COP Moves Up

ConocoPhillips chairman and chief executive Ryan Lance says that with years of exploitation and development opportunities in inventory and the opening of the shales’ vast potential, the company can move into organic growth mode through the drill bit while building on its exploration expertise.

This past July, ConocoPhillips reported its first quarterly results as a standalone upstream company, having split off its downstream assets into Phillips 66 earlier this year to become the largest North American-based independent. Production that quarter was 1.5 million barrels of oil equivalent per day (55% liquids, 25% North American natural gas and 20% international gas and liquefied natural gas (LNG)). Cash from continuing operations was $2.2 billion.

At the helm of the Houston company is chairman and chief executive officer Ryan M. Lance. He is moving the new entity forward by capitalizing on its major production bases in North America, Norway, the United Kingdom, Australia, Indonesia, Qatar and China. Production has declined since 2009 as a result of non-core asset divestments. But volume ramp-ups from shale liquids in the U.S., oil sands in Canada and international development projects, as well as emerging exploration opportunities, should soon take care of that.

The company’s roots date back more than a century to Oklahoma, through heritage companies Continental Oil Co. (Conoco) and Phillips Petroleum. Today the new independent has 16,500 employees and assets in 30 countries. North America makes up more than half the portfolio.

“Five years ago, people would’ve said that our North American focus was a problem, but now it’s where everybody wants to be, thanks to its unconventional resources and deepwater potential,” notes Lance. “Also, 80% of our assets are in OECD countries, and we like the stability and risk mitigation this provides.”

Lance grew up in Montana and earned a degree in petroleum engineering from Montana Tech. He then spent 17 years with Arco, joining Phillips in 2001 when it acquired Arco’s Alaska operations. Since the latter’s merger with Conoco, he has served in leadership roles around the world, most recently as senior vice president of E&P-International until the May 2012 split.

Investor What does forging a new identity as a pure upstream company look like?

Lance It’s blending the old and the new—combining the size, scale and scope of a major integrated company with the aggressiveness and agility of an independent.

People always tell me, “You have to act like an independent now,” and I say, “No, we need to define what it means to be an independent ConocoPhillips.”

We are unique, and uniquely capable. Under (retired chairman and chief executive) Jim Mulva’s leadership during an era of restricted resource access and rising commodity prices, acquisitions built the major portfolio we enjoy today, with 43 billion barrels of total resources. With years of exploitation and development opportunities in inventory and shale opening up once-undreamed-of new potential, we can move into organic growth mode through the drill bit while building on our capabilities as an explorer.

I also like to remind people that some things won’t change—our commitment to safety, environmental protection, operations excellence, financial strength, our moral and ethical compass, and our relationships with the community and host governments.

Investor As the largest North American independent out there, how are you positioning the “new” ConocoPhillips?

Lance On the basis of production and reserves, we are about two times the size of the next-largest independent. But we’re still smaller than the majors, so we are carving out a new space.

Analysts don’t quite know what box to put us in. They don’t know whether to value us as a growth-oriented company or a returns-oriented company. In fact, we believe we are both. We’re aiming for 3% to 5% average production and margin compound annual growth beginning in 2013. We’re producing 1.5- to 1.6 million barrels of oil equivalent per day now, and plan to get to 1.8 million over the next five years, all from visible projects already under way. The unique thing is that this growth will also improve cash flows and margins. For our size, scale and scope, we’ve built a pretty exciting growth platform.

Investor Does this involve building a new culture as well?

Lance Absolutely. We think this is one of the most important opportunities we have as an independent company—to build a culture that’s exciting and compelling. We have a mantra: smart growth, superior returns and our SPIRIT values (Safety, People, Integrity, Respect, Innovation and Teamwork). We also intend to be a company of choice for employees, partners, governments, communities and suppliers, because frankly, you can’t play if others won’t play with you. We intend to continually strengthen our technology, while practicing financial discipline.

Investor To what extent are you focused on unconventionals?

