|• FORM 10-Q • FORM OF RESTRICTED STOCK UNITS AGREEMENT DATED APRIL 4, 2012 • FORM OF RESTRICTED STOCK UNITS AGREEMENT DATED MAY 8, 2012 • AMENDMENT AND RESTATEMENT OF ANNEX • AMENDMENT AND RESTATEMENT OF THE BURLINGTON RESOURCES INC • AMENDMENT, CHANGE OF SPONSORSHIP • AMENDMENT AND RESTATEMENT OF DEFINED CONTRIBUTION TITLE I • AMENDMENT AND RESTATEMENT OF DEFINED CONTRIBUTION TITLE II • AMENDMENT AND RESTATEMENT OF KEY EMPLOYEE TITLE I • AMENDMENT AND RESTATEMENT OF KEY EMPLOYEE TITLE II • AMENDMENT AND RESTATEMENT OF KEY EMPLOYEE SUPPLEMENTAL RETIREMENT PLAN • AMENDMENT AND RESTATEMENT SUPPLEMENTAL EXECUTIVE RETIREMENT PLAN • COMPUTATION OF RATION OF EARNINGS TO FIXED CHARGES • CERTIFICATION OF CHIEF EXECUTIVE OFFICER PURSUANT TO RULE 13A-14(A • CERTIFICATION OF CHIEF FINANCIAL OFFICER PURSUANT TO RULE 13A-14(A • CERTIFICATIONS PURSUANT TO 18 U.S.C. SECTION 1350 • XBRL INSTANCE DOCUMENT • XBRL TAXONOMY EXTENSION SCHEMA • XBRL TAXONOMY EXTENSION CALCULATION LINKBASE • XBRL TAXONOMY EXTENSION DEFINITION LINKBASE • XBRL TAXONOMY EXTENSION LABEL LINKBASE • XBRL TAXONOMY EXTENSION PRESENTATION LINKBASE|
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
For the quarterly period ended June 30, 2012
For the transition period from to
Commission file number: 001-32395
(Exact name of registrant as specified in its charter)
600 North Dairy Ashford, Houston, TX 77079
(Address of principal executive offices) (Zip Code)
(Registrants telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
The registrant had 1,214,549,390 shares of common stock, $.01 par value, outstanding at June 30, 2012.
Consolidated Income Statement
See Notes to Consolidated Financial Statements.
Consolidated Statement of Comprehensive Income
*Plans for which ConocoPhillips is not the primary obligorprimarily those administered by equity affiliates.
**Available-for-sale securities of LUKOIL.
See Notes to Consolidated Financial Statements.
Consolidated Balance Sheet
**Certain amounts have been restated to reflect a prior period adjustment. See Note 16Accumulated Other Comprehensive Income, in the Notes to Consolidated Financial Statements.
See Notes to Consolidated Financial Statements.
Consolidated Statement of Cash Flows
See Notes to Consolidated Financial Statements.
Consolidated Statement of Changes in Equity
*Certain amounts have been restated to reflect a prior period adjustment. See Note 16Accumulated Other Comprehensive Income, in the Notes to Consolidated Financial Statements.
See Notes to Consolidated Financial Statements.
Notes to Consolidated Financial Statements
Note 1Basis of Presentation
The interim-period financial information presented in the financial statements included in this report is unaudited and, in the opinion of management, includes all known accruals and adjustments necessary for a fair presentation of the consolidated financial position of ConocoPhillips and its results of operations and cash flows for such periods. All such adjustments are of a normal and recurring nature unless otherwise disclosed. Certain notes and other information have been condensed or omitted from the interim financial statements included in this report. Therefore, these financial statements should be read in conjunction with the consolidated financial statements and notes included in our 2011 Annual Report on Form 10-K.
The results of operations for our refining, marketing and transportation businesses; most of our Midstream segment; our Chemicals segment; and our power generation and certain technology operations included in our Emerging Businesses segment (collectively, our Downstream business), have been classified as discontinued operations for all periods presented. See Note 2Separation of Downstream Business, for additional information. Unless indicated otherwise, the information in the Notes to the Consolidated Financial Statements relates to our continuing operations.
Note 2Separation of Downstream Business
On April 30, 2012, the separation of our Downstream business was completed, creating two independent energy companies: ConocoPhillips and Phillips 66. After the close of the New York Stock Exchange on April 30, 2012, the shareholders of record as of 5:00 p.m. Eastern time on April 16, 2012 (the Record Date), received one share of Phillips 66 common stock for every two ConocoPhillips common shares held as of the Record Date.
