Russian Gas, U.S. Profits

Last year, Conoco Inc. and Phillips Petroleum merged, adding to the list of integrated oil conglomerates with compound names. But ConocoPhillips (NYSE: COP  ) is more than a mouthful; it's the third-largest integrated energy company in the U.S. and ranks among the world's 100 largest companies.

As you'd imagine, the company's core business is petroleum exploration, refining, and delivery, but the company also gathers and processes natural gas. And it's natural gas that has lately captured the imagination of ConocoPhillips management.

Russians and Americans
In the heady days of the presidential friendship between Bush and Putin, American and Russian energy companies held energy summits to make nice and see what they could offer one another -- a spirit of cooperation that could be paying off for companies in both countries.

At the second annual summit in St. Petersburg, ConocoPhillips and Russian gas company OAO Gazprom set the stage for a $10 billion deal that would enable ConocoPhillips to transport liquefied natural gas (LNG) from Russia to the U.S. The idea is not a new one for ConocoPhillips or its competitors, but a joint operation with the Russians is appealing since shipping LNG from Russia's Far North would be cheaper than from the Middle East, according to Gazprom's deputy chairman, Alexander Ryazanov.

In a shroud of secrecy that seems the Russian way, both sides have declined to confirm the deal. A ConocoPhillips spokesperson would only concede that a discussion with Gazprom had occurred. And it couldn't have happened at a more opportune time.

Energy is a hot topic
Under the auspices of approving the nomination of Utah Governor Mike Leavitt as EPA administrator, the U.S. Senate heated up over domestic energy issues, including oil drilling in the Arctic National Wildlife Refuge and the Bush administration's latest proposals for industrial air pollution control.

In Russia, Yukos-Sibneft -- the country's largest oil producer -- is drawing attention from foreign oil and gas companies. A deal sits on the table for either Exxon Mobil Corp. (NYSE: XOM  ) or ChevronTexaco Corp. (NYSE: CVX  ) to purchase 25% of Yukos.

However the ConocoPhillips/Gazprom talks shake out, it appears that the framework for the deal is rather straightforward. As reported in The Wall Street Journal and The St. Petersburg Times, Gazprom and ConocoPhillips would venture into a joint operation to construct a facility to tap the natural gas in a designated field in Russia as well as coordinate offshore production and liquefying. Once cooled to -260º F, LNG will then be loaded onto a specially designed fleet of tankers and transported to the U.S. East Coast.

The deal seems a natural. LNG is an emerging industry in Russia, whereas ConocoPhillips has significant LNG experience, including a 30% stake in Duke Energy Field Services LLC, a subsidiary of Duke Energy (NYSE: DUK  ) . Meanwhile, ConocoPhillips brings special technologies and expertise to help Russia capitalize on its vast natural gas resources.

Not in Kansas anymore
ConocoPhillips does face some challenges doing business in Russia. With only a decade separating the private enterprise system from the Soviet state-owned system, bureaucracy in Russia is more entrenched than transparency. I recently spent three weeks traveling through western Russia and can attest to a cultural barrier in business dealings with the Russians. And already, there seems to be some misunderstanding as Gazprom officials say that the deal can be finalized within a month, whereas James Mulva, president and CEO at ConocoPhillips, regards that timeframe as premature, considering that the project won't be ready to develop until after 2010.

If the deal does go through, ConocoPhillips stands poised to reap the benefits. Initial qualitative analysis shows that Russia has the natural supply and the U.S. has the growing demand. ConocoPhillips reported $57 billion in sales revenue at year-end 2002, reflecting their merger last year. By the end of second quarter 2003, revenues already total $52 billion, giving investors an indication that the merger was the right thing to do.

ConocoPhillips shares currently fetch approximately $55. With a book value of $45.38 per share, it would seem that this stock is not overpriced.

Slow and steady
The LNG deal with Gazprom is no get-rich-quick strategy for ConocoPhillips. The company needs to maintain a steady financial outlook; after all, Russian gas won't hit U.S. shores for some 10 years (or more). In the meantime, ConocoPhillips must invest tens of billions of dollars to bring LNG capabilities in the U.S. up to speed. Currently, the U.S. only has a handful of terminals that can accept LNG, and ConocoPhillips is already considering building more, including one in Maine.

On the balance, the outlook is bright for ConocoPhillips. The new company has reorganized its operations and eliminated redundancies. In its merged form, it is a smaller, leaner player in the energy marketplace and is on the lookout for deals that can beef up its product portfolio, and its revenues too. As a big player, it can compete with the largest in the industry for major projects but is not so large that significant discoveries don't have an impact.

It's easy to see why a deal of this magnitude was discussed in the fashionable and open St. Petersburg. Away from the heavy militia presence that surrounds the Duma and pervades the consciousness in Moscow, St. Petersburg remains as Peter the Great founded it in 1703 -- "a window on the West." Indeed, new U.S.-Russian opportunities are opening up and this ConocoPhillips-Gazprom deal will be closely watched as Russia continues to graduate its private business practices and the U.S. seeks alternative sources of fuel.

Yvonne Pesquera is a freelance writer working on winning a Pulitzer Prize or the Nobel Prize for Literature -- whichever comes first. You can email her at reply_yvonne@hotmail.com. The Motley Fool is investors writing for investors.


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