tax legislation, with retroactive provisions, which results in a higher production tax structure for ConocoPhillips.
U.S. E&P production averaged 843,000 BOE per day in 2007, an increase of 4 percent from 808,000 in 2006. Production was impacted by the inclusion of the Burlington Resources assets for the full year of 2007, offset slightly by field decline.
Net income from our international E&P operations decreased 93 percent, primarily due to the impairment of expropriated assets in Venezuela, lower crude oil production, higher DD&A expense, and higher operating costs. These decreases were partially offset by higher crude oil and natural gas prices, a net benefit from asset rationalization efforts, and the benefit from the release of the escrowed funds related to the Hamaca project. International E&P production averaged 1,014,000 BOE per day in 2007, a decrease of 10 percent from 1,128,000 in 2006. Production was impacted by the expropriation of our Venezuelan oil projects, planned and unplanned downtime in Australia and the North Sea, production sharing contract impacts in Australia, our exit from Dubai, and the effect of asset dispositions. These decreases were slightly offset by new production volumes from our FCCL upstream business venture with EnCana, as well as inclusion of the Burlington Resources assets for the full year of 2007. Our Syncrude mining operations produced 23,000 barrels per day in 2007, compared with 21,000 in 2006.
During 2006, significant tax legislation was enacted in the United Kingdom and in Canada. The United Kingdom increased income tax rates on upstream income, resulting in a negative earnings impact of $470 million to adjust 2006 taxes and restate deferred tax liabilities. In Canada, an overall rate reduction in 2006 resulted in a favorable earnings impact of $401 million to restate deferred tax liabilities.
The Midstream segment purchases raw natural gas from producers and gathers natural gas through an extensive network of pipeline gathering systems. The natural gas is then processed to extract natural gas liquids from the raw gas stream. The remaining residue gas is marketed to electrical utilities, industrial users, and gas marketing companies. Most of the natural gas liquids are fractionatedseparated into individual components like ethane, butane and propaneand marketed as chemical feedstock, fuel or blendstock. The Midstream segment consists of our 50 percent equity investment in DCP Midstream, as well as our other natural gas gathering and processing operations, and natural gas liquids fractionation and marketing businesses, primarily in the United States and Trinidad.
2008 vs. 2007
Net income from the Midstream segment increased 19 percent in 2008. The increase was primarily due to higher realized natural gas liquids prices, partially offset by higher operating costs and higher depreciation expense.
2007 vs. 2006
Net income from the Midstream segment decreased 5 percent in 2007, reflecting a shift in natural gas purchase contract terms that are more favorable to natural gas producers. In addition, earnings from DCP Midstream were lower, primarily due to increased operating costs, mainly repairs, maintenance and asset integrity work. The results also reflect a positive tax adjustment included in the 2006 results. These decreases were partially offset by higher natural gas liquids prices.
The R&M segments operations encompass refining crude oil and other feedstocks into petroleum products (such as gasoline, distillates and aviation fuels); buying, selling and transporting crude oil; and buying, transporting, distributing and marketing petroleum products. R&M has operations mainly in the United States, Europe and the Asia Pacific region.
2008 vs. 2007
Net income from the R&M segment decreased 61 percent in 2008. The results were lower due to decreases in U.S. refining margins and volumes, increased property impairments, higher operating costs, a reduced benefit from asset rationalization efforts, and lower international marketing and refining volumes due to asset sales. During 2008, our R&M segment had property impairments totaling $511 million after-tax, mostly due to a significantly diminished outlook for refining margins. These R&M decreases were partially offset by higher international marketing margins.
During 2008, our worldwide refining capacity utilization rate was 90 percent, compared with 94 percent in 2007. We expect our 2009 rate to be similar to our rate in 2008.
Net income from our U.S. R&M operations decreased 67 percent in 2008. The decrease was primarily the result of lower refining margins and, to a lesser extent, lower refining volumes and higher turnaround and utility costs. In addition, property impairments increased in 2008, including an impairment related to one of our U.S. refineries.
Our U.S. refining capacity utilization rate was 92 percent in 2008, compared with 96 percent in 2007. The decline in the current-year rate resulted mainly from refinery optimization and unplanned downtime including impacts from hurricanes on our U.S. Gulf Coast refineries.
Net income from our international R&M operations decreased 40 percent in 2008. Contributing to the decrease were higher property impairments, including impacts from a 2008 impairment of a refinery in Europe and the absence of a 2007 benefit related to an increase in the fair value of previously impaired assets held for sale. Net income for 2008 was also impacted by a reduced net benefit from asset rationalization efforts, negative foreign currency exchange impacts, the absence of a $141 million 2007 German tax legislation benefit, and lower refining and marketing volumes due to asset sales. Higher international refining and marketing margins partially offset these decreases.
Our international refining capacity utilization rate was 85 percent in 2008, compared with 90 percent during the previous year. The utilization rate was primarily impacted by reduced crude throughput at our Wilhelmshaven refinery due to economic conditions and planned maintenance.
2007 vs. 2006
Net income from the R&M segment increased 32 percent in 2007. The increase resulted primarily from:
These increases were partially offset by the net impact of our contribution of assets to WRB Refining LLC, foreign currency impacts, and lower marketing sales volumes due to asset sales.
Net income from our U.S. R&M operations increased 18 percent in 2007, primarily due to:
These items were partially offset by the net impact of our contribution of the Wood River and Borger refineries to WRB, and the impact of business interruption insurance recoveries on our 2006 results. Our U.S. refining capacity utilization rate was 96 percent in 2007, compared with 92 percent in 2006, primarily reflecting lower planned maintenance and less weather-related downtime.
Net income from our international R&M operations increased 131 percent in 2007, due primarily to:
These increases were partially offset by foreign currency impacts and lower marketing volumes due to the asset sales. Our international refining capacity utilization rate was 90 percent in 2007, compared with 91 percent in 2006. The 2007 utilization rate was affected by a temporary idling of the Wilhelmshaven refinery in Germany during the month of August due to economic conditions.
This segment represents our investment in the ordinary shares of LUKOIL, an international, integrated oil and gas company headquartered in Russia, which we account for under the equity method. At December 31, 2008, our ownership interest in LUKOIL was 20 percent based on authorized and issued shares. Our ownership interest based on estimated shares outstanding, used for equity method accounting, was 20.06 percent at that date.
Because LUKOILs accounting cycle close and preparation of U.S. generally accepted accounting principles financial statements occur subsequent to our reporting deadline, our equity earnings and statistics for our LUKOIL investment are estimated based on current market indicators, publicly available LUKOIL information, and other objective data. Once the difference between actual and estimated results is known, an adjustment is recorded. This estimate-to-actual adjustment will be a recurring component of future-period results. In addition to our estimated equity share of LUKOILs earnings, this segment reflects the amortization of the basis difference between our equity interest in the net assets of LUKOIL and the book value of our investment. The segment also includes the costs associated with our employees seconded to LUKOIL.
2008 vs. 2007
The LUKOIL Investment segment had a $5,488 million net loss during 2008, compared with $1,818 million of net income in 2007. The 2008 results include a $7,410 million noncash, before- and after-tax impairment of our LUKOIL investment taken during the fourth quarter. For additional information, see the LUKOIL section of Note 7Investments, Loans and Long-Term Receivables, in the Notes to Consolidated Financial Statements, which is incorporated herein by reference.
Excluding the impact of the impairment, income from the LUKOIL Investment segment increased 6 percent in 2008. This increase was primarily due to higher estimated realized prices of both refined product and crude oil sales. Partially offsetting these positive impacts were higher estimated extraction taxes and higher estimated crude and refined product export tariff rates, as well as higher estimated operating costs and lower estimated crude volumes.
The adjustment to estimated results for the fourth quarter of 2007, recorded in 2008, decreased net income $16 million, compared with a $19 million decrease to net income recorded in 2007 to adjust the estimated results for the fourth quarter of 2006.
2007 vs. 2006
Net income from the LUKOIL Investment segment increased 28 percent during 2007, primarily due to higher estimated realized prices, higher estimated volumes, and an increase in our average equity ownership. The increase was partially offset by higher estimated taxes and operating costs, as well as the net impact from the alignment of estimated net income to reported results. The adjustment to estimated results for the fourth quarter of 2006, recorded in 2007, decreased net income $19 million, compared with a $71 million increase to net income recorded in 2006 to adjust the estimated results for the fourth quarter of 2005.
The Chemicals segment consists of our 50 percent interest in Chevron Phillips Chemical Company LLC (CPChem), which we account for under the equity method. CPChem uses natural gas liquids and other feedstocks to produce petrochemicals. These products are then marketed and sold, or used as feedstocks to produce plastics and commodity chemicals.
