To Our Shareholders:

During 2007 ConocoPhillips operated reliably and profitably, overcoming numerous challenges in the increasingly competitive international oil and natural gas industry. Our strategic direction remained consistent. We continued to enhance our portfolio through capital investments. We built additional value for shareholders by increasing our annual stock dividend rate and making significant share repurchases. We also prudently managed our balance sheet.

Safety and environmental stewardship remain core values at ConocoPhillips. Our performance improved during 2007, and we continue working toward our “Journey to Zero” goals of zero injuries, incidents and occupational illnesses. Enhancing this performance was our ongoing emphasis on operating excellence and associated efforts to improve process safety and operational reliability.

Net income during 2007 was $11.9 billion, or $7.22 per share, compared with $15.6 billion, or $9.66 per share, in 2006. The 2007 results included an after-tax impairment of $4.5 billion resulting from the expropriation of our Venezuelan oil projects. Excluding this impairment, 2007 earnings were $16.4 billion or $9.97 per share. We have filed a request for international arbitration concerning the Venezuelan expropriation, while continuing to negotiate in an effort to reach an amicable settlement on compensation. Our capital program totaled $12.9 billion.

ConocoPhillips shareholders realized a 25.4 percent return on their investment during 2007 through share price appreciation and dividends, the fifth consecutive year of returns exceeding 25 percent. We increased the quarterly dividend by 14 percent and undertook a significant share repurchase program. Our repurchases totaled 89.5 million shares for $7 billion during 2007. For 2008, $10 billion in additional repurchases are authorized, and during the first quarter we declared an additional 15 percent increase in the quarterly dividend.

Total debt was reduced by $5.4 billion during 2007 to $21.7 billion, compared with $27.1 billion at year-end 2006. This reduction lowered the debt-to-capital ratio to 19 percent. We foresee no current need for further significant debt reduction.

Over the long term, ConocoPhillips strives to achieve financial performance differential to that of our peers as measured on a per-barrel basis. During 2007, our Refining and Marketing (R&M) business generated income and cash per barrel well above its peer-group average. Our Exploration and Production (E&P) sector outperformed its peer group on cash per barrel but slightly under-performed on income per barrel due to the purchase accounting impact of recent acquisitions. The company’s overall return on capital employed was just under the peer-group average.

 

ConocoPhillips’ market capitalization was $139 billion at the end of 2007, representing a 17 percent increase from 2006. The company had 1,571 million shares outstanding on Dec. 31, 2007, with a year-end closing price of $88.30.

The company’s total shareholder return for 2007 was 25.4 percent, second among its peers. ConocoPhillips’ annualized return to shareholders over the three-year period was 29.4 percent and over a five-year period was 32.6 percent.

 

 

Operational Milestones
Among the year’s operational highlights, ConocoPhillips:

• Produced 2.3 million barrels of oil equivalent (BOE) per day, including volumes from our E&P sector and our LUKOIL investment. We achieved reserve replacement of 159 percent, excluding the impact of the Venezuelan expropriation. Total reserves were 10.6 billion BOE at year end. LUKOIL yielded 0.4 million BOE per day of our net production and $1.8 billion in income.
• Started up the Surmont heavy-oil project in Canada, the Kerisi natural gas project in Indonesia, and the Statfjord Late Life and Kelvin oil projects in the North Sea.
• Achieved a worldwide refining crude oil capacity utilization rate of 94 percent, an increase from 2006. Our U.S. utilization rate of 96 percent exceeded the industry average for the sixth consecutive year. R&M also increased its capacity to process lower-quality, cost-advantaged feedstock and to produce clean fuels.
• Successfully initiated the upstream and downstream business ventures with EnCana and began upgrading the Borger and Wood River refineries to increase their heavy-oil processing capacity.
• Refocused our exploration program to increase exposure to world-class prospects. This process began with thorough geological studies of areas offering major resource potential, followed by key lease acquisitions. We expect to increase wildcat drilling in the future. During 2007, we achieved discoveries in the North Sea, Malaysia and Nigeria. We also continued successful low-risk exploration in the United States and western Canada, primarily in highly prospective resource plays, and added 476,000 acres of new leases.
• Progressed nearly 40 major development projects toward startup. In Kazakhstan, development proceeded on the Kashagan field, and we and our co-venturers reached an agreement with the government on the project’s costs and schedule and on increasing the government’s ownership interest.
• Continued growing the Commercial organization, improving our ability to secure refining feedstocks at favorable cost and sell our products at attractive margins. We concurrently increased our pipeline, terminal, marine transportation and transmission capacities.
• Rationalized our portfolio, realizing $3.6 billion in proceeds primarily from the sale of non-core exploratory and producing properties and refining and marketing assets. We plan further selective divestments to facilitate ongoing portfolio renewal.
• Increased annual spending on technology to $400 million, with $250 million devoted to existing businesses and $150 million to new research and emerging businesses. We expanded our alternative energy capabilities by introducing renewable diesel fuel made from byproduct animal fat, formed an alliance to research production of advanced biofuels from non-food sources, undertook a study on producing synthetic natural gas from coal, and funded several university research programs.

Key Operating and Strategic Initiatives

ConocoPhillips utilizes a well-defined strategy to build shareholder value.