Lance What a huge game-changer they are! When you add in the oil sands, there’s tremendous opportunity in North America. For example, ConocoPhillips expects 210,000 barrels of oil per day of new production from Lower 48 shale trends by 2016. In the Eagle Ford, we’re drilling 180 wells this year and producing 70,000 barrels per day—up from zero only 18 months ago. In the Bakken, we’ll drill 120 wells this year on a 600,000-acre position. In the Permian, we plan 300 wells this year on a 1.1-million-acre position that includes two shale trends as well as conventional potential, with 7,000 identified new well locations.

As for the U.S. overall, rewind five years and everyone was talking about peak oil and importing more than 60% of our oil. The whole conversation is tipped on its head now, when you think about the opportunity we have as a country and its impact on energy policy.

Investor You mentioned being in contact with Interior Secretary Ken Salazar. Do you think he understands the impact of what is happening?

Lance Oh yes. We’ve talked to him several times about how industry and government can work together as partners to realize the dream.

Investor You have a lot of moving parts. What are some of the challenges?

Lance We face a volatile commodity price market. Brent was up to $125, then down to $85 and now it’s back to $115 or so. The North American gas market is pretty depressed, but gas has also lured a lot of energy-intensive manufacturing back here. We’ve seen announcements on the planned construction of a number of new petrochemical plants, steel mills and other facilities that, when completed, will create thousands of jobs and provide future opportunity for the industry to supply them with natural gas.

The people challenge is significant for all of us, given the looming retirement of half of the industry’s technical workforce and the fierce competition for critical skills, especially among independents. Right now in North America if you can spell “shale,” you can get a job pretty much anywhere in the E&P or service industries. We have to be able to compete for talent at all levels, and we are positioning ourselves as a place where employees can add value, have fun and build a great career.

The good news is that new talent is being attracted into the industry again. My son in college wants to be an engineer. I tell him that the oil and gas business will be exciting for the next 30-40-50 years with the unconventional plays, and that it would give him a chance to work globally and be in the forefront of things.

I was talking this morning to members of our Summit engineering program. I love it: you see a lot of bright, young, smiling, energetic people. My leaders and I always have to be thinking about how we develop them, bring them along and mentor them. These new employees want to move up quickly, and we have to give them the opportunity.

Investor How do you achieve 3% to 5% growth?

Lance We have five high-margin areas that will account for 550,000-plus barrels of oil equivalent per day by 2016: U.S. unconventionals; the Canadian oil sands, where we got out of surface mining and remain in SAGD; the North Sea, where we have several projects in development; Malaysia, where we have a big deepwater position; and Australia, through the coalbed methane-to-LNG project in Queensland.

The organization knows what it will take, and all of these projects are now under way. Some will start up this year, like the first phase of the Malaysia development. The U.K. Jasmine project comes online next year, as well as more of our Canadian oil sands. The Asia-Pacific LNG is in 2015 and 2016. LNG is very important, as Asia and Europe are short on natural gas, making these projects very competitive.

ConocoPhillips has five high-margin areas that will account for 550,000-plus barrels of oil equivalent per day by 2016: U.S. unconventionals; the Canadian oil sands; the North Sea; Malaysia; and Australia. Source: ConocoPhillips

For the longer term, we’ve built a significant exploration portfolio of both unconventional and conventional opportunities. For example, we’re now the industry’s sixth-largest deepwater acreage holder in the Gulf of Mexico, and have recently started drilling there. We hold two exploration blocks in offshore Angola offsetting large recent discoveries, as well as blocks in the Bengal fan off Bangladesh and the Browse Basin off Australia, to name a few. We’re looking to expand our positions and add new ones if they can be competitive.

Investor You have a robust divestment program. Is that close to done?

Lance No. This started in 2009-2010 as ConocoPhillips began to reposition, and we’ll sell between $8 billion and $10 billion in noncore properties in 2012 and 2013, but there are also little things here and there in the U.S.

