Gaining in stature

ConocoPhillips (COP, NYSE) is currently the third largest integrated energy company in the United States, by market cap, proven reserves, and production. As such, we believe the oil major offers substantial leverage to rising oil prices. In addition to an impressive reserve base, Conoco boasts a remarkable replacement rate. A heavy investment programme, and a commitment to growth by acquisition, has provided a firm platform for earnings growth.

The merger of oil heavyweights Conoco and Phillips in 2002 created the enlarged group. However, more humble beginnings go all the way back to 1875. The Utah-based Continental Oil and Transportation company distributed coal, oil, kerosene, grease and candles. Phillips Petroleum meanwhile first discovered oil in Oklahoma in 1905.

Today ConocoPhillips explores for and produces crude oil, natural gas and natural gas liquids (NGL) on a worldwide basis. The company also mines oil sands to produce Syncrude. Daily crude oil production averaged 907,000 barrels last year. Natural gas and NGL contributed 3.3 billion cubic feet, and 91,000 barrels per day respectively.

ConocoPhillips is also the world's fourth largest refiner. The group has 12 refineries in the US, six in Europe and one in Malaysia. At year-end, ConocoPhillips refineries had a combined net capacity of 2.61 million barrels of oil per day.

The company sells gasoline and distillates in branded outlets in the US, Europe and Asia. Refined products sales were 3.3 million barrels per day last year.

The company also has a 'midstream' presence primarily through a 50 percent interest in Duke Energy Field Services. Denver-based Duke is one of the largest natural gas and gas liquids gathering, processing and marketing companies in the United States. Last year's raw natural gas throughput averaged 5.9 billion cubic feet per day, and NGL extraction averaged 353,000 barrels per day.

Conoco participates in the chemicals sector through a joint-venture with Chevron. The group is also investing in several high growth emerging businesses such as fuel cells, gas-to-liquids, and power generation.

Along with the other oil majors, ConocoPhillips has flourished in a high oil price environment. This has resulted in the stock price accelerating sharply over the past three and a half years. From $22.01 in October 2002 the stock rose by 225 percent to reach an all-time high of $71.48 in September.

Fourth-quarter net income rose 51 percent to $3,7 billion despite the disruption caused by storms in the Gulf of Mexico. Revenues rose 30 percent to $52.2 billion. The company produced 1.88 million barrels of oil equivalent per day last quarter. For the year net income rose 66 percent to $13.5 billion.

Boosting the company's earnings growth profile was last month's acquisition of Burlington Resources. The deal has expanded the group's portfolio of high-quality, low-risk, long-lived gas reserves. The acquisition sees ConocoPhillips emerge as a leading producer of natural gas in North America.

As a result of the $33.9 billion deal, net proved reserves increased to 11.5 billion barrels of oil equivalent (boe). Combined 2005 production totalled around 2.3 million boe per day - 50 percent of which is in North America.

ConocoPhillips expects efficiencies of around $375 million annually once operations are fully integrated.

Significantly the deal also positions ConocoPhillips as a potential participant in the development of Russia's Shtokman project, the largest undeveloped natural gas field in the world. (Statoil is also a finalist, see FAT10). Earlier this week, Russia's gas monopoly Gazprom upped its estimate of reserves in the Barents Sea field to around 3.7 trillion cubic metres of gas. The final partners for the 49 percent equity stake should be selected soon.

Meanwhile, the production outlook from existing operations is robust. Management are forecasting steady first-quarter volumes, with the Prudhoe Bay field in Alaska returning to production in the second quarter.

Conoco expects to add around 45,000 bopd to production in Libya. The company is returning to a 16.33 percent interest in the Waha concessions. The potential for growth here however is significant as the concessions contain sizeable undeveloped oil and gas resources.

Elsewhere, production commenced at the liquefied natural gas (LNG) facility in Darwin, Australia in January. The facility will produce sales of approximately 3 million tons of LNG per year for a period of 16 years. The company is also participating in the Qatar gas 3 LNG project. Once fully operational, the facility will produce 1.4 billion cubic feet of gas per day.

Operations are set to recommence at the 247,000 barrel per day Alliance facility, boosting the refining business The company has also made significant progress toward expanding European capabilities by completing the acquisition of the Wilhelmshaven refinery in Germany. Management intend to invest a further $4 to $5 billion over the next five to six years in refining capacity, which should more than compensate for further margin pressures.

Across the company capital expenditures totalled around $11,620 million last year. The company plans to increase investment to approximately $14 billion in 2006. One of management's stated objectives is to raise the 16.1 percent stake in LUKOIL, Russia's largest oil company, to 20 percent.

Conoco Philips' consistent ability to replenish reserves expended through production is impressive. The group added 1.553 billion barrels of oil equivalent (boe) last year to reserves (9.4 billion boe pre Burlington) which equates to a replacement ratio of 230 percent. Even excluding sales and acquisitions, the ratio was still 100 percent last year, and has averaged 109 percent of production over the last five years.

The strength of Conoco's balance sheet reinforces our confidence that the reserve base will continue to grow. As a result of the Burlington deal, debt increased to around $32.2 billion. However gearing is more than manageable at 24 percent and cash balances are robust at around $3 billion. Strong cash flows will allow the company the financial flexibility to reduce debt, as well as make further strategic investments.

Stock price consolidation over the past six months has not been surprising given the strength of the preceding rally. The consolidation phase culminated in a triangle formation. This type of pattern is identified by its narrowing range and commonly precedes a resumption of the underlying trend.

A break through the range during the past two weeks indicates that upward momentum is being re-established, in our opinion. The positive break mirrors the recent upward move in oil prices. Fat Prophets have long held the view that oil is in a long term bull market. We believe the sector will continue to outperform in coming years.

Our attraction to ConocoPhillips is further enhanced by the company's sound valuation. The shares trade on an EV/EBITDA (enterprise value to earnings before interest, tax and depreciation) multiple of just 6 times. In addition, the forward price earnings ratio is under 10 times.

With the long term upward trend firmly intact Fat Prophets recommend buying COP around $67.25.