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Notes to Consolidated Financial Statements

 

Note 7 — Variable Interest Entities (VIEs)

In June 2006, ConocoPhillips acquired a 24 percent interest in West2East Pipeline LLC (West2East), a company holding a 100 percent interest in Rockies Express Pipeline LLC (Rockies Express). Rockies Express plans to construct a 1,633-mile natural gas pipeline from Wyoming to Ohio. West2East is a VIE because a third party other than ConocoPhillips and our partners holds a significant voting interest in the company until project completion. We currently participate in the management committee of West2East as a non-voting member. We are not the primary beneficiary of West2East, and we use the equity method of accounting for our investment. We issued a guarantee for 24 percent of the $2 billion in credit facilities of Rockies Express. At December 31, 2006, we had made no capital investment in West2East. See Note 17 — Guarantees, for additional information.

In June 2005, ConocoPhillips and OAO LUKOIL (LUKOIL) created the OOO Naryanmarneftegaz (NMNG) joint venture to develop resources in the Timan-Pechora province of Russia. The NMNG joint venture is a VIE because we and our related party, LUKOIL, have disproportionate interests. We have a 30 percent ownership interest with a 50 percent governance interest in the joint venture. We are not the primary beneficiary of the VIE and we use the equity method of accounting for this investment. At December 31, 2006, the book value of our investment in the venture was $984 million.

Production from the NMNG joint-venture fields is transported via pipeline to LUKOIL’s existing terminal at Varandey Bay on the Barents Sea and then shipped via tanker to international markets. LUKOIL intends to complete an expansion of the terminal’s oil-throughput capacity from 30,000 barrels per day to 240,000 barrels per day, with ConocoPhillips participating in the design and financing of the expansion. The terminal entity, Varandey Terminal Company, is a VIE because we and our related party, LUKOIL, have disproportionate interests. We have an obligation to fund, through loans, 30 percent of the terminal’s costs, but we will have no governance or ownership interest in the terminal. We are not the primary beneficiary and account for our loan to Varandey Terminal Company as a financial asset. 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.

In 2004, we finalized a transaction with Freeport LNG Development, L.P. (Freeport LNG) to participate in a liquefied natural gas (LNG) receiving terminal in Quintana, Texas. We have no ownership in Freeport LNG; however, we obtained a 50 percent interest in Freeport LNG GP, Inc., which serves as the general partner managing the venture. We entered into a credit agreement with Freeport LNG, whereby we will provide loan financing of approximately $630 million for the construction of the terminal. Through December 31, 2006, we had provided $520 million in financing, including accrued interest. Freeport LNG is a VIE, and we are not the primary beneficiary. We account for our loan to Freeport LNG as a financial asset.

In 2003, we entered into two 20-year agreements establishing separate guarantee facilities of $50 million each for two LNG ships then under construction. Subject to the terms of the facilities, we will be required to make payments should the charter revenue generated by the respective ships fall below a certain specified minimum threshold, and we will receive payments to the extent that such revenues exceed those thresholds. To the extent we receive any such payments, our actual gross payments over the 20 years could exceed $100 million. In September 2003, the first ship was delivered to its owner and in July 2005, the second ship was delivered to its owner. Both agreements represent a VIE, but we are not the primary beneficiary and, therefore, we do not consolidate these entities. The amount drawn under the guarantee facilities at December 31, 2006, was approximately $5 million for both ships. We currently account for these agreements as guarantees and contingent liabilities. See Note 17 — Guarantees, for additional information.

In 1997, Phillips 66 Capital II (Trust II) was created for the sole purpose of issuing mandatorily redeemable preferred securities to third-party investors and investing the proceeds thereof in an approximate amount of subordinated debt securities of ConocoPhillips. At December 31, 2006, we reported debt of $361 million of 8% Junior Subordinated Deferrable Interest Debentures due 2037. Trust II is a VIE, but we do not consolidate it in our financial statements because we are not the primary beneficiary. Effective January 15, 2007, we redeemed the 8% Junior Subordinated Deferrable Interest Debentures due 2037 at a premium of $14 million, plus accrued interest. See Note 15 — Debt, for additional information about Trust II.

In December 2006, we terminated the lease of certain refining assets which we consolidated due to our designation as the primary beneficiary of the lease entity. As part of the termination, we exercised a purchase option of the assets totaling $111 million and retired the related debt obligations of $104 million 5.847% Notes due 2006. An associated interest rate swap was also liquidated.

Ashford Energy Capital S.A. (Ashford) is consolidated in our financial statements because we are the primary beneficiary. In December 2001, in order to raise funds for general corporate purposes, ConocoPhillips and Cold Spring Finance S.a.r.l. (Cold Spring) formed Ashford through the contribution of a $1 billion ConocoPhillips subsidiary promissory note and $500 million cash. Through its initial $500 million investment, Cold Spring is entitled to a cumulative annual preferred return, based on three-month LIBOR rates, plus 1.32 percent. The preferred return at December 31, 2006, was 6.69 percent. In 2008, and each 10-year anniversary thereafter, Cold Spring may elect to remarket their investment in Ashford, and if unsuccessful, could require ConocoPhillips to provide a letter of credit in support of Cold Spring’s investment, or in the event that such letter of credit is not provided, then cause the redemption of their investment in Ashford. Should ConocoPhillips’ credit rating fall below investment grade, Ashford would require a letter of credit to support $475 million of the term loans, as of December 31, 2006, made by Ashford to other ConocoPhillips subsidiaries. If the letter of credit is not obtained within 60 days, Cold Spring could cause Ashford to sell the ConocoPhillips subsidiary notes. At December 31, 2006, Ashford held $1.9 billion of ConocoPhillips subsidiary notes and $29 million in investments unrelated to ConocoPhillips. We report Cold Spring’s investment as a minority interest because it is not mandatorily redeemable and the entity does not have a specified liquidation date. Other than the obligation to make payment on the subsidiary notes described above, Cold Spring does not have recourse to our general credit.