Thursday, October 8, 2009

Natural Gas Giant ConocoPhillips Selling Assets

HOUSTON -- ConocoPhillips announced Wednesday that it planned to sell $10 billion in assets, slash capital spending to $11 billion next year, boost its dividend and pay down debt.

Is this window dressing ahead of putting the company up for sale?

The third-largest U.S. oil company, with production of 1.78 million barrels of oil (and gas equivalents) per day, is probably too big to be bought. But it could be an excellent merger partner for a mid-sized oil company with a strong exploration team.

Last May the head of ConocoPhillips' ( COP - news - people ) upstream division, James Gallogly, left the company. The two guys who had the job before Gallogly had also departed in recent years. ConocoPhillips Chairman and Chief Executive James Mulva plans to retire in a couple years. This has led to analyst concerns about the depth of the company's bench.

Oil industry dealmakers have been predicting this year that the U.S. recession won't end without meaningful consolidation among oil companies. Names bandied about include the big independents Anadarko Petroleum ( APC - news - people ), Apache ( APA - news - people ) Energy, Devon Energy ( DVN - news - people ), each of which has about half the market cap of ConocoPhillips ($73 billion). Another potential match-up could be Marathon Oil ( MRO - news - people ), which likewise has sizable refining operations.

It's been a tough year for ConocoPhillips. In January it took $34 billion in writedowns on its 20% stake in Russia's Lukoil and its 2005 acquisition of U.S. natural gas player Burlington Resources. It also overpaid in a $8 billion deal for gas assets of Australia's Origin Energy. With gas prices plunging further since then, bottoming out below $3 per million BTU last month, neither deal has looked smart.
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That's not to say ConocoPhillips doesn't have its share of sterling assets. Deutsche Bank ( DB - news - people ) analyst Paul Sankey has drawn attention in recent days for a 61-page research report in which he says that Conoco's long-lived, mature oil fields will require little new investment but generate enormous cash flows once oil spikes again in the years to come. Conoco gets roughly 25% of its production from fields in Lower 48, where it has more oil and gas production than any other company, with 13,000 wells in the San Juan Basin of Colorado and New Mexico and 1,800 wells in the Lobo field of South Texas.

But the biggest opportunities lie overseas. For the past decade ConocoPhillips has been part of the consortium developing the Kashagan field in Kazakhstan at a cost upward of $40 billion. With first production scheduled for 2012, Kashagan is expected to pump 1.5 million barrels per day within a decade. In Qatar, the company is building a mammoth liquefied natural gas project to help tap Qatar's North Field, the biggest gas field in the world. In Queensland, Australia, the company hopes to apply lessons learned over 50 years in the San Juan basin to similar coal-bed methane plays.

So what is Conoco likely to jettison in its $10 billion of planned sales? International operations in higher risk areas. Last week the junta-led government of Myanmar reportedly sent troops to the border with Bangladesh after complaining that offshore blocks Conoco was exploring for Bangladesh were actually in Myanmar waters. What oil company wants to deal with that headache?

Likewise, last week it sold its rights in a Venezuelan gas field back to state-run Petroleos de Venezuela (Pdvsa). It also has an oil venture in Libya with Marathon Oil and Amerada Hess. Yet Deutsche Bank's Sankey suggests that the best way for Conoco to free up cash would be to sell its 20% stake in Lukoil back to the company. Further, says Sankey, Lukoil could be a willing buyer for Conoco's European refineries, as the Russian major has recently made refining investments there.

Conoco is the fifth-largest refiner in the world. That's a terrible business right now, with fuel demand plummeting, and its unlikely that any buyers would materialize for those assets until after the uncertainty surrounding potential carbon cap-and-trade legislation is resolved.

The drag on profits from those refining assets would likely scare off the upstream pure plays like Anadarko and Apache from linking up with ConocoPhillips. But it could very well appeal to Marathon Oil, which recently shelved a plan to separate its upstream and downstream into two separate companies.

Marathon, which has a lot of international operations for its size ($23 billion market cap), is a partner of Conoco's in Libya and on an LNG terminal in Alaska. Marathon's LNG project in Equatorial Guinea uses Conoco technology. For added synergy, both companies' headquarters are close by, on the west side of Houston. Why not?

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