Why ConocoPhillips Is So Hot on Gas
By Mark Morrison
Conventional wisdom says this isn't the time to be making major energy acquisitions. Stocks have been on a two-year tear based partly on temporary disruptions of supply and rampant speculation on oil and gas prices. But ConocoPhillips' (COP ) James J. Mulva marches to a different drummer (see BW, 12/12/05, "ConocoPhillips: The Making of an Oil Major"). Already one of the most aggressive spenders on future supplies, Mulva is now poised to make a whopper of a deal: an acquisition of Burlington Resources (BR ) for $35.6 billion, AP reported on Dec. 13 (see BW Online, 12/13/05 "ConocoPhillips to Buy Burlington for $35.6B").
Neither company was commenting on Dec. 12 about reports in The Wall Street Journal and elsewhere that serious talks are taking place. For ConocoPhillips, buying Burlington Resources, its Houston neighbor, would be a giant bet on the red-hot U.S. natural gas market. While Burlington has international operations in Algeria, China, and Latin America, some 84% of its reserves are in North America.
RELIEF YEARS AWAY.
With U.S. gas prices at record highs, ConocoPhillips is betting that supplies will remain tight for many years. Massive new drilling for gas is under way in the Rocky Mountains, Texas, and offshore. ConocoPhillips and others are also rushing to build additional pipelines to the Lower 48 from Alaska and Canada.
The major energy companies are also moving as fast as possible to build facilities for importing liquefied gas to the U.S. (see BW, 3/28/05, "Ports in the Storm for Liquefied Natural Gas"). All these efforts will eventually bring relief to gas prices, but that's likely to be many years away because of the long lag times for drilling and construction.
Even if oil prices moderate because of additional imports from around the world, natural gas is a different story because it isn't easily transported. "We wouldn't expect substantial new supplies of gas until 2008 or beyond," says Tom Covington, analyst at A.G. Edwards in Denver (see BW, 6/27/05, "Energy: Hitch Your Wagon to a Wildcatter").
The move by ConocoPhillips would round out its expansion strategy. Not only has it recently added capital spending to boost output at its U.S. refineries but the company, the No. 3 American major behind Exxon Mobil (XOM ) and Chevron (CVX ), has also been making giant international investments in Russia's Lukoil and production projects in Venezuela and Australia.
In November, ConocoPhillips announced that it would be buying a big German refiner, Wilhelmshaven, that would accelerate capital spending next year by $1.4 billion on top of the $10 billion previously planned. Add it all up, and ConocoPhillips will be spending 70% or more of its expected cash flow on capital spending in 2006, even before adding on the cost of Burlington.
Because of that heavy spending, Wall Street expects any deal between ConocoPhillips and Burlington to be mostly for stock. Conoco has plenty of financial muscle, with its debt expected to be running only 20% of capitalization next year. While its stock has outgained many of the other big integrated oils, Conoco, with a price-earnings multiple of seven, still sells at a substantial discount to many of its peers.
Investors' initial reaction to news of a possible acquisition was to sell shares of Conoco, which sunk about 4%. (Burlington shares jumped 7% on Dec. 12.) But don't expect that to give Mulva any second thoughts. He's on a mission to make sure his company has the scale and breadth to compete with the world's supermajors.
Morrison is national correspondent for BusinessWeek in Austin, Tex.
Edited by Phil Mintz