2008 vs. 2007
Net income from the Chemicals segment decreased 69 percent in 2008 due to higher utilities and other operating costs, the absence of 2007 one-time tax benefits, lower specialties, aromatics and styrenics margins, and lower olefins and polyolefins volumes. Increases in olefins and polyolefins margins somewhat offset these negative effects. Business conditions in the chemicals and plastics industry are expected to remain challenging in the near term.
2007 vs. 2006
Net income from the Chemicals segment decreased 27 percent during 2007, primarily due to lower olefins and polyolefins margins and higher turnaround and weather-related repair costs, offset partially by a capital-loss tax benefit of $65 million recorded in the fourth quarter of 2007.
The Emerging Businesses segment represents our investment in new technologies or businesses outside our normal scope of operations. Activities within this segment are currently focused on power generation and innovation of new technologies, such as those related to conventional and nonconventional hydrocarbon recovery (including heavy oil), refining, alternative energy, biofuels, and the environment.
2008 vs. 2007
Emerging Businesses reported net income of $30 million in 2008, compared with a net loss of $8 million in 2007. The increase primarily reflects improved international power generation results, including the impact of higher spark spreads. These benefits were partially offset by an $85 million after-tax impairment of a U.S. cogeneration power plant, as well as by lower domestic power results.
2007 vs. 2006
The Emerging Businesses segment had a net loss of $8 million in 2007, compared with net income of $15 million in 2006. The decrease reflects lower margins from the Immingham power plant in the United Kingdom, as well as higher spending associated with alternative energy programs. These decreases were slightly offset by the inclusion of a write-down of a damaged gas turbine at a domestic power plant in 2006 results.
Corporate and Other
2008 vs. 2007
Net interest consists of interest and financing expense, net of interest income and capitalized interest, as well as premiums incurred on the early retirement of debt. In 2008, net interest decreased 32 percent primarily due to lower average interest rates and a higher effective tax rate. Corporate general and administrative expenses increased 15 percent in 2008, mainly as a result of increased charitable contributions. Acquisition-related costs in 2007 included transition costs associated with the Burlington Resources acquisition. The category Other includes certain foreign currency transaction gains and losses, environmental costs associated with sites no longer in operation, and other costs not directly associated with an operating segment. Other expenses increased in 2008 due to various tax-related adjustments, partially offset by lower foreign currency losses.
2007 vs. 2006
Net interest decreased 6 percent in 2007, primarily due to higher amounts of interest being capitalized, partially offset by a premium on the early retirement of debt. Corporate general and administrative expenses increased 32 percent in 2007, primarily due to higher benefit-related expenses. Acquisition-related costs in 2007 included transition costs associated with the Burlington Resources acquisition. Results from Other were primarily impacted by foreign currency losses in 2007.
CAPITAL RESOURCES AND LIQUIDITY
To meet our short- and long-term liquidity requirements, we look to a variety of funding sources. Cash generated from operating activities is the primary source of funding. In addition, during 2008 we raised $1,640 million in proceeds from asset dispositions. During 2008, available cash was used to support our ongoing capital expenditures and investments program, repurchase shares of our common stock, provide loan financing to certain equity affiliates, pay dividends, and meet the funding requirements to FCCL Oil Sands Partnership. Total dividends paid on our common stock during the year were $2,854 million. During 2008, cash and cash equivalents decreased $701 million to $755 million.
In addition to cash flows from operating activities and proceeds from asset sales, we rely on our commercial paper and credit facility programs, and our shelf registration statements to support our short- and long-term liquidity requirements. The credit markets, including the commercial paper markets in the United States, have recently experienced adverse conditions. Although we have not been materially impacted by these conditions, continuing volatility in the credit markets may increase costs associated with issuing commercial paper or other debt instruments due to increased spreads over relevant interest rate benchmarks. Such volatility may also affect our ability, or the ability of third parties with whom we seek to do business, to access those credit markets. Notwithstanding these adverse market conditions, we believe current cash and short-term investment balances and cash generated by operations, together with access to external sources of funds as described below in the Significant Sources of Capital section, will be sufficient to meet our funding requirements in the near- and long-term, including our capital spending program, dividend payments, required debt payments and the funding requirements to FCCL.
Significant Sources of Capital
During 2008, cash of $22,658 million was provided by operating activities, an 8 percent decrease from cash from operations of $24,550 million in 2007. Contributing to the decrease were lower U.S. refining margins and volumetric inventory builds in our R&M segment in 2008, versus reductions in 2007. These factors were partially offset by higher commodity prices in our E&P segment.
During 2007, cash flow from operations increased $3,034 million to $24,550 million. Contributing to the improvement over 2006 results was a planned inventory reduction in the 2007 period, partially related to the formation of the WRB downstream business venture; the impact of the Burlington Resources acquisition late in the first quarter of 2006; and higher worldwide crude oil prices in 2007. These positive factors were partially offset by the absence of dividends from our Venezuelan operations in 2007.
While the stability of our cash flows from operating activities benefits from geographic diversity and the effects of upstream and downstream integration, our short- and long-term operating cash flows are highly dependent upon prices for crude oil, natural gas and natural gas liquids, as well as refining and marketing margins. During 2008 and 2007, we benefited from favorable crude oil and natural gas prices, although these prices deteriorated significantly in the fourth quarter of 2008. Prices and margins are driven by market conditions over which we have no control. Absent other mitigating factors, as these prices and margins fluctuate, we would expect a corresponding change in our operating cash flows.
The level of our production volumes of crude oil, natural gas and natural gas liquids also impacts our cash flows. These production levels are impacted by such factors as acquisitions and dispositions of fields, field production decline rates, new technologies, operating efficiency, weather conditions, the addition of proved reserves through exploratory success, and the timely and cost-effective development of those proved reserves. While we actively manage these factors, production levels can cause variability in cash flows, although historically this variability has not been as significant as that caused by commodity prices.
Our production for 2008, including our share of production from equity affiliates, averaged 2.21 million BOE per day. Future production is subject to numerous uncertainties, including, among others, the volatile crude oil and natural gas price environment, which may impact project investment decisions; the price effect of production sharing contracts; changes in fiscal terms of projects; project delays; and weather-related disruptions. Although actual year-to-year production levels will vary, based on our current outlook and planning assumptions, we project no material change in annual production levels from 2008 through 2013.
To maintain or grow our production volumes, we must continue to add to our proved reserve base. Our reserve replacement in 2008, including equity affiliates, was 31 percent. The 2008 reserve replacement was adversely impacted by low year-end commodity prices, which resulted in significant negative reserve revisions. Our 2008 reserve replacement from consolidated operations and from our equity affiliates was a negative 23 percent and a positive 224 percent, respectively. Over the three-year period ending December 31, 2008, our reserve replacement was 124 percent. This was comprised of a reserve replacement from consolidated operations of 115 percent and from equity affiliates of 153 percent. The purchase of reserves in place was a significant factor in replacing our reserves over the past three-year period, partially offset by the expropriation of our Venezuelan oil assets. Significant purchases during this three-year period included reserves added as part of the 2008 Origin Energy joint venture, the 2007 EnCana business venture, and the 2006 acquisition of Burlington Resources, as well as proved reserves added through our investments in LUKOIL in 2006. The reserve replacement amounts above were based on the sum of our net additions (revisions, improved recovery, purchases, extensions and discoveries, and sales) divided by our production, as shown in our reserve table disclosures in the Oil and Gas Operations section of this report.
We are developing and pursuing projects we anticipate will allow us to add to our reserve base. However, access to additional resources has become increasingly difficult as direct investment is prohibited in some nations, while fiscal and other terms in other countries can make projects uneconomic or unattractive. In addition, political instability, competition from national oil companies, and lack of access to high-potential areas due to environmental or other regulation may negatively impact our ability to increase our reserve base. As such, the timing and level at which we add to our reserve base may, or may not, allow us to replace our production over subsequent years.
As discussed in the Critical Accounting Estimates section, engineering estimates of proved reserves are imprecise, and therefore, each year reserves may be revised upward or downward due to the impact of changes in oil and gas prices or as more technical data becomes available on reservoirs. In 2008 and 2006, revisions decreased our reserves, while in 2007 revisions increased reserves. It is not possible to reliably predict how
revisions will impact reserve quantities in the future. See the Capital Spending section for an analysis of proved undeveloped reserves.
In addition, the level and quality of output from our refineries impacts our cash flows. The output at our refineries is impacted by such factors as operating efficiency, maintenance turnarounds, feedstock availability and weather conditions. We actively manage the operations of our refineries and, typically, any variability in their operations has not been as significant to cash flows as that caused by refining margins.
