or ConocoPhillips’ Exploration and Production (E&P) business, 2007 was a year of operational progress in a number of areas despite challenges posed by the intensely competitive international oil and natural gas industry.

Highlights included the attainment of a leading ownership position in Canada’s Athabasca oil sands trend, the startup of several producing projects and ongoing progress on many others, and the continued strengthening of its exploration program. These successes and the company’s substantial opportunity portfolio have favorably positioned ConocoPhillips for the future.

“Our prospects and capabilities have never been greater,” says John Lowe, executive vice president, E&P. “We have 35 major development projects under way, two-thirds of which we expect to start up in the next five years, and we have opportunities to further maximize production from our legacy assets.”

E&P holds one of the industry’s largest land positions in North America and is a leading operator in many of its key producing regions.

As always, E&P’s most important priority is safety. Its total recordable incident rate declined by more than 20 percent in 2007, and E&P is working to further improve process safety and personal safety performances.

During the year, E&P benefited from favorable crude oil and natural gas prices, but production declined due in part to the expropriation of the company’s Venezuelan oil projects. E&P delivered production (including Syncrude) of 1.88 million barrels of oil equivalent (BOE) per day, a 4 percent decrease from 2006. ConocoPhillips’ 2007 reserve replacement was 159 percent, excluding the expropriation impact, or 29 percent including the expropriation impact. Total proved reserves (excluding Syncrude) at year-end 2007 were 10.6 billion BOE. E&P conducted an $11 billion capital program during 2007 and plans a $12 billion program for 2008, including a joint venture aquisition obligation and loans to affiliates.

“We were disappointed by the Venezuelan expropriation, but we continue negotiations concerning appropriate compensation and are hopeful that an amicable settlement can be achieved,” Lowe says. “In order to protect the interest of our shareholders, we also filed a request for arbitration with the World Bank’s International Centre for the Settlement of Investment Disputes.”

 

 

Worldwide Operational Milestones

E&P recorded a number of exploration, development and strategic accomplishments during 2007.

The company’s agreement with EnCana Corporation, finalized early in the year, created an integrated heavy-oil venture that includes a 50 percent interest in the Foster Creek and Christina Lake oil sands projects in Alberta. Through the initial acquisition and subsequent extensions and discoveries, this partnership contributed over 600 million barrels to year-end proved reserves. The projects are estimated to hold 6.3 billion gross barrels of recoverable bitumen. Current production from these projects is about 60,000 gross barrels of oil per day (BOD), with significant growth expected over the next decade. Additionally, the ConocoPhillips-operated Surmont phase I oil sands project started production in the fourth quarter.

E&P’s exploration achievements included two successes in the U.K. North Sea. A natural gas discovery, Jasmine Northeast Terrace, was achieved near the 2006 Jasmine discovery; and the Clair phase II appraisal program confirmed the viability of the Clair Ridge discovery, with development planning under way. In East Texas, the Turner and Feldman natural gas discoveries, near the Savell field, enhanced the company’s position in the prolific Bossier Trend.

In order to strengthen its exploration portfolio, the company added 30 deepwater tracts in the Gulf of Mexico, as well as offshore acreage in Australia, Indonesia and the North Sea. E&P also added 476,000 net acres onshore in Canada and the U.S. Lower 48 states, as well as onshore acreage in Peru.

Additionally, in the Asia Pacific region, growth continued offshore Malaysia, with the Gumusut-Kakap field development sanction and the Petai discovery. E&P also was successful in acquiring the Kebabangan Cluster production sharing contract. In Nigeria, E&P conducted successful exploration and appraisal programs onshore and offshore.

Among development milestones, first production was achieved in Indonesia’s Kerisi field, Colorado’s Piceance Basin, the Statfjord Late Life program in the Norwegian North Sea, and the Kelvin platform in the U.K. North Sea.