In connection with the separation, Phillips 66 distributed approximately $7.8 billion to us in a special cash distribution, primarily using the proceeds from the $5.8 billion in Senior Notes issued by Phillips 66 in March 2012, as well as a portion of the approximately $3.6 billion in cash transferred to Phillips 66 at separation, comprised of funds received from the $2.0 billion term loan entered into by Phillips 66 immediately prior to the separation, and approximately $1.6 billion of cash held by Phillips 66 subsidiaries. Pursuant to the private letter ruling from the Internal Revenue Service (IRS), the principal funds from the special cash distribution will be used solely to pay dividends, repurchase common stock, repay debt, or a combination of the foregoing, within twelve months following the distribution. At June 30, 2012, the remaining balance of this cash distribution was $5,000 million and was included in the Restricted cash line on our consolidated balance sheet.
In order to effect the separation and govern our relationship with Phillips 66 after the separation, we entered into a Separation and Distribution Agreement, an Indemnification and Release Agreement, an Intellectual Property Assignment and License Agreement, a Tax Sharing Agreement, an Employee Matters Agreement and a Transition Services Agreement. The Separation and Distribution Agreement governs the separation of the Downstream business, the transfer of assets and other matters related to our relationship with Phillips 66. The Indemnification and Release Agreement provides for cross-indemnities between Phillips 66 and us and established procedures for handling claims subject to indemnification and related matters. The Intellectual Property Assignment and License Agreement governs the allocation of intellectual property rights and assets between Phillips 66 and us.
The Tax Sharing Agreement governs the respective rights, responsibilities and obligations of Phillips 66 and ConocoPhillips with respect to taxes, tax attributes, tax returns, tax proceedings and certain other tax matters. In addition, the Tax Sharing Agreement imposed certain restrictions on Phillips 66 and its subsidiaries (including restrictions on share issuances, business combinations, sales of assets and similar transactions) that are designed to preserve the tax-free status of the distribution and certain related transactions. The Tax Sharing Agreement sets forth the obligations of Phillips 66 and us as to the filing of tax returns, the administration of tax proceedings and assistance and cooperation on tax matters.
The Employee Matters Agreement governs the compensation and employee benefit obligations with respect to the current and former employees and non-employee directors of Phillips 66 and ConocoPhillips, and generally allocates liabilities and responsibilities relating to employee compensation, benefit plans and programs. The Employee Matters Agreement provides that employees of Phillips 66 will no longer participate in benefit plans sponsored or maintained by ConocoPhillips. In addition, the Employee Matters Agreement provides that each of the parties will be responsible for their respective current employees and compensation plans for such current employees, and we will be responsible for all liabilities relating to former employees. The Employee Matters Agreement sets forth the general principles relating to employee matters and also addresses any special circumstances during the transition period. The Employee Matters Agreement also provides that (i) the distribution does not constitute a change in control under existing plans, programs, agreements or arrangements, and (ii) the distribution and the assignment, transfer or continuation of the employment of employees with another entity will not constitute a severance event under the applicable plans, programs, agreements or arrangements.
The Transition Services Agreement sets forth the terms on which we will provide Phillips 66, and Phillips 66 will provide to us, certain services or functions Phillips 66 and ConocoPhillips historically have shared. Transition services include administrative, payroll, human resources, data processing, environmental health and safety, financial audit support, financial transaction support, and other support services, information technology systems and various other corporate services. The agreement provides for the provision of specified transition services, generally for a period of up to 12 months, with a possible extension of 6 months (an aggregate of 18 months), on a cost or a cost-plus basis.
The following table presents the carrying value of the major categories of assets and liabilities of Phillips 66, immediately preceding the separation of our Downstream business on April 30, 2012, excluded from our consolidated balance sheet at June 30, 2012:
Sales and other operating revenues and income from discontinued operations were as follows:
Income from discontinued operations after-tax includes transaction, information systems and other costs incurred to effect the separation of $26 million and $70 million for the three-month and six-month periods ended June 30, 2012, respectively. No separation costs were incurred during the first six months of 2011.