In 2006, we received approximately $1.1 billion in distributions from two heavy-oil projects in Venezuela. The majority of these distributions represented operating results from previous years. We did not receive an operating distribution related to these projects in 2007 or 2008.
Proceeds from asset sales in 2008 were $1,640 million, compared with $3,572 million in 2007. The amounts for both periods are mainly due to asset rationalization efforts related to the program we announced in April 2006 to dispose of assets that no longer fit into our strategic plans or those that could bring more value by being monetized in the near term. We do not expect any material asset dispositions in 2009 beyond the sale of our U.S. retail marketing assets. In January 2009, we closed on the sale of a large part of these assets, which included seller financing in the form of a $370 million five-year note and letters of credit totaling $54 million.
Commercial Paper and Credit Facilities
At December 31, 2008, we had two revolving credit facilities totaling $9.85 billion, consisting of a $7.35 billion facility, expiring in September 2012, and a $2.5 billion facility scheduled to expire in September 2009 (terminated in early 2009, see the Shelf Registrations section below). The $7.35 billion facility was reduced from $7.5 billion during the third quarter of 2008 due to the bankruptcy of Lehman Commercial Paper Inc., one of the revolver participants. The $2.5 billion facility is a 364-day bank facility entered into during October 2008 to provide additional support of a temporary expansion of our commercial paper program. We expanded our commercial paper program to ensure adequate liquidity after the initial funding of our transaction with Origin Energy. For additional information on the Origin transaction, see Note 7Investments, Loans and Long-Term Receivables, in the Notes to Consolidated Financial Statements.
Our revolving credit facilities may be used as direct bank borrowings, as support for issuances of letters of credit totaling up to $750 million, as support for our commercial paper programs, or as support of up to $250 million on commercial paper issued by TransCanada Keystone Pipeline LP, a Keystone pipeline joint venture entity. The revolving credit facilities are broadly syndicated among financial institutions and do not contain any material adverse change provisions or any covenants requiring maintenance of specified financial ratios or ratings. The facility agreements contain a cross-default provision relating to the failure to pay principal or interest on other debt obligations of $200 million or more by ConocoPhillips, or by any of its consolidated subsidiaries.
Our primary funding source for short-term working capital needs is the ConocoPhillips $8.1 billion commercial paper program. Commercial paper maturities are generally limited to 90 days. We also have the ConocoPhillips Qatar Funding Ltd. $1.5 billion commercial paper program, which is used to fund commitments relating to the Qatargas 3 project. At December 31, 2008 and 2007, we had no direct outstanding borrowings under the revolving credit facilities, but $40 million and $41 million, respectively, in letters of credit had been issued. In addition, under both commercial paper programs, there was $6,933 million of commercial paper outstanding at December 31, 2008, compared with $725 million at December 31, 2007. Since we had $6,933 million of commercial paper outstanding, had issued $40 million of letters of credit and had up to a $250 million guarantee on commercial paper issued by Keystone, we had access to $2.6 billion in borrowing capacity under our revolving credit facilities at December 31, 2008.
We have a universal shelf registration statement on file with the U.S. Securities and Exchange Commission (SEC) under which we, as a well-known seasoned issuer, have the ability to issue and sell an indeterminate amount of various types of debt and equity securities. Under this shelf registration, in May 2008 we issued notes consisting of $400 million of 4.40% Notes due 2013, $500 million of 5.20% Notes due 2018 and
$600 million of 5.90% Notes due 2038. The proceeds from the offering were used at that time to reduce commercial paper and for general corporate purposes.
Also under this shelf registration, in early 2009 we issued $1.5 billion of 4.75% Notes due 2014, $2.25 billion of 5.75% Notes due 2019, and $2.25 billion of 6.50% Notes due 2039. The proceeds of the notes were primarily used to reduce outstanding commercial paper balances. Under the terms of the $2.5 billion, 364-day revolving credit facility noted above, the receipt of the proceeds from this bond offering terminated this revolving credit facility.
Our senior long-term debt is rated A1 by Moodys Investor Service and A by both Standard and Poors Rating Service and Fitch, unchanged from December 31, 2008. We do not have any ratings triggers on any of our corporate debt that would cause an automatic default, and thereby impact our access to liquidity, in the event of a downgrade of our credit rating. In the event our credit rating deteriorates to a level prohibiting us from accessing the commercial paper market, we would still be able to access funds under our $7.35 billion revolving credit facility.
We also have on file with the SEC a shelf registration statement under which ConocoPhillips Canada Funding Company I and ConocoPhillips Canada Funding Company II, both wholly owned subsidiaries, could issue an indeterminate amount of senior debt securities, fully and unconditionally guaranteed by ConocoPhillips and ConocoPhillips Company.
At December 31, 2008, we had outstanding $1,100 million of equity in less than wholly owned consolidated subsidiaries held by minority interest owners, including a minority interest of $507 million in Ashford Energy Capital S.A. The remaining minority interest amounts are primarily related to operating joint ventures we control. The largest of these, amounting to $580 million, was related to Darwin LNG, an operation located in Australias Northern Territory.
In December 2001, in order to raise funds for general corporate purposes, ConocoPhillips and Cold Spring Finance S.a.r.l. formed Ashford Energy Capital S.A. through the contribution of a $1 billion ConocoPhillips subsidiary promissory note and $500 million cash by Cold Spring. Through its initial $500 million investment, Cold Spring is entitled to a cumulative annual preferred return consisting of 1.32 percent plus a three-month LIBOR rate set at the beginning of each quarter. The preferred return at December 31, 2008, was 5.37 percent. In 2008, Cold Spring declined its option to remarket its investment in Ashford. This option remains available in 2018 and at each 10-year anniversary thereafter. If remarketing is unsuccessful, we could be required to provide a letter of credit in support of Cold Springs investment, or in the event such a letter of credit is not provided, cause the redemption of Cold Springs investment in Ashford. Should our credit rating fall below investment grade, Ashford would require a letter of credit to support $475 million of the term loans, as of December 31, 2008, made by Ashford to other ConocoPhillips subsidiaries. If the letter of credit is not obtained within 60 days, Cold Spring could cause Ashford to sell the ConocoPhillips subsidiary notes. At December 31, 2008, Ashford held $2.0 billion of ConocoPhillips subsidiary notes and $28 million in investments unrelated to ConocoPhillips. We report Cold Springs investment as a minority interest because it is not mandatorily redeemable, and the entity does not have a specified liquidation date. Other than the obligation to make payment on the subsidiary notes described above, Cold Spring does not have recourse to our general credit.
Off-Balance Sheet Arrangements
As part of our normal ongoing business operations and consistent with normal industry practice, we enter into numerous agreements with other parties to pursue business opportunities, which share costs and apportion risks among the parties as governed by the agreements. At December 31, 2008, we were liable for certain contingent obligations under the following contractual arrangements:
For additional information about guarantees, see Note 14Guarantees, in the Notes to Consolidated Financial Statements, which is incorporated herein by reference.
Our debt balance at December 31, 2008, was $27.5 billion, an increase of $5.8 billion during 2008, and our debt-to-capital ratio was 33 percent at year-end 2008, versus 19 percent at the end of 2007. The increase in the debt-to-capital ratio was mainly due to noncash impairments taken in the fourth quarter of 2008 and the increase in debt. Our debt-to-capital target range is 20 percent to 25 percent.
In January 2008, we reduced our Floating Rate Five-Year Term Note due 2011 from $3 billion to $2 billion, with a subsequent reduction in June 2008 to $1.5 billion. In March 2008, we redeemed our $300 million 7.125% Debentures due 2028 at a premium of $8 million, plus accrued interest.
On January 3, 2007, we closed on a business venture with EnCana. As part of this transaction, we are obligated to contribute $7.5 billion, plus accrued interest, over a 10-year period, beginning in 2007, to the upstream business venture, FCCL, formed as a result of the transaction. An initial contribution of $188 million was made upon closing in January. Quarterly principal and interest payments of $237 million began in the second quarter of 2007, and will continue until the balance is paid. Of the principal obligation amount, approximately $625 million is short-term and was included in the Accounts payablerelated parties line on our December 31, 2008, consolidated balance sheet. The principal portion of these payments, which totaled $593 million in 2008, was included in the Other line in the financing activities section of our consolidated statement of cash flows. Interest accrues at a fixed annual rate of 5.3 percent on the unpaid principal balance. Fifty percent of the quarterly interest payments was reflected as an additional capital contribution and was included in the Capital expenditures and investments line on our consolidated statement of cash flows.
On July 9, 2007, we announced plans to repurchase up to $15 billion of our common stock through the end of 2008. This amount included $2 billion remaining under a previously announced program. At year-end 2007, approximately $10.1 billion remained authorized for share repurchases in 2008. During 2008, we repurchased 103.7 million shares of our common stock at a cost of $8.2 billion.
