Our share of income taxes incurred directly by the equity companies is reported in equity in earnings of affiliates, and as such is not included in income taxes in our consolidated financial statements.
At December 31, 2006, retained earnings included $5,113 million related to the undistributed earnings of affiliated companies, and distributions received from affiliates were $3,294 million, $1,807 million and $1,035 million in 2006, 2005 and 2004, respectively.
LUKOIL
LUKOIL is an integrated energy company headquartered in Russia, with operations worldwide. In 2004, we made a joint announcement with LUKOIL of an agreement to form a broad-based strategic alliance, whereby we would become a strategic equity investor in LUKOIL.
We were the successful bidder in an auction of 7.6 percent of LUKOIL’s authorized and issued ordinary shares held by the Russian government for a price of $1,988 million, or $30.76 per share, excluding transaction costs. The transaction closed on October 7, 2004. We increased our ownership in LUKOIL to 16.1 percent by the end of 2005. During the January 24, 2005, extraordinary general meeting of LUKOIL shareholders, all charter amendments reflected in the Shareholder Agreement were passed and ConocoPhillips’ nominee was elected to LUKOIL’s Board. The Shareholder Agreement limits our ownership interest in LUKOIL to 20 percent of the shares authorized and issued and limits our ability to sell our LUKOIL shares for a period of four years from September 29, 2004, except in certain circumstances.
We increased our ownership interest in LUKOIL to 20 percent at December 31, 2006, based on 851 million shares authorized and issued. For financial reporting under U.S. generally accepted accounting principles, treasury shares held by LUKOIL are not considered outstanding for determining our equity-method ownership interest in LUKOIL. Our ownership interest, based on estimated shares outstanding, was 20.6 percent at December 31, 2006.
Because LUKOIL’s accounting cycle close and preparation of U.S. generally accepted accounting principles (GAAP) financial statements occur subsequent to our reporting deadline, our equity earnings and statistics for our LUKOIL investment are estimated, based on current market indicators, historical production and cost trends of LUKOIL, and other objective data. Once the difference between actual and estimated results is known, an adjustment is recorded. This estimate-to-actual adjustment will be a recurring component of future period results. Any difference between our estimate of fourth-quarter 2006 and the actual LUKOIL U.S. GAAP net income will be reported in our 2007 equity earnings. At December 31, 2006, the book value of our ordinary share investment in LUKOIL was $9,564 million. Our 20 percent share of the net assets of LUKOIL was estimated to be $6,851 million. This basis difference of $2,713 million is primarily being amortized on a unit-of-production basis. Included in net income for 2006, 2005 and 2004 was after-tax expense of $41 million, $43 million and $14 million, respectively, representing the amortization of this basis difference.
On December 31, 2006, the closing price of LUKOIL shares on the London Stock Exchange was $86.70 per share, making the aggregate total market value of our LUKOIL investment $14,749 million.
DCP Midstream
DCP Midstream owns and operates gas plants, gathering systems, storage facilities and fractionation plants. In July 2005, ConocoPhillips and Duke Energy Corporation (Duke) restructured their respective ownership levels in DCP Midstream, which resulted in DCP Midstream becoming a jointly controlled venture, owned 50 percent by each company. This restructuring increased our ownership in DCP Midstream to 50 percent from 30.3 percent through a series of direct and indirect transfers of certain Canadian Midstream assets from DCP Midstream to Duke, a disproportionate cash distribution from DCP Midstream to Duke from the sale of DCP Midstream’s interest in TEPPCO Partners, L.P., and a combined payment by ConocoPhillips to Duke and DCP Midstream of approximately $840 million. Our interest in the Empress plant in Canada was not included in the initial transaction as originally anticipated due to weather-related damage to the facility. Subsequently, the Empress plant was sold to Duke on August 1, 2005, for approximately $230 million. In the first quarter of 2005, as a part of equity earnings, we recorded our $306 million (after-tax) equity share of the gain from DCP Midstream’s sale of its interest in TEPPCO.
