DBRS Confirms ConocoPhillips Long-Term Ratings at “A,” Commercial Paper at R-1 (low), with Stable Trends

DBRS has confirmed the Unsecured Long-Term Notes & Debentures and Commercial Paper ratings of ConocoPhillips (COP or the Company) at “A” and R-1 (low), respectively, both with Stable trends. DBRS has also confirmed the Senior Unsecured Notes & Debentures of Burlington Resources Inc. at “A,” with a Stable trend. The confirmations are based on results and corporate developments in the six months ending June 30, 2012 (H1 2012).

During Q2 2012, the spinoff previously announced by the Company was completed. ConocoPhillips now operates as the world’s largest independent E&P Company (by production), with no downstream operations. The lack of integration post-spinoff increases COP’s exposure to volatile energy pricing, potentially impacting both earnings and cash flow, as downstream operations generally act as a natural hedge to price volatility, and benefit from lower-priced feedstock during price declines (as seen in Q2 2012).

Post-spinoff, the Company has indicated its intention to maintain leverage below 30%. At June 30, 2012, COP’s debt-to-capital was 33.1% (up from 25.6% at year-end 2011). The increase is largely due to a decreased equity base as a result of the spinoff, as the majority of debt remained with COP. The Company does have $5 billion in restricted cash available from a $7.8 billion special distribution from Phillips 66, which is to be used for dividends, share buybacks or debt reduction (or some combination thereof). In Q3 2012, $1.5 billion in long-term debt was retired early. DBRS estimates leverage lowered to 31.7% as a result.

Capital spending (capex) for 2012 ($16 billion) and 2013 ($15 billion) is aggressive relative to COP’s expected cash flow ($12 billion to $14 billion in 2012 and 2013). As a result, operating cash flow is not expected to be sufficient to fund capex and dividends (estimated at $3 billion for each of 2012 and 2013). Deficits could be up to between $5 billion and $7 billion in each year. Although the Company intends to use cash on hand and proceeds from asset sales to fund the shortfalls, credit metrics could be negatively impacted if asset sales (expected at $8 billion to $10 billion by the end of 2013, with $1.6 billion to date) are not at expected levels, or if a recurrence of the crude price declines experienced in Q2 occurs. Continued aggressive share buybacks ($5.1 billion as of the date of this report) could also negatively impact credit metrics, given the expected cash flow shortfalls. Any significant weakness in credit metrics could result in a negative rating action.

Notes:
All figures are in U.S. dollars unless otherwise noted.

The applicable methodology is Rating Oil and Gas Companies, which can be found on the DBRS website under Methodologies.