In December 2005, we entered into a credit agreement with Qatargas 3, whereby we will provide loan financing of approximately $1.2 billion for the construction of an LNG train in Qatar. This financing will represent 30 percent of the projects total debt financing. Through December 31, 2008, we had provided $835 million in loan financing, and an additional $76 million of accrued interest.
In 2004, we finalized our transaction with Freeport LNG Development, L.P. to participate in an LNG receiving terminal in Quintana, Texas, for which construction began in early 2005. We do not have an ownership interest in the facility, but we do have a 50 percent interest in the general partnership managing the venture, along with contractual rights to regasification capacity of the terminal. We entered into a credit agreement with Freeport to provide loan financing for the construction of the facility. The terminal became operational in June 2008, and in August 2008, the loan was converted from a construction loan to a term loan and consisted of $650 million in loan financing and $124 million of accrued interest. Freeport began making repayments in September 2008, and the loan balance outstanding at December 31, 2008, was $757 million.
In 2004, ConocoPhillips and LUKOIL agreed to the expansion of the Varandey terminal as part of our investment in the OOO Naryanmarneftegaz (NMNG) joint venture. We have an obligation to provide loan financing to Varandey Terminal Company for 30 percent of the costs of the terminal expansion, but we will have no governance or ownership interest in the terminal. Terminal construction was completed in June 2008, and the final loan amount was $275 million at December 2008 exchange rates, excluding accrued interest. Although repayments are not required to start until May 2010, Varandey used available cash to repay $12 million of interest in the second half of 2008. The outstanding accrued interest at December 31, 2008, was $38 million at December exchange rates.
Our loans to Qatargas 3, Freeport and Varandey Terminal Company are included in the Loans and advancesrelated parties line on our consolidated balance sheet, while the short-term portion is in Accounts and notes receivablerelated parties.
In February 2009, we announced a quarterly dividend of 47 cents per share. The dividend is payable March 2, 2009, to stockholders of record at the close of business February 23, 2009.
The following table summarizes our aggregate contractual fixed and variable obligations as of December 31, 2008:
Capital Expenditures and Investments
Our capital expenditures and investments for the three-year period ending December 31, 2008, totaled $46.5 billion, with 77 percent going to our E&P segment. Included in these amounts was approximately $4.7 billion related to the October 2008 closing of a transaction with Origin Energy to further enhance our long-term Australasian natural gas business through a 50/50 joint venture named Australia Pacific LNG. The joint venture will focus on coalbed methane production from the Bowen and Surat basins in Queensland, Australia, and LNG processing and export sales. For additional information about the Origin transaction,
see Note 7Investments, Loans and Long-Term Receivables, in the Notes to Consolidated Financial Statements.
Our capital expenditures and investments budget for 2009 is $11.7 billion. Included in this amount is approximately $600 million in capitalized interest. The decline from 2008 spending is primarily due to the closing of the transaction with Origin Energy in 2008 and the deferring or slowing of some projects or programs in 2009, as a result of the current business environment. We plan to direct 81 percent of the capital expenditures and investments budget to E&P and 17 percent to R&M. With the addition of loans to certain affiliated companies and principal contributions related to funding our portion of the FCCL business venture, our total capital program for 2009 is approximately $12.5 billion.
Capital expenditures and investments for E&P during the three-year period ending December 31, 2008, totaled $35.9 billion. The expenditures over this period supported key exploration and development projects including:
2009 CAPITAL EXPENDITURES AND INVESTMENTS BUDGET
E&Ps 2009 capital expenditures and investments budget is $9.5 billion, 43 percent lower than actual expenditures in 2008. The decline is primarily due to the 2008 Origin transaction and the deferring or slowing of some projects or programs. Thirty-seven percent of E&Ps 2009 capital expenditures and investments budget is planned for the United States.
Capital spending for our Alaskan operations is expected to fund Prudhoe Bay, Kuparuk and Western North Slope operations, including the Alpine satellite fields, as well as initiatives to progress DenaliThe Alaska Gas Pipeline, and exploration activities.
In the Lower 48, we expect to make capital expenditures and investments for ongoing development programs in the Permian, San Juan, Williston and Fort Worth basins and the Lobo Trend in South Texas, as well as for development of projects such as the Rockies Express natural gas pipeline.
E&P is directing $6.0 billion of its 2009 capital expenditures and investments budget to international projects. Funds in 2009 will be directed to developing major long-term projects including:
PROVED UNDEVELOPED RESERVES
The net addition of proved undeveloped reserves accounted for 156 percent, 77 percent and 37 percent of our total net additions in 2008, 2007 and 2006, respectively. During these years, we converted, on average, 15 percent per year of our proved undeveloped reserves to proved developed reserves. Of our 2,823 million total BOE proved undeveloped reserves at December 31, 2008, we estimated that the average annual conversion rate for these reserves for the three-year period ending 2011 will be approximately 15 percent.
Costs incurred for the years ended December 31, 2008, 2007 and 2006, relating to the development of proved undeveloped reserves were $4.8 billion, $4.3 billion, and $3.9 billion, respectively. Estimated future development costs relating to the development of proved undeveloped reserves for the years 2009 through 2011 are projected to be $3.9 billion, $3.1 billion, and $2.0 billion, respectively.
Approximately 80 percent of our proved undeveloped reserves at year-end 2008 were associated with 10 major development areas in our E&P segment, and our investment in LUKOIL. Eight of the major development areas within E&P are currently producing and are expected to have proved reserves convert from undeveloped to developed over time as development activities continue and/or production facilities are expanded or upgraded, and include:
The remaining two major projects, Qatargas 3 in Qatar and the Kashagan field in Kazakhstan, will have undeveloped proved reserves convert to developed as these projects begin production.
Capital spending for R&M during the three-year period ending December 31, 2008, was primarily for acquiring additional crude oil refining capacity, clean fuels projects to meet new environmental standards, refinery upgrade projects to improve product yields, the operating integrity of key processing units, as well as for safety projects. During this three-year period, R&M capital spending was $6.7 billion, representing 14 percent of our total capital expenditures and investments.
Key projects during the three-year period included:
Major construction activities in progress include:
2009 CAPITAL EXPENDITURES AND INVESTMENTS BUDGET
R&Ms 2009 capital budget is $2.0 billion, a 12 percent decrease from actual spending in 2008. Domestic spending in 2009 is expected to comprise 71 percent of the R&M budget.
We plan to direct about $1.1 billion of the R&M capital budget to domestic refining, primarily for projects related to sustaining and improving existing business with a focus on safety, regulatory compliance, reliability and capital maintenance. Work continues on projects to expand conversion capability and increase clean product yield, including funding for the San Francisco hydrocracker project. Our U.S. transportation, marketing and specialty businesses are expected to spend about $300 million, including investments in the Keystone project.
Internationally, we plan to spend about $600 million, with a focus on projects related to reliability, safety and the environment, as well as an upgrade project at the Wilhelmshaven, Germany, refinery. The construction bidding process for the refinery project in Yanbu, Saudi Arabia, is currently scheduled to take place in 2009.
Capital spending in our LUKOIL Investment segment during the three-year period ending December 31, 2008, was for purchases of ordinary shares of LUKOIL in 2006 to increase our ownership interest. No additional purchases were made in 2007 or 2008, and none are expected in 2009.
Capital spending for Emerging Businesses during the three-year period ending December 31, 2008, was primarily for an expansion of the Immingham combined heat and power cogeneration plant near the companys Humber refinery in the United Kingdom. In addition, in October 2007, we purchased a 50 percent interest in Sweeny Cogeneration LP.
Legal and Tax Matters
We accrue for non-income-tax-related contingencies when a loss is probable and the amounts can be reasonably estimated. If a range of amounts can be reasonably estimated and no amount within the range is a better estimate than any other amount, then the minimum of the range is accrued. In the case of income-tax-related contingencies, we adopted Financial Accounting Standards Board (FASB) Interpretation No. 48, Accounting for Uncertainty in Income Taxesan interpretation of FASB Statement No. 109 (FIN 48), effective January 1, 2007. FIN 48 requires a cumulative probability-weighted loss accrual in cases where sustaining a tax position is less than certain. Based on currently available information, we believe it is remote that future costs related to known contingent liability exposures will exceed current accruals by an amount that would have a material adverse impact on our consolidated financial statements.