Prior to the separation, commodity sales to Phillips 66 were $919 million and $4,973 million for the three-month and six-month periods ended June 30, 2012, and $3,842 million and $7,599 million for the three-month and six-month periods ended June 30, 2011. Prior to the separation, commodity purchases from Phillips 66 were $7 million and $166 million for the three-month and six-month periods ended June 30, 2012, and $112 million and $264 million for the three-month and six-month periods ended June 30, 2011. Prior to May 1, 2012, commodity sales and related costs were eliminated in consolidation between ConocoPhillips and Phillips 66. Beginning May 1, 2012, these revenues and costs represent third-party transactions with Phillips 66. Although we expect certain transactions related to the sale and purchase of crude oil, natural gas and products to continue in the future with Phillips 66, the expected continuing cash flows are not considered significant; thus, the operations and cash flows of our former Downstream business are considered to be eliminated from our ongoing operations.
Note 3Variable Interest Entities (VIEs)
We hold significant variable interests in VIEs that have not been consolidated because we are not considered the primary beneficiary. Information on our significant VIE follows:
We have an agreement with Freeport LNG Development, L.P. (Freeport LNG) to participate in a liquefied natural gas (LNG) receiving terminal in Quintana, Texas. We have no ownership in Freeport LNG; however, we own a 50 percent interest in Freeport LNG GP, Inc. (Freeport GP), which serves as the general partner managing the venture. We entered into a credit agreement with Freeport LNG, whereby we agreed to provide loan financing for the construction of the terminal. We also entered into a long-term agreement with Freeport LNG to use 0.9 billion cubic feet per day of regasification capacity. The terminal became operational in June 2008, and we began making payments under the terminal use agreement. Freeport LNG began making loan repayments in September 2008, and the loan balance outstanding was $592 million at June 30, 2012, and $612 million at December 31, 2011. Freeport LNG is a VIE because Freeport GP holds no equity in Freeport LNG, and the limited partners of Freeport LNG do not have any substantive decision making ability. We performed an analysis of the expected losses and determined we are not the primary beneficiary. This expected loss analysis took into account that the credit support arrangement requires Freeport LNG to maintain sufficient commercial insurance to mitigate any loan losses. The loan to Freeport LNG is accounted for as a financial asset, and our investment in Freeport GP is accounted for as an equity investment.
Inventories consisted of the following:
Inventories valued on the last-in, first-out (LIFO) basis totaled $315 million and $3,387 million at June 30, 2012, and December 31, 2011, respectively. The estimated excess of current replacement cost over LIFO cost of inventories amounted to approximately $100 million and $8,400 million at June 30, 2012, and December 31, 2011, respectively.
A significant portion of our inventories at December 31, 2011, was related to our Downstream business. See Note 2Separation of Downstream Business, for additional information.
Note 5Assets Held for Sale or Sold
In April 2012, we sold our interest in the Statfjord Field and associated satellites, all of which are located in the North Sea, and recognized a gain of $431 million before-tax which was included in the Gain on dispositions line of our consolidated income statement. At the time of disposition, the carrying value of our interest, which was included in the Europe segment, included $205 million of properties, plants and equipment (PP&E) and $445 million of asset retirement obligations.
In May 2012, we sold our interest in the North Sea Alba Field and recognized a gain of $155 million before-tax, which was included in the Gain on dispositions line on our consolidated income statement. At the time of the disposition, the carrying value of our interest, which was included in our Europe segment, included $160 million of PP&E and $86 million of asset retirement obligations.
Note 6Investments, Loans and Long-Term Receivables
Australia Pacific LNG
In January 2012, Australia Pacific LNG (APLNG) and China Petrochemical Corporation (Sinopec) signed an amendment to their existing LNG sales agreement for the sale and purchase of an additional 3.3 million tonnes of LNG per year through 2035. This agreement, in combination with the binding Heads of Agreement with Kansai Electric Power Co. Inc., signed in November 2011, finalized the marketing of the second train.
In July 2012, we sanctioned the development of the second 4.5-million-tonnes-per-year LNG production train for our APLNG coal seam gas to LNG project. In addition, APLNG signed project financing agreements during the second quarter of 2012, which are subject to certain conditions precedent. APLNG expects to begin drawing on the financing in the fourth quarter of 2012. LNG exports from the second train are expected to commence in early 2016 under binding sales agreements to Sinopec and Kansai. Upon sanctioning of the second train in July and in conjunction with the LNG sales agreement, Sinopec subscribed for additional shares in APLNG, which increased its equity interest from 15 percent to 25 percent. As a result, on July 12, 2012, both our ownership interest and Origin Energys ownership interest diluted from 42.5 percent to 37.5 percent. This reduction, along with project financing, lowers our future capital requirements to fund the APLNG Project. We expect to record a loss of approximately $135 million after-tax from the dilution in the third quarter of 2012.