At December 31, 2006, the book value of our common investment in DCP Midstream was $1,150 million. Our 50 percent share of the net assets of DCP Midstream was $1,133 million. This difference of $17 million includes a profit-in-inventory elimination of $2 million and a basis difference of $19 million which is being amortized on a straight-line basis through 2014 consistent with the remaining estimated useful lives of DCP Midstream’s properties, plants and equipment. Included in net income for 2006 was an after-tax expense of $2 million and in 2005 and 2004, an after-tax income of $17 million and $36 million, respectively, representing the amortization of the basis difference.
DCP Midstream markets a portion of its natural gas liquids to us and CPChem under a supply agreement that continues until December 31, 2014. This purchase commitment is on an “if-produced, will-purchase” basis so it has no fixed production schedule, but has been, and is expected to be, a relatively stable purchase pattern over the term of the contract. Natural gas liquids are purchased under this agreement at various published market index prices, less transportation and fractionation fees.
CPChem
CPChem manufactures and markets petrochemicals and plastics. At December 31, 2006, the book value of our investment in CPChem was $2,252 million. Our 50 percent share of the total net assets of CPChem was $2,119 million. This basis difference of $133 million is being amortized through 2020, consistent with the remaining estimated useful lives of CPChem properties, plants and equipment.
We have multiple supply and purchase agreements in place with CPChem, ranging in initial terms from one to 99 years, with extension options. These agreements cover sales and purchases of refined products, solvents, and petrochemical and natural gas liquids feedstocks, as well as fuel oils and gases. Delivery quantities vary by product, and are generally on an “if-produced, will-purchase” basis. All products are purchased and sold under specified pricing formulas based on various published pricing indices, consistent with terms extended to third-party customers.
Loans to Related Parties
As part of our normal ongoing business operations and consistent with normal industry practice, we invest and enter into numerous agreements with other parties to pursue business opportunities, which share costs and apportion risks among the parties as governed by the agreements. Included in such activity are loans made to certain affiliated companies. Loans are recorded within “Loans and advances — related parties” when cash is transferred to the affiliated company pursuant to a loan agreement. The loan balance will increase as interest is earned on the outstanding loan balance and will decrease as interest and principal payments are received. Interest is earned at the loan agreement’s stated interest rate. Loans are assessed for impairment when events indicate the loan balance will not be fully recovered.
Significant loans to affiliated companies include the following:
- We entered into a credit agreement with Freeport LNG, whereby we will provide loan financing of approximately $630 million for the construction of an LNG facility. Through December 31, 2006, we had provided $520 million in loan financing, including accrued interest. See Note 7 — Variable Interest Entities (VIEs), for additional information.
- We have an obligation to provide loan financing to Varandey Terminal Company for 30 percent of the costs of the terminal expansion. We estimate our total loan obligation for the terminal expansion to be approximately $460 million at current exchange rates, including interest to be accrued
during construction. This amount will be adjusted as the project’s cost estimate and schedule are updated and the ruble exchange rate fluctuates. Through December 31, 2006, we had provided $203 million in loan financing, including accrued interest. See Note 7 — Variable Interest Entities (VIEs), for additional information.
- Qatargas 3 is an integrated project to produce and liquefy natural gas from Qatar’s North field. We own a 30 percent interest in the project. The other participants in the project are affiliates of Qatar Petroleum (68.5 percent) and Mitsui & Co., Ltd. (Mitsui) (1.5 percent). Our interest is held through a jointly owned company, Qatar Liquefied Gas Company Limited (3), for which we use the equity method of accounting. Qatargas 3 secured project financing of $4 billion in December 2005, consisting of $1.3 billion of loans from export credit agencies (ECA), $1.5 billion from commercial banks, and $1.2 billion from ConocoPhillips. The ConocoPhillips loan facilities have substantially the same terms as the ECA and commercial bank facilities. Prior to project completion certification, all loans, including the ConocoPhillips loan facilities, are guaranteed by the participants based on their respective ownership interests. Accordingly, our maximum exposure to this financing structure is $1.2 billion. Upon completion certification, which is expected to be December 31, 2009, all project loan facilities, including the ConocoPhillips loan facilities, will become non-recourse to the project participants. At December 31, 2006, Qatargas 3 had $1.2 billion outstanding under all the loan facilities, of which ConocoPhillips provided $371 million, including accrued interest
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