We are subject to the same numerous international, federal, state and local environmental laws and regulations as other companies in the petroleum exploration and production, refining and crude oil and refined product marketing and transportation businesses. The most significant of these environmental laws and regulations include, among others, the:
These laws and their implementing regulations set limits on emissions and, in the case of discharges to water, establish water quality limits. They also, in most cases, require permits in association with new or modified operations. These permits can require an applicant to collect substantial information in connection with the application process, which can be expensive and time-consuming. In addition, there can be delays associated with notice and comment periods and the agencys processing of the application. Many of the delays associated with the permitting process are beyond the control of the applicant.
Many states and foreign countries where we operate also have, or are developing, similar environmental laws and regulations governing these same types of activities. While similar, in some cases these regulations may impose additional, or more stringent, requirements that can add to the cost and difficulty of marketing or transporting products across state and international borders.
The ultimate financial impact arising from environmental laws and regulations is neither clearly known nor easily determinable as new standards, such as air emission standards, water quality standards and stricter fuel regulations continue to evolve. However, environmental laws and regulations, including those that may arise to address concerns about global climate change, are expected to continue to have an increasing impact on our operations in the United States and in other countries in which we operate. Notable areas of potential impacts include air emission compliance and remediation obligations in the United States.
For example, the Energy Policy Act of 2005 imposed obligations to provide increasing volumes on a percentage basis of renewable fuels in transportation motor fuels through 2012. These obligations were changed with the enactment of the Energy Independence & Security Act of 2007, which was signed in late December. The new law requires fuel producers and importers to provide approximately 66 percent more renewable fuels in 2008 as compared with amounts set forth in the Energy Policy Act of 2005, with increases in amounts of renewable fuels required through 2022. We are in the process of establishing implementation, operating and capital strategies, along with advanced technology development, to meet these requirements.
We also are subject to certain laws and regulations relating to environmental remediation obligations associated with current and past operations. Such laws and regulations include CERCLA and RCRA and their state equivalents. Remediation obligations include cleanup responsibility arising from petroleum releases from underground storage tanks located at numerous past and present ConocoPhillips-owned and/or operated petroleum-marketing outlets throughout the United States. Federal and state laws require contamination caused by such underground storage tank releases be assessed and remediated to meet applicable standards. In addition to other cleanup standards, many states adopted cleanup criteria for methyl tertiary-butyl ether (MTBE) for both soil and groundwater.
At RCRA permitted facilities, we are required to assess environmental conditions. If conditions warrant, we may be required to remediate contamination caused by prior operations. In contrast to CERCLA, which is often referred to as Superfund, the cost of corrective action activities under RCRA corrective action programs typically is borne solely by us. Over the next decade, we anticipate increasing expenditures for RCRA remediation activities may be required, but such annual expenditures for the near term are not expected to vary significantly from the range of such expenditures we have experienced over the past few years. Longer-term expenditures are subject to considerable uncertainty and may fluctuate significantly.
We, from time to time, receive requests for information or notices of potential liability from the EPA and state environmental agencies alleging that we are a potentially responsible party under CERCLA or an equivalent state statute. On occasion, we also have been made a party to cost recovery litigation by those agencies or by private parties. These requests, notices and lawsuits assert potential liability for remediation costs at various sites that typically are not owned by us, but allegedly contain wastes attributable to our past operations. As of December 31, 2007, we reported we had been notified of potential liability under CERCLA and comparable state laws at 68 sites around the United States. At December 31, 2008, we re-opened three sites and closed one of those sites, resolved and closed seven sites, and received two new notices of potential liability, leaving 65 unresolved sites where we have been notified of potential liability.
For most Superfund sites, our potential liability will be significantly less than the total site remediation costs because the percentage of waste attributable to us, versus that attributable to all other potentially responsible parties, is relatively low. Although liability of those potentially responsible is generally joint and several for federal sites and frequently so for state sites, other potentially responsible parties at sites where we are a party typically have had the financial strength to meet their obligations, and where they have not, or where potentially responsible parties could not be located, our share of liability has not increased materially. Many of the sites at which we are potentially responsible are still under investigation by the EPA or the state agencies concerned. Prior to actual cleanup, those potentially responsible normally assess site conditions, apportion responsibility and determine the appropriate remediation. In some instances, we may have no liability or attain a settlement of liability. Actual cleanup costs generally occur after the parties obtain EPA or equivalent state agency approval. There are relatively few sites where we are a major participant, and given the timing and
amounts of anticipated expenditures, neither the cost of remediation at those sites nor such costs at all CERCLA sites, in the aggregate, is expected to have a material adverse effect on our competitive or financial condition.
Expensed environmental costs were $957 million in 2008 and are expected to be about $1.0 billion per year in 2009 and 2010. Capitalized environmental costs were $1,025 million in 2008 and are expected to be about $900 million per year in 2009 and 2010.
We accrue for remediation activities when it is probable that a liability has been incurred and reasonable estimates of the liability can be made. These accrued liabilities are not reduced for potential recoveries from insurers or other third parties and are not discounted (except those assumed in a purchase business combination, which we do record on a discounted basis).
Many of these liabilities result from CERCLA, RCRA and similar state laws that require us to undertake certain investigative and remedial activities at sites where we conduct, or once conducted, operations or at sites where ConocoPhillips-generated waste was disposed. The accrual also includes a number of sites we identified that may require environmental remediation, but which are not currently the subject of CERCLA, RCRA or state enforcement activities. If applicable, we accrue receivables for probable insurance or other third-party recoveries. In the future, we may incur significant costs under both CERCLA and RCRA. Considerable uncertainty exists with respect to these costs, and under adverse changes in circumstances, potential liability may exceed amounts accrued as of December 31, 2008.
Remediation activities vary substantially in duration and cost from site to site, depending on the mix of unique site characteristics, evolving remediation technologies, diverse regulatory agencies and enforcement policies, and the presence or absence of potentially liable third parties. Therefore, it is difficult to develop reasonable estimates of future site remediation costs.
At December 31, 2008, our balance sheet included total accrued environmental costs of $979 million, compared with $1,089 million at December 31, 2007. We expect to incur a substantial amount of these expenditures within the next 30 years.
Notwithstanding any of the foregoing, and as with other companies engaged in similar businesses, environmental costs and liabilities are inherent in our operations and products, and there can be no assurance that material costs and liabilities will not be incurred. However, we currently do not expect any material adverse effect upon our results of operations or financial position as a result of compliance with current environmental laws and regulations.
There has been a broad range of proposed or promulgated state, national and international laws focusing on greenhouse gas (GHG) reduction. These proposed or promulgated laws apply or could apply in countries where we have interests or may have interests in the future. Laws in this field continue to evolve, and while they are likely to be increasingly widespread and stringent, at this stage it is not possible to accurately estimate either a timetable for implementation or our future compliance costs relating to implementation. Compliance with changes in laws, regulations and obligations that create a GHG emissions trading scheme or GHG reduction policies generally could significantly increase costs or reduce demand for fossil energy derived products. Examples of legislation or precursors for possible regulation that does or could affect our operations include:
In the EU, we have assets that are subject to the ETS. The first phase of the EU ETS was completed at the end of 2007, with EU ETS phase II running from 2008 through 2012. The European Commission has approved most of the phase II national allocation plans. We are actively engaged to minimize any financial impact from the trading scheme.
In the United States, there is growing consensus that some form of regulation will be forthcoming at the federal level with respect to GHG emissions and such regulation could result in the creation of additional costs in the form of taxes or required acquisition or trading of emission allowances. In light of this consensus, we have taken a position to encourage the adoption of a pragmatic and sustainable regulatory framework addressing GHG. To that end, we joined the U.S. Climate Action Partnership (USCAP) in support of the development of a national regulatory framework to reduce the level of GHG emissions. We support a framework that is economically sustainable, environmentally effective, transparent and fair, and internationally linked. We are working to continuously improve operational and energy efficiency through resource and energy conservation throughout our operations.
We have deferred tax assets related to certain accrued liabilities, loss carryforwards and credit carryforwards. Valuation allowances have been established to reduce these deferred tax assets to an amount that will, more likely than not, be realized. Based on our historical taxable income, our expectations for the future, and available tax-planning strategies, management expects that the net deferred tax assets will be realized as offsets to reversing deferred tax liabilities and as reductions in future taxable income.
NEW ACCOUNTING STANDARDS
In December 2007, the FASB issued Statement of Financial Accounting Standards (SFAS) No. 141 (Revised), Business Combinations (SFAS No. 141(R)). This Statement will apply to all transactions in which an entity obtains control of one or more other businesses. In general, SFAS No. 141(R) requires the acquiring entity in a business combination to recognize the fair value of all the assets acquired and liabilities assumed in the transaction; establishes the acquisition date as the fair value measurement point; and modifies the disclosure requirements. Additionally, it changes the accounting treatment for transaction costs, acquired contingent arrangements, in-process research and development, restructuring costs, changes in deferred tax asset valuation allowances as a result of business combination, and changes in income tax uncertainties after the acquisition date. This Statement applies prospectively to business combinations for which the acquisition date is on or after January 1, 2009. However, starting January 1, 2009, accounting for changes in valuation allowances for acquired deferred tax assets and the resolution of uncertain tax positions for prior business combinations will impact tax expense instead of impacting goodwill.