Loans and Long-Term Receivables
As part of our normal ongoing business operations and consistent with industry practice, we enter into numerous agreements with other parties to pursue business opportunities. Included in such activity are loans made to certain affiliated and non-affiliated companies. Significant loans to affiliated companies at June 30, 2012, included the following:
The long-term portion of these loans is included in the Loans and advancesrelated parties line on our consolidated balance sheet, while the short-term portion is in Accounts and notes receivablerelated parties.
Long-term receivables from non-affiliated companies are included in the Investments and long-term receivables line on our consolidated balance sheet, while the short-term portion related to non-affiliate loans is in Accounts and notes receivable.
Note 7Suspended Wells
The capitalized cost of suspended wells at June 30, 2012, was $1,057 million, an increase of $20 million from $1,037 million at year-end 2011. For the category of exploratory well costs capitalized for a period greater than one year as of December 31, 2011, no wells were charged to dry hole expense during the first six months of 2012.
During the three- and six-month periods of 2012 and 2011, we recognized before-tax impairment charges within the following segments:
The three- and six-month periods of 2012 included a $78 million impairment in our Europe segment, primarily due to an increase in the asset retirement obligation for the Don Field in the United Kingdom, which has ceased production. Additionally, the six-month period of 2012 included a $213 million property impairment in our Canada segment for the carrying value of capitalized project development costs associated with our Mackenzie Gas Project. Advancement of the project was suspended indefinitely in the first quarter of 2012 due to a continued decline in market conditions and the lack of acceptable commercial terms. We also recorded a $481 million impairment for the undeveloped leasehold costs associated with the project, which was included in the Exploration expenses line on our consolidated income statement. See Note 20Segment Disclosures and Related Information, for additional information on our segments.
In May 2012, we decreased our total revolving credit facilities from $8.0 billion to $7.5 billion by terminating all commitments under the $500 million credit facility which was due to expire in July 2012.
We have two commercial paper programs supported by our $7.5 billion revolving credit facility: the ConocoPhillips $6.35 billion program, primarily a funding source for short-term working capital needs, and the ConocoPhillips Qatar Funding Ltd. $1.15 billion commercial paper program, which is used to fund commitments relating to the QG3 Project. Commercial paper maturities are generally limited to 90 days.
At both June 30, 2012, and December 31, 2011, we had no direct outstanding borrowings under our revolving credit facilities, with no letters of credit issued as of June 30, 2012, and $40 million as of December 31, 2011. In addition, under the two commercial paper programs, there was $1,929 million of commercial paper outstanding at June 30, 2012, compared with $1,128 million at December 31, 2011. Since we had $1,929 million of commercial paper outstanding and had issued no letters of credit, we had access to $5.6 billion in borrowing capacity under our revolving credit facilities at June 30, 2012.
At June 30, 2012, we classified $1,011 million of short-term debt as long-term debt, based on our ability and intent to refinance the obligation on a long-term basis under our revolving credit facilities. In July 2012, irrevocable early redemption notices were issued for settlement with respect to $1.5 billion of outstanding bonds. Accordingly, those bonds with due dates beyond one year were classified as short-term debt on our consolidated balance sheet as of June 30, 2012. Upon settlement in the third quarter of 2012, a before-tax loss on the redemption of approximately $75 million is expected, consisting of a make-whole premium and unamortized issuance costs.
Note 10Joint Venture Acquisition Obligation
We are obligated to contribute $7.5 billion, plus interest, over a 10-year period that began in 2007, to FCCL Partnership. Quarterly principal and interest payments of $237 million began in the second quarter of 2007, and will continue until the balance is paid. Of the principal obligation amount, approximately $752 million was short-term and was included in the Accounts payablerelated parties line on our June 30, 2012, consolidated balance sheet. The principal portion of these payments, which totaled $361 million in the first six months of 2012, is included in the Other line in the financing activities section on our consolidated statement of cash flows. Interest accrues at a fixed annual rate of 5.3 percent on the unpaid principal balance. Fifty percent of the quarterly interest payment is reflected as a capital contribution and is included in the Capital expenditures and investments line on our consolidated statement of cash flows.