Progress occurred on a number of major, ongoing projects including the development of multiple oil-producing facilities in Bohai Bay offshore China. The first wellhead platform from the phase II development was placed onstream in 2007, and full field startup is expected in 2009. Progressing toward startup in 2008 were the North Sea Britannia satellite fields and the Yuzhno Khylchuyu field, part of the Naryanmarneftegaz joint venture with LUKOIL in northern Russia. In preparation for the 2009 startup of the Qatargas 3 natural gas liquefaction facility in Qatar, three production jackets were installed and development drilling was initiated. ConocoPhillips also acquired an interest in the Golden Pass regasification facility, which is under construction near Sabine, Texas. It will be supplied by Qatargas 3.

In Kazakhstan, development of the Kashagan field continued with the construction of artificial drilling islands, processing facilities, living quarters and pipelines. The project’s co-venturers also reached a preliminary agreement with the government of Kazakhstan on the development costs and schedule and on increasing the Kazakhstan national oil company’s ownership percentage in the project. As a result, ConocoPhillips’ ownership interest in the project would decline from 9.26 percent to 8.40 percent.

The Piceance Basin was the site of an innovative approach to reduce the impact of drilling activity. E&P built temporary living quarters for up to 400 contract workers, and it has been lauded by community leaders and neighbors for shrinking the operating footprint, reducing traffic congestion and eliminating local infrastructure needs.

Portfolio rational-ization was another key 2007 achievement, as E&P sold non-core assets in seven countries for approximately $2 billion.

“These were generally mature producing properties scattered throughout our worldwide portfolio that were on the high end of the cost curve. They accounted for only 1.5 percent of our volumes and had limited upside potential,” Lowe says. “We plan ongoing sales that, combined with an inflow of new properties, assure the continual up-grading of our portfolio.”

 

A Sound Strategic Direction

E&P is focused on transforming its substantial resource potential into proven reserves and ultimately production, and is pursuing new opportunities through focused exploration and business development. The company intends to achieve, on average, annual reserve replacement in excess of 100 percent; and an average annual production growth rate through 2012 of 2 percent.

The company’s legacy assets, which include large operations in Alaska, repeatable drilling trends in the U.S. Lower 48 states and Canada, and long-life properties in the North Sea, represent a substantial and stable base of production. Growth is expected from the Athabasca oil sands, the Asia Pacific region, Russia and the Caspian Sea, the Middle East and Africa.

To enhance its exploration capabilities, E&P is working to supplement its traditional, low-risk drilling program with more high-risk, high-potential prospects. The process began with regional studies that identified such key focus areas as the Arctic, the deepwater Gulf of Mexico, the North Sea and offshore Australia. Increased acreage acquisitions in these areas began in 2007, with similar acquisitions and drilling expected to follow.

Meanwhile, E&P is responding to the challenging operating environment. While the entire industry is hampered by government-imposed restrictions on access to resources in many countries, E&P has the advantage of a substantial, existing opportunity portfolio primarily concentrated in relatively stable OECD countries.

Industry cost inflation inevitably accompanies strong commodity prices. In response, E&P is leveraging its economies of scale in negotiating supply agreements, shortening project cycle times, employing new technology and selling underperforming assets.

“We continue to exercise strict capital discipline while conducting thorough analyses that enable us to fund the investments that add the greatest value,” says Ryan Lance, president, E&P – Europe, Asia, Africa and the Middle East.

Looking toward the long term, ConocoPhillips continues striving to advance the construction of a natural gas pipeline from Alaska’s North Slope, which would provide market access to significant gas resources. Additionally, the company supports the construction of a natural gas pipeline from Canada’s Mackenzie Delta.

“Although the outlook for both pipelines remains uncertain, these natural gas supplies will be needed by North American markets in the future,” Lowe says.

“In the meantime, our strong asset base, our strategic direction, and the opportunities we see in the market enable us to move into 2008 with a high level of confidence,” he adds. “We are poised to continue our long-term growth and thereby build value for our shareholders.”