Also in December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statementsan amendment of ARB No. 51, which requires noncontrolling interests, also called minority interests, to be presented as a separate item in the equity section of the consolidated balance sheet. It also requires the amount of consolidated net income attributable to the noncontrolling interest to be clearly presented on the face of the consolidated income statement. Additionally, this Statement clarifies that changes in a parents ownership interest in a subsidiary that do not result in deconsolidation are equity transactions, and when a subsidiary is deconsolidated, it requires gain or loss recognition in net income based on the fair value on the deconsolidation date. This Statement is effective January 1, 2009, and will be applied prospectively
with the exception of the presentation and disclosure requirements, which must be applied retrospectively for all periods presented.
In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activitiesan amendment of FASB No. 133. This Statement expands disclosure requirements of SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, for derivative instruments within the scope of that Statement to provide greater transparency. This includes disclosure of the additional information regarding how and why derivative instruments are used, how derivatives are accounted for, and how they affect an entitys financial performance. This Statement is effective for interim and annual financial statements beginning with the first quarter of 2009, but it will not have any impact on our consolidated financial statements, other than the additional disclosures.
In November 2008, the FASB reached a consensus on Emerging Issues Task Force Issue No. 08-6, Equity Method Investment Accounting Considerations (EITF 08-6), which was issued to clarify how the application of equity method accounting will be affected by SFAS No. 141(R) and SFAS No. 160. EITF 08-6 clarifies that an entity shall continue to use the cost accumulation model for its equity method investments. It also confirms past accounting practices related to the treatment of contingent consideration and the use of the impairment model under Accounting Principles Board (APB) Opinion No. 18, The Equity Method of Accounting for Investments in Common Stock. Additionally, it requires an equity method investor to account for a share issuance by an investee as if the investor had sold a proportionate share of the investment. This issue is effective January 1, 2009, and will be applied prospectively.
In December 2008, the FASB issued FASB Staff Position (FSP) No. 132(R)-1, Employers Disclosures about Postretirement Benefit Plan Assets, to improve the transparency associated with the disclosures about the plan assets of a defined benefit pension or other postretirement plan. This FSP requires the disclosure of each major asset category at fair value using the fair value hierarchy in SFAS No. 157, Fair Value Measurements. Also, this FSP requires entities to disclose the net periodic benefit cost recognized for each annual period for which a statement of income is presented. This FSP is effective for annual statements beginning with 2009.
CRITICAL ACCOUNTING ESTIMATES
The preparation of financial statements in conformity with generally accepted accounting principles requires management to select appropriate accounting policies and to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. See Note 1Accounting Policies, in the Notes to Consolidated Financial Statements, for descriptions of our major accounting policies. Certain of these accounting policies involve judgments and uncertainties to such an extent that there is a reasonable likelihood that materially different amounts would have been reported under different conditions, or if different assumptions had been used. These critical accounting estimates are discussed with the Audit and Finance Committee of the Board of Directors at least annually. We believe the following discussions of critical accounting estimates, along with the discussions of contingencies and of deferred tax asset valuation allowances in this report, address all important accounting areas where the nature of accounting estimates or assumptions is material due to the levels of subjectivity and judgment necessary to account for highly uncertain matters or the susceptibility of such matters to change.
Oil and Gas Accounting
Accounting for oil and gas exploratory activity is subject to special accounting rules unique to the oil and gas industry. The acquisition of geological and geophysical seismic information, prior to the discovery of proved reserves, is expensed as incurred, similar to accounting for research and development costs. However, leasehold acquisition costs and exploratory well costs are capitalized on the balance sheet pending determination of whether proved oil and gas reserves have been discovered on the prospect.
Property Acquisition Costs
For individually significant leaseholds, management periodically assesses for impairment based on exploration and drilling efforts to date. For leasehold acquisition costs that individually are relatively small, management
exercises judgment and determines a percentage probability that the prospect ultimately will fail to find proved oil and gas reserves and pools that leasehold information with others in the geographic area. For prospects in areas that have had limited, or no, previous exploratory drilling, the percentage probability of ultimate failure is normally judged to be quite high. This judgmental percentage is multiplied by the leasehold acquisition cost, and that product is divided by the contractual period of the leasehold to determine a periodic leasehold impairment charge that is reported in exploration expense.
This judgmental probability percentage is reassessed and adjusted throughout the contractual period of the leasehold based on favorable or unfavorable exploratory activity on the leasehold or on adjacent leaseholds, and leasehold impairment amortization expense is adjusted prospectively. At year-end 2008, the book value of the pools of property acquisition costs, that individually are relatively small and thus subject to the above-described periodic leasehold impairment calculation, was $1,447 million and the accumulated impairment reserve was $494 million. The weighted-average judgmental percentage probability of ultimate failure was approximately 65 percent, and the weighted-average amortization period was approximately 2.4 years. If that judgmental percentage were to be raised by 5 percent across all calculations, pretax leasehold impairment expense in 2009 would increase by approximately $30 million. The remaining $4,745 million of capitalized unproved property costs at year-end 2008 consisted of individually significant leaseholds, mineral rights held in perpetuity by title ownership, exploratory wells currently drilling, and suspended exploratory wells. Management periodically assesses individually significant leaseholds for impairment based on the results of exploration and drilling efforts and the outlook for project commercialization. Of this amount, approximately $2.4 billion is concentrated in 10 major development areas. None of these major assets are expected to move to proved properties in 2009.
For exploratory wells, drilling costs are temporarily capitalized, or suspended, on the balance sheet, pending a determination of whether potentially economic oil and gas reserves have been discovered by the drilling effort to justify completion of the find as a producing well.
Once a determination is made the well did not encounter potentially economic oil and gas quantities, the well costs are expensed as a dry hole and reported in exploration expense. If exploratory wells encounter potentially economic quantities of oil and gas, the well costs remain capitalized on the balance sheet as long as sufficient progress assessing the reserves and the economic and operating viability of the project is being made. The accounting notion of sufficient progress is a judgmental area, but the accounting rules do prohibit continued capitalization of suspended well costs on the mere chance that future market conditions will improve or new technologies will be found that would make the projects development economically profitable. Often, the ability to move the project into the development phase and record proved reserves is dependent on obtaining permits and government or co-venturer approvals, the timing of which is ultimately beyond our control. Exploratory well costs remain suspended as long as the company is actively pursuing such approvals and permits, and believes they will be obtained. Once all required approvals and permits have been obtained, the projects are moved into the development phase, and the oil and gas reserves are designated as proved reserves. For complex exploratory discoveries, it is not unusual to have exploratory wells remain suspended on the balance sheet for several years while we perform additional appraisal drilling and seismic work on the potential oil and gas field, or while we seek government or co-venturer approval of development plans or seek environmental permitting.
Management reviews suspended well balances quarterly, continuously monitors the results of the additional appraisal drilling and seismic work, and expenses the suspended well costs as a dry hole when it determines the potential field does not warrant further investment in the near term. Criteria utilized in making this determination include evaluation of the reservoir characteristics and hydrocarbon properties, expected development costs, ability to apply existing technology to produce the reserves, fiscal terms, regulations or contract negotiations, and our required return on investment.
At year-end 2008, total suspended well costs were $660 million, compared with $589 million at year-end 2007. For additional information on suspended wells, including an aging analysis, see Note 8Properties, Plants and Equipment, in the Notes to Consolidated Financial Statements.
Proved Oil and Gas Reserves and Canadian Syncrude Reserves
Engineering estimates of the quantities of recoverable oil and gas reserves in oil and gas fields and in-place crude bitumen volumes in oil sand mining operations are inherently imprecise and represent only approximate amounts because of the subjective judgments involved in developing such information. Reserve estimates are based on subjective judgments involving geological and engineering assessments of in-place hydrocarbon volumes, the production or mining plan, historical extraction recovery and processing yield factors, installed plant operating capacity and operating approval limits. The reliability of these estimates at any point in time depends on both the quality and quantity of the technical and economic data and the efficiency of extracting and processing the hydrocarbons.