Note 11Noncontrolling Interests
Activity attributable to common stockholders equity and noncontrolling interests for the first six months of 2012 and 2011 was as follows:
*Certain amounts have been restated to reflect a prior period adjustment. See Note 16Accumulated Other Comprehensive Income.
**Includes components of other comprehensive income, which are disclosed separately in the Consolidated Statement of Comprehensive Income.
Income from continuing operations and discontinued operations attributable to ConocoPhillips for the three- and six-month periods of 2012 and 2011 were as follows:
At June 30, 2012, we were liable for certain contingent obligations under various contractual arrangements as described below. We recognize a liability, at inception, for the fair value of our obligation as a guarantor for newly issued or modified guarantees. Unless the carrying amount of the liability is noted below, we have not recognized a liability either because the guarantees were issued prior to December 31, 2002, or because the fair value of the obligation is immaterial. In addition, unless otherwise stated, we are not currently performing with any significance under the guarantee and expect future performance to be either immaterial or have only a remote chance of occurrence.
Construction Completion Guarantee
At June 30, 2012, we have guaranteed the performance of APLNG with regard to a construction contract executed in connection with APLNGs issuance of the Train 1 Notice to Proceed. Our maximum potential amount of future payments related to this guarantee is approximately $200 million at June 2012 exchange rates based on our 42.5 percent ownership in APLNG and would become payable if APLNG cancels the applicable construction contract and does not perform with respect to the amounts owed to the contractor. See below for additional guarantees of APLNGs performance.
Guarantees of Joint Venture Debt
At June 30, 2012, we had guarantees outstanding for our portion of joint venture debt obligations, which have terms of up to 24 years. The maximum potential amount of future payments under the guarantees is approximately $60 million. Payment would be required if a joint venture defaults on its debt obligations.
Over the years, we have entered into various agreements to sell ownership interests in certain corporations, joint ventures and assets that gave rise to qualifying indemnifications. Agreements associated with these sales include indemnifications for taxes, environmental liabilities, permits and licenses, employee claims, real estate indemnity against tenant defaults, and litigation. The terms of these indemnifications vary greatly. The majority of these indemnifications are related to environmental issues, the term is generally indefinite and the maximum amount of future payments is generally unlimited. The carrying amount recorded for these indemnifications at June 30, 2012, was approximately $80 million. We amortize the indemnification liability over the relevant time period, if one exists, based on the facts and circumstances surrounding each type of indemnity. In cases where the indemnification term is indefinite, we will reverse the liability when we have information the liability is essentially relieved or amortize the liability over an appropriate time period as the fair value of our indemnification exposure declines. Although it is reasonably possible future payments may exceed amounts recorded, due to the nature of the indemnifications, it is not possible to make a reasonable estimate of the maximum potential amount of future payments. Included in the recorded carrying amount were approximately $60 million of environmental accruals for known contamination that are included in asset retirement obligations and accrued environmental costs at June 30, 2012. For additional information about environmental liabilities, see Note 13Contingencies and Commitments.
In connection with the separation of the Downstream business, the Company entered into an Indemnification and Release Agreement with Phillips 66, see Note 2Separation of Downstream Business. This agreement provides for cross-indemnities between Phillips 66 and ConocoPhillips and established procedures for handling claims subject to indemnification and related matters. We evaluated the impact of the indemnifications given and the Phillips 66 indemnifications received as of the separation date and concluded those fair values were immaterial.
Note 13Contingencies and Commitments
A number of lawsuits involving a variety of claims have been made against ConocoPhillips that arise in the ordinary course of business. We also may be required to remove or mitigate the effects on the environment of the placement, storage, disposal or release of certain chemical, mineral and petroleum substances at various active and inactive sites. We regularly assess the need for accounting recognition or disclosure of these contingencies. In the case of all known contingencies (other than those related to income taxes), we accrue a liability when the loss is probable and the amount is reasonably estimable. If a range of amounts can be reasonably estimated and no amount within the range is a better estimate than any other amount, then the minimum of the range is accrued. We do not reduce these liabilities for potential insurance or third-party recoveries. If applicable, we accrue receivables for probable insurance or other third-party recoveries. In the case of income-tax-related contingencies, we use a cumulative probability-weighted loss accrual in cases where sustaining a tax position is less than certain.