We pursue capital growth by capturing the opportunities inherent in our high-quality asset base, as well as newly developed opportunities that meet our operating and financial parameters. We do this with a balance that serves both energy consumers and shareholders, driven by operating and financial performance that continues to enhance our financial strength and flexibility. Cash flow in excess of immediate capital investment needs is predominantly dedicated to the direct benefit of shareholders through share repurchases and dividends. These complementary actions build the underlying value of our base businesses, with this value enhanced on a per-share basis by share repurchases and dividends.

The process begins with our attractive assets. We are a leading North American oil and natural gas producer, with a major legacy position in the North Sea and growth prospects in the Middle East, Asia Pacific, Russia and the Caspian Sea. Our R&M business stands second in U.S. crude oil refining capacity and offers opportunities to increase refining complexity and capacity to manufacture environmentally desirable clean fuels. Our other downstream businesses further leverage the energy value chain.

To exploit the opportunities available, we plan a $15.3 billion capital program for 2008, with $12 billion allocated to E&P, $2.8 billion to R&M, and $500 million to Emerging Businesses and Corporate. Key E&P goals also include averaging at least 100 percent annual reserve replacement and 2 percent annual production growth. In response to current industry cost inflation, our priority will be creating value.

 

 

The Challenging Industry Environment

The global energy market appears poised for long-term strength, driven by growing world population and increased energy demand in developing countries. We believe ConocoPhillips is favorably positioned to operate in this environment and to cope with the market’s vulnerability to occasional downturns. Although the energy industry faces challenging operational obstacles, we believe that we are prepared to meet them.

Perhaps foremost among these challenges is society’s need to achieve energy supply security and its desire to address the climate impact of greenhouse gas emissions.

ConocoPhillips believes that energy supply security would improve significantly if national governments opened access to restricted areas known to offer energy development potential and encouraged the more efficient use of energy.

However, we also believe that climate-change concerns must be addressed, and that neither issue can be solved separately. Otherwise, public concerns over potential energy shortages would defeat efforts to reduce greenhouse gas emissions, while concerns over climate change would defeat energy development initiatives. These global issues must be addressed together through well-integrated government policies.

Recent energy legislation in the United States focused exclusively on promoting renewable and alternative energy. The legislation ignored the vast oil and natural gas potential located on public lands that are off limits to drilling and the vital role these energy sources must play in the future.

ConocoPhillips therefore calls for enactment of a comprehensive U.S. energy policy that facilitates production of all energy sources, enhances energy efficiency, and initiates action on climate change. We believe the public would welcome such a policy.

We further call on the energy industry to engage in the debate on climate-change solutions. During 2007, ConocoPhillips became the only major U.S.-based oil company to join the U.S. Climate Action Partnership, which supports development of a mandatory national framework to reduce greenhouse gas emissions. In anticipation of possible future regulations, we are preparing carbon baselines and incorporating potential carbon costs into our capital projects. We also joined the Duke University Climate Change Partnership, which is striving to develop workable public policies.

ConocoPhillips is responding to other vital issues, such as the growing tendency of energy-exporting countries to restrict access to their resources. Some allow only their national oil companies to operate within their borders. Others impose impractical fiscal terms or, on occasion, even violate contracts and expropriate properties. These actions tend to tighten energy supplies, despite the fact that the world still possesses substantial undeveloped potential.

ConocoPhillips is well-suited to withstand this resource nationalism because a significant proportion of our assets are located in the United States, Canada, European nations and other Organization of Economic Cooperation and Development (OECD) member countries.

Additionally, in order to overcome industry-wide shortages of technical personnel, we broadened our college and experienced recruiting programs. To meet the growing need for innovation, we significantly increased research and development expenditures. And to resist cost inflation, we implemented more comprehensive planning and procurement strategies for our development projects.

 

 

Corporate Citizenship

While ConocoPhillips believes that our responsibility to society begins with providing reliable and sustainable energy, we also are committed to improving the well-being of the communities in which we operate.

One of the many ways we practiced corporate citizenship during 2007 was the contribution of approximately $60 million in donations to worthy educational, youth, health, social service, civic, art, environmental and safety initiatives, as well as charities. Our employees also contributed thousands of hours of their personal time to these causes.

To enhance dialogue with the public, we continued our Conversation on Energy program, advocating wider diversification of energy supply sources, more efficient energy use, greater technological innovation and environmental responsibility. By year-end 2007, members of management had visited 35 U.S. cities to meet with the public, political leaders, educators and the media. We also created accompanying television and print advertising. Our plans are to continue this dialogue in 2008.

ConocoPhillips is taking action on a number of environmental concerns. For example, to enhance the worldwide availability of fresh water, we are establishing a water sustainability center in Qatar. It will research the safe reuse in farm and industrial applications of byproduct water from oil production and refining.

 

The ConocoPhillips of Tomorrow

Our results for 2007 represent substantial progress in increasing the ability of ConocoPhillips to deliver sustainable supplies of energy. For now, we must focus primarily on developing oil and natural gas. These essential energy sources power today’s economy and are needed to serve as bridging fuels until the energy sources of tomorrow are developed in sufficient scale.

Concurrently, we are working to bring unconventional fossil fuels to market in cleaner forms while developing biofuels and other renewable energy sources.

We are determined to continue this progress, while in the near term meeting our goals of delivering energy reliably and profitably, generating growth, and building shareholder value.

James J. Mulva

Chairman and Chief Executive Officer

March 1, 2008