Despite the inherent imprecision in these engineering estimates, accounting rules require disclosure of proved reserve estimates due to the importance of these estimates to better understand the perceived value and future cash flows of a companys E&P operations. There are several authoritative guidelines regarding the engineering criteria that must be met before estimated reserves can be designated as proved. Our reservoir engineering organization has policies and procedures in place that are consistent with these authoritative guidelines. We have trained and experienced internal engineering personnel who estimate our proved crude oil, natural gas and natural gas liquids reserves held by consolidated companies, as well as our share of equity affiliates, with assistance from third-party petroleum engineering consultants with regard to our equity interests in LUKOIL and Australia Pacific LNG.
Proved reserve estimates are updated annually and take into account recent production and subsurface information about each field or oil sand mining operation. Also, as required by current authoritative guidelines, the estimated future date when a field or oil sand mining operation will be permanently shut down for economic reasons is based on an extrapolation of sales prices and operating costs prevalent at the balance sheet date. This estimated date when production will end affects the amount of estimated reserves. Therefore, as prices and cost levels change from year to year, the estimate of proved reserves also changes.
Our proved reserves include estimated quantities related to production sharing contracts, which are reported under the economic interest method and are subject to fluctuations in prices of crude oil, natural gas and natural gas liquids; recoverable operating expenses; and capital costs. If costs remain stable, reserve quantities attributable to recovery of costs will change inversely to changes in commodity prices. For example, if prices increase, then our applicable reserve quantities would decline.
The estimation of proved reserves also is important to the statement of operations because the proved oil and gas reserve estimate for a field or the estimated in-place crude bitumen volume for an oil sand mining operation serves as the denominator in the unit-of-production calculation of depreciation, depletion and amortization of the capitalized costs for that asset. At year-end 2008, the net book value of productive E&P properties, plants and equipment subject to a unit-of-production calculation, including our Canadian Syncrude bitumen oil sand assets, was approximately $58 billion and the depreciation, depletion and amortization recorded on these assets in 2008 was approximately $7.7 billion. The estimated proved developed oil and gas reserves of these fields were 6.1 billion BOE at the beginning of 2008 and were 5.5 billion BOE at the end of 2008. The estimated proved reserves of Canadian Syncrude assets were 221 million barrels at the beginning of 2008 and were 249 million barrels at the end of 2008. If the estimates of proved reserves used in the unit-of-production calculations had been lower by 5 percent across all calculations, pretax depreciation, depletion and amortization in 2008 would have increased by an estimated $406 million. Impairments of producing oil and gas properties in 2008, 2007 and 2006 totaled $793 million, $471 million and $215 million, respectively. Of these write-downs, $56 million in 2008, $76 million in 2007 and $131 million in 2006 were due to downward revisions of proved reserves due to reservoir performance.
Long-lived assets used in operations are assessed for impairment whenever changes in facts and circumstances indicate a possible significant deterioration in the future cash flows expected to be generated by an asset group. If, upon review, the sum of the undiscounted pretax cash flows is less than the carrying value of the asset group, the carrying value is written down to estimated fair value. Individual assets are grouped for impairment purposes based on a judgmental assessment of the lowest level for which there are identifiable cash flows that
are largely independent of the cash flows of other groups of assetsgenerally on a field-by-field basis for exploration and production assets, at an entire complex level for downstream assets, or at a site level for retail stores. Because there usually is a lack of quoted market prices for long-lived assets, the fair value of impaired assets is determined based on the present values of expected future cash flows using discount rates commensurate with the risks involved in the asset group or based on a multiple of operating cash flow validated with historical market transactions of similar assets where possible. The expected future cash flows used for impairment reviews and related fair value calculations are based on judgmental assessments of future production volumes, prices and costs, considering all available information at the date of review. See Note 10Impairments, in the Notes to Consolidated Financial Statements, for additional information.
Investments in nonconsolidated entities accounted for under the equity method are reviewed for impairment when there is evidence of a loss in value. Such evidence of a loss in value might include our inability to recover the carrying amount, the lack of sustained earnings capacity which would justify the current investment amount, or a current fair value less than the investments carrying amount. When it is determined such a loss in value is other than temporary, an impairment charge is recognized for the difference between the investments carrying value and its estimated fair value. When determining whether a decline in value is other than temporary, management considers factors such as the length of time and extent of the decline, the investees financial condition and near-term prospects, and the companys ability and intention to retain its investment for a period that will be sufficient to allow for any anticipated recovery in the market value of the investment. When quoted market prices are not available, the fair value is usually based on the present value of expected future cash flows using discount rates commensurate with the risks of the investment. Differing assumptions could affect the timing and the amount of an impairment of an investment in any period. For additional information, see the LUKOIL section of Note 7Investments, Loans and Long-Term Receivables, in the Notes to Consolidated Financial Statements.
Asset Retirement Obligations and Environmental Costs
Under various contracts, permits and regulations, we have material legal obligations to remove tangible equipment and restore the land or seabed at the end of operations at operational sites. Our largest asset removal obligations involve removal and disposal of offshore oil and gas platforms around the world, oil and gas production facilities and pipelines in Alaska, and asbestos abatement at refineries. The fair values of obligations for dismantling and removing these facilities are accrued at the installation of the asset based on estimated discounted costs. Estimating the future asset removal costs necessary for this accounting calculation is difficult. Most of these removal obligations are many years, or decades, in the future and the contracts and regulations often have vague descriptions of what removal practices and criteria must be met when the removal event actually occurs. Asset removal technologies and costs are changing constantly, as well as political, environmental, safety and public relations considerations.
In addition, under the above or similar contracts, permits and regulations, we have certain obligations to complete environmental-related projects. These projects are primarily related to cleanup at domestic refineries and underground storage tanks at U.S. service stations, and remediation activities required by Canada and the state of Alaska at exploration and production sites. Future environmental remediation costs are difficult to estimate because they are subject to change due to such factors as the uncertain magnitude of cleanup costs, the unknown time and extent of such remedial actions that may be required, and the determination of our liability in proportion to that of other responsible parties.
Purchase Price Allocation
Accounting for the acquisition of a business requires the allocation of the purchase price to the various assets and liabilities of the acquired business. For most assets and liabilities, purchase price allocation is accomplished by recording the asset or liability at its estimated fair value. The most difficult estimations of individual fair values are those involving properties, plants and equipment and identifiable intangible assets. We use all available information to make these fair value determinations. We have, if necessary, up to one year after the acquisition closing date to finish these fair value determinations and finalize the purchase price allocation.
Intangible Assets and Goodwill
At December 31, 2008, we had $738 million of intangible assets determined to have indefinite useful lives, thus they are not amortized. This judgmental assessment of an indefinite useful life must be continuously evaluated in the future. If, due to changes in facts and circumstances, management determines these intangible assets have definite useful lives, amortization will have to commence at that time on a prospective basis. As long as these intangible assets are judged to have indefinite lives, they will be subject to periodic lower-of-cost-or-market tests that require managements judgment of the estimated fair value of these intangible assets. See Note 9Goodwill and Intangibles, in the Notes to Consolidated Financial Statements, for additional information.
In the fourth quarter of 2008, we fully impaired the recorded goodwill associated with our Worldwide E&P reporting unit. See the Goodwill Impairment section of Note 9Goodwill and Intangibles, in the Notes to Consolidated Financial Statements, which is incorporated herein by reference, for a detailed discussion of the facts and circumstances leading to this impairment, as well as the judgments required by management in the analysis leading to the impairment determination. After the goodwill impairment, at December 31, 2008, we had $3,778 million of goodwill remaining on our balance sheet, all of which was attributable to the Worldwide R&M reporting unit.
Projected Benefit Obligations
Determination of the projected benefit obligations for our defined benefit pension and postretirement plans are important to the recorded amounts for such obligations on the balance sheet and to the amount of benefit expense in the statement of operations. The actuarial determination of projected benefit obligations and company contribution requirements involves judgment about uncertain future events, including estimated retirement dates, salary levels at retirement, mortality rates, lump-sum election rates, rates of return on plan assets, future health care cost-trend rates, and rates of utilization of health care services by retirees. Due to the specialized nature of these calculations, we engage outside actuarial firms to assist in the determination of these projected benefit obligations and company contribution requirements. For Employee Retirement Income Security Act-qualified pension plans, the actuary exercises fiduciary care on behalf of plan participants in the determination of the judgmental assumptions used in determining required company contributions into plan assets. Due to differing objectives and requirements between financial accounting rules and the pension plan funding regulations promulgated by governmental agencies, the actuarial methods and assumptions for the two purposes differ in certain important respects. Ultimately, we will be required to fund all promised benefits under pension and postretirement benefit plans not funded by plan assets or investment returns, but the judgmental assumptions used in the actuarial calculations significantly affect periodic financial statements and funding patterns over time. Benefit expense is particularly sensitive to the discount rate and return on plan assets assumptions. A 1 percent decrease in the discount rate would increase annual benefit expense by $79 million, while a 1 percent decrease in the return on plan assets assumption would increase annual benefit expense by $43 million. In determining the discount rate, we use yields on high-quality fixed income investments matched to the estimated benefit cash flows of our plans.