Based on currently available information, we believe it is remote that future costs related to known contingent liability exposures will exceed current accruals by an amount that would have a material adverse impact on our consolidated financial statements. As we learn new facts concerning contingencies, we reassess our position both with respect to accrued liabilities and other potential exposures. Estimates particularly sensitive to future changes include contingent liabilities recorded for environmental remediation, tax and legal matters. Estimated future environmental remediation costs are subject to change due to such factors as the uncertain magnitude of cleanup costs, the unknown time and extent of such remedial actions that may be required, and the determination of our liability in proportion to that of other responsible parties. Estimated future costs related to tax and legal matters are subject to change as events evolve and as additional information becomes available during the administrative and litigation processes.
We are subject to international, federal, state and local environmental laws and regulations. When we prepare our consolidated financial statements, we record accruals for environmental liabilities based on managements best estimates, using all information that is available at the time. We measure estimates and base liabilities on currently available facts, existing technology, and presently enacted laws and regulations, taking into account stakeholder and business considerations. When measuring environmental liabilities, we also consider our prior experience in remediation of contaminated sites, other companies cleanup experience, and data released by the U.S. Environmental Protection Agency (EPA) or other organizations. We consider unasserted claims in our determination of environmental liabilities, and we accrue them in the period they are both probable and reasonably estimable.
Although liability of those potentially responsible for environmental remediation costs is generally joint and several for federal sites and frequently so for state sites, we are usually only one of many companies cited at a particular site. Due to the joint and several liabilities, we could be responsible for all cleanup costs related to any site at which we have been designated as a potentially responsible party. We have been successful to date in sharing cleanup costs with other financially sound companies. Many of the sites at which we are potentially responsible are still under investigation by the EPA or the state agencies concerned. Prior to actual cleanup, those potentially responsible normally assess the site conditions, apportion responsibility and determine the appropriate remediation. In some instances, we may have no liability or may attain a settlement of liability. Where it appears that other potentially responsible parties may be financially unable to bear their proportional share, we consider this inability in estimating our potential liability, and we adjust our accruals accordingly. As a result of various acquisitions in the past, we assumed certain environmental obligations. Some of these environmental obligations are mitigated by indemnifications made by others for our benefit and some of the indemnifications are subject to dollar and time limits.
We are currently participating in environmental assessments and cleanups at numerous federal Superfund and comparable state sites. After an assessment of environmental exposures for cleanup and other costs, we make accruals on an undiscounted basis (except in respect of sites acquired in a purchase business combination,
which we record on a discounted basis) for planned investigation and remediation activities for sites where it is probable future costs will be incurred and these costs can be reasonably estimated. At June 30, 2012, our balance sheet included a total environmental accrual of $440 million, compared with $922 million at December 31, 2011. A significant portion of our environmental contingencies at December 31, 2011, was related to our Downstream business. See Note 2Separation of Downstream Business, for additional information. We expect to incur a substantial amount of these expenditures within the next 30 years. We have not reduced these accruals for possible insurance recoveries. In the future, we may be involved in additional environmental assessments, cleanups and proceedings.
Our legal organization applies its knowledge, experience and professional judgment to the specific characteristics of our cases, employing a litigation management process to manage and monitor the legal proceedings against us. Our process facilitates the early evaluation and quantification of potential exposures in individual cases. This process also enables us to track those cases that have been scheduled for trial and/or mediation. Based on professional judgment and experience in using these litigation management tools and available information about current developments in all our cases, our legal organization regularly assesses the adequacy of current accruals and determines if adjustment of existing accruals, or establishment of new accruals, are required.
We have contingent liabilities resulting from throughput agreements with pipeline and processing companies not associated with financing arrangements. Under these agreements, we may be required to provide any such company with additional funds through advances and penalties for fees related to throughput capacity not utilized. In addition, at June 30, 2012, we had performance obligations secured by letters of credit of $1,035 million (issued as direct bank letters of credit) related to various purchase commitments for materials, supplies, services and items of permanent investment incident to the ordinary conduct of business.
In 2007, we announced we had been unable to reach agreement with respect to our migration to an empresa mixta structure mandated by the Venezuelan governments Nationalization Decree. As a result, Venezuelas national oil company, Petróleos de Venezuela S.A. (PDVSA), or its affiliates, directly assumed control over ConocoPhillips interests in the Petrozuata and Hamaca heavy oil ventures and the offshore Corocoro development project. In response to this expropriation, we filed a request for international arbitration on November 2, 2007, with the World Banks International Centre for Settlement of Investment Disputes (ICSID). An arbitration hearing was held before an ICSID tribunal during the summer of 2010, and we are currently awaiting an interim decision on key legal and factual issues. A different arbitration hearing was held in January 2012 with the International Chamber of Commerce on ConocoPhillips separate claims against PDVSA for certain breaches of their Association Agreements prior to the expropriation. The arbitration process is ongoing.