Investor How much are you buying in the U.S.?

Lance We’ve added about 700,000 acres since 2011 in North American unconventional plays and are always looking for opportunities. We seek out areas where we can build material positions early, at reasonable cost—as in the Eagle Ford, where our position cost only around $300 an acre.

Investor What portfolio mix are you aiming for?

Lance I don’t have a set goal for a certain mix, but we’re not investing any money in North American dry-gas plays, obviously. We target investments in high-quality assets that will improve our margins and fit in with where we’re going overall.

People ask me, “Do you like oil or gas? In what areas?” I like good rocks, low cost of supply and access to good markets. You can get these through either oil or gas, depending on location. I don’t have an absolute target—I don’t think about the business that way.

Investor ConocoPhillips is being criticized for outspending cash flow, and recently you stopped the stock buyback program.

Lance We built the “new” ConocoPhillips around an annual capital program of about $15 billion, with a sector-leading dividend and great long-term, profitable projects. And we believe our dividend is a key differentiator. We anticipated a couple years of outspending cash flows until the volume and margin growth from our identified major projects kicked in. We planned to fill the gap with proceeds from asset sales and balance sheet capacity, if needed.

We had $5 billion in buybacks planned this year and we’ve completed that. We still have authorization remaining on that program, but our priority for cash has shifted from buybacks to funding our dividend and our capital program for now. We’ll consider buybacks again depending on commodity prices and where our disposition program ends up.

Long term, we have the goal of living within our means. The dividend is a top priority; we are going to maintain it. It’s a good thing to do because it imposes capital discipline on us. The dividend currently yields 4.8% or so, and that’s healthy compared to some of the big integrateds and other large independents. We think it’s a good allocation of part of our cash flow.

We’re at an inflection point when all our big projects will start coming onstream over the next few years and create additional cash flow. It’s just that right now, especially with lower North American gas prices, we are still in transition. If we conclude that oil prices will trend lower, then we’ll adjust our capital program. But for now we think we are making the right decision to invest prudently for long-term growth, returns and yield.

Investor Tell us more about the Eagle Ford.

Lance We love it. We were one of the first in this play, and added about 300,000 acres in 2005 and 2006. We identified the condensate window early on; it was not just the result of our Burlington Resources acquisition. Today, we’re among the best operators there, and are taking lessons learned and applying them in a dozen other North American shale trends.

Investor You talked about the shales at the OPEC meeting earlier this year. How did the ministers react?

Lance I told them that these unconventional plays and the oil sands have changed the game, and there is an opportunity for North America to be a net exporter by, pick a date, maybe in 2025.

The reaction varied from some people who don’t want to believe this will happen, to others who want to learn more about it and consider it in their own plans. There’s no doubt the reserves are there, so it’s a question of deliverability, timing of production, and whether appropriate legislative and regulatory approvals can be obtained.

The other question is how will the unconventional opportunities present themselves abroad? For example, the jury is still out in Poland, where we are drilling pilot wells and preparing to fracture them. It’s still early. The resource is there, the question is deliverability.

Investor What about the Arctic?

Lance The Arctic is one of our legacy areas of both production and expertise, given that we are the leading producer on Alaska’s North Slope. We have experience in other Arctic areas, including offshore exploration. We believe that offshore development will occur, but at a pace that does not outrun the technology. We believe that development will begin in areas that are ice-free, such as off Norway, or have ice-free drilling seasons, such as the Chukchi Sea. We have acreage there and in the Barents Sea off Norway, the Canadian Beaufort Sea, and Baffin Bay off western Greenland. Any projects proposed in these areas would have to compete with our other assets in order to justify capital investments.

You know, the juxtaposition of all these trends—development of the unconventional resources, the deepwater plays, the LNG projects and so on—makes it a great time to be in this business. I’m excited about where we are and where we’re going, and the opportunity to deliver on the plans we’ve set in motion. The best days for ConocoPhillips are still ahead.Australia. Source: ConocoPhillips