CAUTIONARY STATEMENT FOR THE PURPOSES OF THE SAFE HARBOR PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
This report includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. You can identify our forward-looking statements by the words anticipate, estimate, believe, continue, could, intend, may, plan, potential, predict, should, will, expect, objective, projection, forecast, goal, guidance, outlook, effort, target and similar expressions.
We based the forward-looking statements relating to our operations on our current expectations, estimates and projections about ourselves and the industries in which we operate in general. We caution you these statements are not guarantees of future performance and involve risks, uncertainties and assumptions we cannot predict. In addition, we based many of these forward-looking statements on assumptions about future events that may prove to be inaccurate. Accordingly, our actual outcomes and results may differ materially from what we have expressed or forecast in the forward-looking statements. Any differences could result from a variety of factors, including the following:
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Financial Instrument Market Risk
We and certain of our subsidiaries hold and issue derivative contracts and financial instruments that expose our cash flows or earnings to changes in commodity prices, foreign exchange rates or interest rates. We may use financial and commodity-based derivative contracts to manage the risks produced by changes in the prices of electric power, natural gas, crude oil and related products, fluctuations in interest rates and foreign currency exchange rates, or to exploit market opportunities.
Our use of derivative instruments is governed by an Authority Limitations document approved by our Board of Directors that prohibits the use of highly leveraged derivatives or derivative instruments without sufficient liquidity for comparable valuations. The Authority Limitations document also authorizes the Chief Operating Officer to establish the maximum Value at Risk (VaR) limits for the company and compliance with these limits is monitored daily. The Chief Financial Officer monitors risks resulting from foreign currency exchange rates and interest rates and reports to the Chief Executive Officer. The Senior Vice President of Commercial monitors commodity price risk and reports to the Chief Operating Officer. The Commercial organization manages our commercial marketing, optimizes our commodity flows and positions, monitors related risks of our upstream and downstream businesses, and selectively takes price risk to add value.
Commodity Price Risk
We operate in the worldwide crude oil, refined products, natural gas, natural gas liquids, and electric power markets and are exposed to fluctuations in the prices for these commodities. These fluctuations can affect our revenues, as well as the cost of operating, investing, and financing activities. Generally, our policy is to remain exposed to the market prices of commodities; however, executive management may elect to use derivative instruments to hedge the price risk of our crude oil and natural gas production, as well as refinery margins.
Our Commercial organization uses futures, forwards, swaps, and options in various markets to optimize the value of our supply chain, which may move our risk profile away from market average prices to accomplish the following objectives:
We use a VaR model to estimate the loss in fair value that could potentially result on a single day from the effect of adverse changes in market conditions on the derivative financial instruments and derivative commodity instruments held or issued, including commodity purchase and sales contracts recorded on the balance sheet at December 31, 2008, as derivative instruments in accordance with SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended (SFAS No. 133). Using Monte Carlo simulation, a 95 percent confidence level and a one-day holding period, the VaR for those instruments issued or held for trading purposes at December 31, 2008 and 2007, was immaterial to our net income and cash flows.
The VaR for instruments held for purposes other than trading at December 31, 2008 and 2007, was also immaterial to our net income and cash flows.
Interest Rate Risk
The following tables provide information about our financial instruments that are sensitive to changes in short-term U.S. interest rates. The debt table presents principal cash flows and related weighted-average interest rates by expected maturity dates. Weighted-average variable rates are based on implied forward rates in the yield curve at the reporting date. The carrying amount of our floating-rate debt approximates its fair value. The fair value of the fixed-rate financial instruments is estimated based on quoted market prices.
The following tables present principal cash flows of the fixed-rate 5.3 percent joint venture acquisition obligation owed to FCCL Oil Sands Partnership. The fair value of the obligation is estimated based on the net present value of the future cash flows, discounted at a year-end 2008 and 2007 effective yield rate of 5.4 percent and 4.9 percent, respectively, based on yields of U.S. Treasury securities of a similar average duration adjusted for ConocoPhillips average credit risk spread and the amortizing nature of the obligation principal.
Foreign Currency Risk
We have foreign currency exchange rate risk resulting from international operations. We do not comprehensively hedge the exposure to currency rate changes, although we may choose to selectively hedge exposures to foreign currency rate risk. Examples include firm commitments for capital projects, net investments in foreign subsidiaries, certain local currency tax payments and dividends, and cash returns from net investments in foreign affiliates to be remitted within the coming year.
At December 31, 2008 and 2007, we held foreign currency swaps hedging short-term intercompany loans between European subsidiaries and a U.S. subsidiary. Although these swaps hedge exposures to fluctuations in exchange rates, we elected not to utilize hedge accounting as allowed by SFAS No. 133. As a result, the change in the fair value of these foreign currency swaps is recorded directly in earnings. Since the gain or loss on the swaps is offset by the gain or loss from remeasuring the intercompany loans into the functional currency of the lender or borrower, there would be no material impact to income from an adverse hypothetical 10 percent change in the December 31, 2008 or 2007, exchange rates. The notional and fair market values of these positions at December 31, 2008 and 2007, were as follows:
For additional information about our use of derivative instruments, see Note 16Financial Instruments and Derivative Contracts, in the Notes to Consolidated Financial Statements.
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO FINANCIAL STATEMENTS
Report of Management
Management prepared, and is responsible for, the consolidated financial statements and the other information appearing in this annual report. The consolidated financial statements present fairly the companys financial position, results of operations and cash flows in conformity with accounting principles generally accepted in the United States. In preparing its consolidated financial statements, the company includes amounts that are based on estimates and judgments that management believes are reasonable under the circumstances. The companys financial statements have been audited by Ernst & Young LLP, an independent registered public accounting firm appointed by the Audit and Finance Committee of the Board of Directors and ratified by stockholders. Management has made available to Ernst & Young LLP all of the companys financial records and related data, as well as the minutes of stockholders and directors meetings.
Assessment of Internal Control Over Financial Reporting
Management is also responsible for establishing and maintaining adequate internal control over financial reporting. ConocoPhillips internal control system was designed to provide reasonable assurance to the companys management and directors regarding the preparation and fair presentation of published financial statements.
All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.
Management assessed the effectiveness of the companys internal control over financial reporting as of December 31, 2008. In making this assessment, it used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal ControlIntegrated Framework. Based on our assessment, we believe the companys internal control over financial reporting was effective as of December 31, 2008.
Ernst & Young LLP has issued an audit report on the companys internal control over financial reporting as of December 31, 2008.
February 25, 2009
Report of Independent Registered Public Accounting Firm on Consolidated Financial Statements
The Board of Directors and Stockholders
We have audited the accompanying consolidated balance sheets of ConocoPhillips as of December 31, 2008 and 2007, and the related consolidated statements of operations, changes in common stockholders equity, and cash flows for each of the three years in the period ended December 31, 2008. Our audits also included the related condensed consolidating financial information listed in the Index at Item 8 and financial statement schedule listed in Item 15(a). These financial statements, condensed consolidating financial information, and schedule are the responsibility of the Companys management. Our responsibility is to express an opinion on these financial statements, condensed consolidating financial information, and schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of ConocoPhillips at December 31, 2008 and 2007, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2008, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related condensed consolidating financial information and financial statement schedule, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.
As discussed in Note 2 to the consolidated financial statements, in 2006 ConocoPhillips adopted Emerging Issues Task Force Issue No. 04-13, Accounting for Purchases and Sales of Inventory with the Same Counterparty, and the recognition and disclosure provisions of Statement of Financial Accounting Standards No. 158, Employers Accounting for Defined Benefit Pension and Other Postretirement Plansan amendment of FASB Statements No. 87, 88, 106, and 132(R).
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), ConocoPhillips internal control over financial reporting as of December 31, 2008, based on criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 25, 2009 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
February 25, 2009
Report of Independent Registered Public Accounting Firm on
Internal Control Over Financial Reporting
The Board of Directors and Stockholders
We have audited ConocoPhillips internal control over financial reporting as of December 31, 2008, based on criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). ConocoPhillips management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included under the heading Assessment of Internal Control Over Financial Reporting in the accompanying Report of Management. Our responsibility is to express an opinion on the Companys internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, ConocoPhillips maintained, in all material respects, effective internal control over financial reporting as of December 31, 2008, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the 2008 consolidated financial statements of ConocoPhillips and our report dated February 25, 2009 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
February 25, 2009
See Notes to Consolidated Financial Statements.
See Notes to Consolidated Financial Statements.