Drilling With The Big Boys

At ConocoPhillips, CEO Mulva is creating a truly integrated global oil giant

When Conoco and Phillips Petroleum announced plans to merge in late 2001, it looked to some like a desperate move to survive in a business squeezed by falling oil and gas prices and increasingly dominated by such giants as ExxonMobil (XOM ) and ChevronTexaco (CVX ). But more than two years after the marriage was completed, ConocoPhillips (COP ) is proving that it's nimble enough to play with the big boys as it takes larger risks around the globe.

Certainly, soaring oil and gas prices and robust refining margins have played a major part in lifting the Houston company's fortunes. With oil surging past $50 a barrel, 2004 profits should jump 64%, to $7.6 billion, according to a Thomson First Call (TOC ) survey of analysts; revenues are expected to rise 30%, to $135 billion. Hefty cost-cutting helped vault the company to No. 8 on last spring's BusinessWeek 50 ranking of top-performing companies. More important for future growth, though, ConocoPhillips has assembled a promising pipeline of oil and gas projects -- including its recent $2.6 billion stake in Russia's biggest oil company, Lukoil (LUKOY ).

Chief Executive James J. Mulva, 58, is well on his way to fulfilling a longtime goal: creating a truly integrated oil giant. "He wanted membership in the exclusive club," with the likes of ExxonMobil, BP (BP ), and Total (TOT ), says Oppenheimer & Co. senior oil analyst Fadel Gheit. Mulva's dealmaking streak began with the acquisitions of Atlantic Richfield Co.'s Alaska production assets in 2000, followed by independent refiner Tosco Corp. in 2001. Then came the $16 billion Conoco deal, for which the hard-charging Mulva paid no premium. ConocoPhillips had proven reserves of 8.1 billion barrels of oil equivalent at the end of 2003, vs. 22 billion for ExxonMobil and 12 billion for ChevronTexaco. "We certainly believe we have the scope and size to compete with the largest companies in the industry, but not in every part of the world. So we have to be more selective," Mulva told analysts on Nov. 17. He declined to talk to BusinessWeek (MHP ) for this story.

The bigger oil companies still command richer stock multiples thanks to their stronger balance sheets and more diverse assets. But ConocoPhillips' improving returns on capital -- now near the high end of the range of its bigger peers -- have won kudos from investors. Hefty profits helped ConocoPhillips pare debt from $22.6 billion at the start of 2003 to an estimated $15 billion at the end of this year. It has also moved quickly to shed nearly $5 billion in assets, including mature oil and gas properties and gas stations, and cut 22,000 jobs. "They have an exceptionally strong financial position now," says analyst L. Bruce Lanni of A.G. Edwards & Sons (AGE ) Inc. Since January its stock, which trades at about $90, has returned 41% to shareholders, vs. 32% for the Standard & Poor's 500 Integrated Oil & Gas index.

Mulva joined Phillips in 1973 and rose through the finance ranks. His selection as CEO in '99 was a bit of a surprise; he was considered a dark horse in a company that normally favored execs from exploration for the top post. Now, with big acquisitions out of the way for a while, he is focused on methodically building profitable strongholds in some of the world's richest oil and gas regions. Mulva also is investing in carefully chosen refining projects that will let the company handle more of the heavier, lower-quality oils that increasingly will make up the world's supplies and that tie into the company's production in such places as Venezuela and Canada. With more reliance on U.S. refining than some of the other majors, ConocoPhillips is likely to benefit in the coming years from tight refining capacity and growing demand.

Building on its stable production base in such places as Alaska and the North Sea. ConocoPhillips should see healthy 5% annual growth in oil and gas volumes for at least the next two years, analysts say. But Mulva promises "sustainable growth" for the long term as he turns to riskier projects in Russia, Asia, and the Middle East. "Executing in each place is different, and only time will tell," says J. Robinson West, chairman of consultant PFC Energy. But he wouldn't bet against Mulva. "Jim is very disciplined, very smart. He never lets up. He never stops."

"THE ENTRY TICKET"

Mulva's persistence paid off in September -- after 18 months of negotiations -- with a 7.6% stake in Russia's Lukoil. That will grow to 10% by yearend and as much as 20% over the next few years. While analysts worry about the amount of control ConocoPhillips will exert with a minority stake in a country plagued by legal and political uncertainty, Mulva did win a board seat and veto power over decisions involving corporate reorganizations, stock issuance, and other moves. He's also paying $400 million for a 30% interest in a joint venture with Lukoil in the northern part of Russia's Timan-Pechora province. His stake is small compared with the Russian investments of giants such as BP, which last year paid $8 billion to form a 50-50 joint venture with oil company TNK. "ConocoPhillips is coming late to the party in Russia, and it's really doing it indirectly," says analyst John B. Parry of energy consultant John S. Herold Inc. Still, he calls the Lukoil deal "the entry ticket" to that region's rich oil reserves.

One of the biggest risks facing ConocoPhillips is a crash in oil and gas prices, which few consider likely anytime soon. But in that event, ConocoPhillips might become a consolidator, gobbling up bigger independents. For now, its own independence seems assured thanks to CEO Mulva's savvy dealmaking.

By Wendy Zellner in Dallas

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