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Rating Action:

MOODY'S UPGRADES DEBT RATINGS OF CONOCOPHILLIPS TO A1 AND PRIME-1; MEREY SWEENY L.P. TO Baa2; OUTLOOK STABLE

07 Nov 2005
MOODY'S UPGRADES DEBT RATINGS OF CONOCOPHILLIPS TO A1 AND PRIME-1; MEREY SWEENY L.P. TO Baa2; OUTLOOK STABLE

New York, November 07, 2005 -- Moody's Investors Service upgraded ConocoPhillips's (COP) senior long-term debt to A1 from A3 and its commercial paper to Prime-1 from Prime-2, concluding a review announced on August 3, 2005. The outlook for the ratings is stable. Concurrently, Moody's upgraded the senior note rating of Merey Sweeny LP from Baa3 to Baa2, with a stable outlook. COP ratings upgraded include the issuer rating, debentures, notes, revolving credit facilities, industrial revenues bonds and various shelf registrations for COP and its guaranteed facilities. Also upgraded with a stable outlook are the preferred stock of ConocoPhillips Capital Trust II, to A3 from Baa2; and the pass-through certificates of Conoco Phillips Company, to Aa3 from A2.

The rating upgrade reflects COP's operational success and growth since the 2002 merger of Conoco and Phillips Petroleum. COP's upstream scale and geographic diversification, and its refining and marketing and mid-stream operations all place it very competitively among the second tier of the top integrated oil companies. Since the merger, COP has rationalized and re-positioned the upstream and downstream asset base and reduced costs in the upstream to aim for sustained production growth of about 3% p.a. from identified sources. It also has consolidated its midstream investment in Duke Energy Field Services (DEFS) in 2005 by investing to increase its stake to 50%. In Moody's view, COP is well-positioned for future international upstream growth, which will help mitigate higher cost declining production in the U.S. and the North Sea. COP has also made a major investment with high growth potential in Russia via its 14.8% stake in LUKOIL (rated Ba1 senior implied), at a cost to date of about $4.2 billion.

Since 2002, COP has used free cash flow and substantial cash from asset sales to reduce total debt obligations by more than $11 billion to current adjusted debt of $22.5 billion. These debt obligations include on- and off-balance-sheet debt, significant non-recourse JV debt, pension liabilities, and guarantees. Moody's believes that COP has reduced its financial leverage to the lower end of the range in which it plans to manage its leverage position (debt ratio target TD/Cap 20%-25%), although the company has indicated strong free cash generation could be used for additional debt reduction. Beginning in 2005, COP is also using free cash flow to repurchase its stock. However, even with an orientation to shareholder rewards, the focus has been largely on anti-dilution of stock options, and Moody's believes the company will manage share repurchases relative to free cash flow to prevent significant re-leveraging.

COP's financial performance has reached a record level in 2005. Cash flow from operations reached $12.9 billion in the first nine months of the year and the company should be able to fund its dividend, capital spending, an increased investment in LUKOIL, and its share repurchases from internal cash flow in 2005. COP also reduced debt by $1.5 billion during that period. COP's liquidity position is strong, including $2.8 billion of cash at 9/30/05.

COP's oil and gas production, excluding its equity share of LUKOIL's production, has been relatively flat in 2005. However, the company has identified a roster of development projects, including integrated gas projects that should support production growth of 3% p.a. over the medium-term. A risk for the company will be its ability to sustain production growth if any significant development projects are delayed for operational or political risk reasons. COP's proved reserves and production base will remain concentrated in mature areas such as North America and the North Sea for the foreseeable future which, while favorable from a political risk perspective, also presents challenges to production growth and cost structure.

COP's cash production costs and finding and development costs are competitive with its major upstream competitors'. However, upstream unit costs will be under pressure given its mature legacy positions and the external inflation pressures confronting the industry as a whole. COP is also building up its investment in the integrated LNG gas value chain. At this juncture it trails its largest integrated peers in this area, and the investment both in integrated projects and U.S. re-gasification faces long-term spending cycles, commercial challenges, political risk, and environmental opposition. Moody's also believes that while COP plans to maintain a conservative balance sheet, international expansion could lead to leverage increases via non-recourse debt in significant projects.

COP has largely repositioned its upstream asset base since the merger and embarked on a significant investment in LUKOIL. Despite substantial political risk, LUKOIL presents large opportunities in Russia and further diversification in the international growth portfolio. While acquisition event risk is a potential concern, it is mitigated by management's view that it does not need to make acquisitions given its current reserve position and internal investment opportunities. Moreover, strong cash liquidity and COP's reduced financial leverage mitigate the risk that large transactions would negatively affect its credit ratings.

Moody's is maintaining a stable outlook for COP's long-term A1 rating. Under reasonable pricing scenarios, COP should continue to be a strong free cash generator and, as noted, the scale of COP's operations and conservative financial targets, as well as many of its financial/reserve metrics, align with those of higher-rated integrated peer companies. Further upside in the long-term rating may emerge as Moody's monitors COP's financial and operating performance for greater visibility on reserve replacement and cost structure trends, on the level of debt and sustainability of leverage reductions, and on progress with its investment in LUKOIL investment, as well as acquisition event risk.

In a related rating action, Moody's upgraded to Baa2 from Baa3 the senior notes of Merey Sweeny LP, a delayed coking project finance owned 50% by COP. However, MSLP's debt is non-recourse to the partners. The upgrade is based on Merey Sweeny's strong operating tie-in to COP's 275,000 bpd refinery in Sweeny, Texas, on partner structural supports that put an effective floor on MSLP's debt service coverage, and on COP's strong motivation to support the project in the event of financial or operating problems. The rating outlook is stable. PDVSA (B2 foreign currency debt) is the 50% partner in MSLP. Its several, not joint, support obligations as well as the single asset nature of the project constrain further upside rating potential.

CononcoPhillips, a major integrated oil company, is headquartered in Houston, Texas. Merey Sweeny LP is sited at COP's large refinery complex at Sweeny, Texas.

New York
John Diaz
Managing Director
Corporate Finance Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

New York
Thomas S. Coleman
Senior Vice President
Corporate Finance Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

No Related Data.
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