Jim Mulva of ConocoPhillips is rolling those dice again, and the stakes are high: about $34 billion in cash and stock for Houston-based Burlington Resources. At first blush, ConocoPhillips stockholders headed for the exits, cutting the value of the company’s shares by 8 percent between Dec. 9, just before the deal was announced, and Dec. 14.
If the merger goes through, ConocoPhillips will be tops in North American natural gas production, leapfrogging ExxonMobil, BP, EnCana, and three other companies.
Total daily North American output will be about 3.5 billion cubic feet. The company’s 1.7 billion daily cubic feet of Canadian gas will be second behind EnCana’s 2.1 bcf per day.
But the price being paid by Houston-based ConocoPhillips is steep — around $18 for each of Burlington’s 2 billion barrels of oil equivalent reserves.
Chevron paid about $10.50 per barrel of reserves with its Unocal takeover. Occidental spent $9 per barrel for Vintage Petroleum. Chesapeake recently paid about $12 per BOE for gas reserves in the U.S. Appalachians.
So it’s no surprise the market was a bit skeptical of Mulva’s move, even though natural gas in North America has been selling at the equivalent of $90-a-barrel oil. Burlington’s reserves are 85 percent gas, and 90 percent of that is in North America. The company also has a big inventory of exploration acreage.
Burlington Resources owners will get $46.50 in cash and 0.7214 shares of ConocoPhillips stock for each BR share. That amounted to $92 a share or $35.6 billion Dec. 9, but shrunk to $88.51 a share or $34.2 billion by Dec. 14 as ConocoPhillips shares declined. Burlington’s shares closed at $76.09 Dec. 9, just before the deal was announced. A year ago, the stock was trading in the low $40s.
$7 gas OK for deal
Mulva maintains the deal is a positive for ConocoPhillips even if North American gas prices decline substantially from the current lofty peaks of $14 or $15 per thousand cubic feet.
“We don’t see necessarily a continuation of gas prices that we’ve seen here recently going out over the long term,” he said at a conference call with analysts Dec. 13. “What we really look at is prices of $7 to $8 … and if they’re north of that, that’s all the better for the transaction.
“We tested also at about $5 per mcf. The numbers don’t look particularly good at $5 per mcf, but on the other hand we can live with it in terms of its presence in the portfolio.
“We don’t think you’re going to see $5 mcf gas prices — quite likely we will see $7 or $8, and we pretty strongly believe we’ll see double-digit gas prices as we go out over the next year or two or three years.”
San Juan cash machine
The companies already are the top two producers in the San Juan basin, the biggest U.S. gas field. Together, they pump 1.3 billion cubic feet daily from the basin. But gas wells tend to taper down quickly, so it takes a lot of holes to maintain that kind of production. Burlington already was planning to boost its activity in the field to 300 wells a year by the end of the decade, said Bobby Shackouls, Burlington’s CEO.
“Once we get the two operations integrated, we think we’ll be increasing our operations even more,” he told the analysts. But that doesn’t mean a substantial increase in production there.
“San Juan is a huge cash flow machine that is flat or growing slightly,” Shackouls said. “It’s tough to grow from a 1.3 billion cubic feet base.” The fields in western Canada will also remain essentially flat, he said, though Shackouls likes the look of the Deep basin, where the Gulf Canada acquisition gave ConocoPhillips a leading stake.
“I believe it’s a slam-dunk look-alike to the San Juan Basin,” the Burlington leader said. “It’s probably 20 to 25 years behind the San Juan Basin, very early in its development.”
Growth potential
In the near term, added volumes from the Burlington inventory will come from the Bossier Trend in Texas, the Barnett Shale, and the Cedar Creek Anticline in North Dakota’s Williston basin, he said. There are also a couple of international operations coming on line. Shackouls, who will join the ConocoPhillips board but end his executive role, said Burlington’s growth has been 3 to 8 percent annually.
Burlington has a huge amount of acreage and plenty of potential for increasing the resource base, Shackouls said.
“At the end of last year, we had 7 trillion cubic feet of inventory drilling opportunities — over 9,000 projects,” he said. About half of that fell in the proved undeveloped category.
No change in COP capex
ConocoPhillips won’t trim back its ambitious capital spending plans, Mulva said, and the combined operations will devote $17.2 billion to capital projects next year and $15.4 billion in 2007.
“Everything we’ve announced, we will continue straight on doing — Asia, the Mideast, the Caspian, North America,” Mulva said. “We don’t change our strategy at all.”
As for property dispositions to reduce debt, that’s not on the agenda.
“We like the assets we have in ConocoPhillips,” Mulva said. “We like the assets we have in Burlington Resources.”
Debt reduction will come from the huge cash flow the operations will generate, he said. “Within two or three years, we pay back all of the debt associated with the transaction,” he told the analysts. “We still have at least 2 billion barrels of oil equivalent, hopefully more….”
Upstream focus
The addition of Burlington also swings the company decisively to the upstream, increasing that component to 74 percent of the operation from the current 61 percent.
“I suspect going forward you’re going to see our portfolio be about 70 percent E&P (exploration and production) and maybe a little more than 20 percent, maybe 25 percent, R&M (refining and marketing),” he said.
Adding Burlington will bring total reserves to about 11 billion barrels of oil equivalent, with gas providing 41 percent of that, up from 35 percent in the current ConocoPhillips.
Long-term approach
The future company’s Number 1 position in gas production, as well as natural gas liquids, dovetails nicely with plans for future development of the company’s substantial gas resources in Alaska and Arctic Canada.
“It puts us in a very strong position where we expect that we can be adding reserves and growing production,” Mulva said. “That fits very nicely as we go into the next decade, because we can see very recently there’s been quite a bit of progress with respect to the advancement of the Mackenzie Delta Canadian gas pipeline and development there. As well, we’re making good progress in the State of Alaska negotiations, moving to the next step with respect to the development of the Alaska gas pipeline.”
Gas production from Canada, the San Juan Basin, and the rest of the Lower 48 “will be supplemented over time as we bring the LNG resource to North America and the Arctic gas coming from the north,” he said. “We’ll be a major player with respect to gas in North American for decades to come.”
The companies don’t expect any antitrust problems. Regulatory approvals are likely in the first quarter of 2006 and the deal should close in the first half, Mulva said, assuming Burlington shareholders approve.
“Synergies” are expected to save the new entity about $375 million annually once the operations are combined. Mulva said cost savings would come from reductions in headquarters and financial accounting, as well as consolidating some offices. “We really want to keep the BR people,” he said. “With 2,400 employees, there aren’t going to be a lot of reductions.”