In 2008, Burlington Resources, Inc., a wholly owned subsidiary of ConocoPhillips, initiated arbitration before ICSID against The Republic of Ecuador, as a result of the newly enacted Windfall Profits Tax Law and government-mandated renegotiation of our production sharing contracts. Despite a restraining order issued by ICSID, Ecuador confiscated the crude oil production of Burlington and its co-venturer and sold the illegally seized crude oil. In 2009, Ecuador took over operations in Blocks 7 and 21, fully expropriating our assets. In June 2010, the ICSID tribunal concluded it has jurisdiction to hear the expropriation claim. An arbitration hearing on case merits occurred in March 2011, and we are awaiting a decision. On April 24, 2012, Ecuador filed a revised supplemental counterclaim asserting environmental damages, which we believe are not material. The arbitration process is ongoing.
Note 14Derivative and Financial Instruments
We use derivative instruments to manage our exposure to cash flow variability from commodity price risk. We occasionally use derivatives to capture market opportunities based on our industry knowledge. Our commodity business primarily consists of natural gas, crude oil, bitumen, LNG and natural gas liquids.
Our derivative instruments are held at fair value on our consolidated balance sheet. Where these balances have the right of setoff, they are presented net. Related cash flows are recorded as operating activities on the consolidated statement of cash flows. On the consolidated income statement, realized and unrealized gains and losses are recognized either on a gross basis if directly related to our physical business or a net basis if held for trading. Gains and losses related to contracts that meet and are designated with the normal purchase normal sale exception are recognized upon settlement. We generally apply this exception to eligible crude contracts. We do not use hedge accounting for our commodity derivatives.
The following table presents the gross fair values of our commodity derivatives, excluding collateral, and the line items where they would appear on our consolidated balance sheet:
The gains (losses) from commodity derivatives incurred, and the line items where they appear on our consolidated income statement were:
The table below summarizes our material net exposures resulting from outstanding commodity derivative contracts.
We have certain financial instruments on the consolidated balance sheet related to interest bearing time deposits and commercial paper. These held-to-maturity financial instruments are included in Cash and cash equivalents on our consolidated balance sheet if the maturities at the time we made the investments were 90 days or less; otherwise, these investments are included in Short-term investments on our consolidated balance sheet. These balances consisted of the following:
In conjunction with the separation of our Downstream business, we received a special cash distribution from Phillips 66 of $7,818 million. See Note 2Separation of Downstream Business, for additional information. At June 30, 2012, the unused amount of the special cash distribution was $5,000 million and is designated as Restricted cash on our consolidated balance sheet. At June 30, 2012, the funds in the restricted cash account were invested in U.S. Treasury Bills ($2,650 million), money market funds ($2,200 million) and cash ($150 million), all with maturities within 90 days from June 30, 2012.
Financial instruments potentially exposed to concentrations of credit risk consist primarily of cash equivalents, over-the-counter (OTC) derivative contracts and trade receivables. Our cash equivalents and short-term investments are placed in high-quality commercial paper, money market funds, government debt securities and time deposits with major international banks and financial institutions.
The credit risk from our OTC derivative contracts, such as forwards and swaps, derives from the counterparty to the transaction. Individual counterparty exposure is managed within predetermined credit limits and includes the use of cash-call margins or letters of credit when appropriate, thereby reducing the risk of significant nonperformance. We also use futures, swaps and option contracts that have a negligible credit risk because these trades are cleared with an exchange clearinghouse and subject to mandatory margin requirements until settled; however, we are exposed to the credit and performance risk of those exchange brokers for receivables arising from daily margin cash calls, as well as for cash deposited to meet initial margin requirements.
Our trade receivables result primarily from our petroleum operations and reflect a broad national and international customer base, which limits our exposure to concentrations of credit risk. The majority of these receivables have payment terms of 30 days or less, and we continually monitor this exposure and the creditworthiness of the counterparties. We do not generally require collateral to limit the exposure to loss; however, we will sometimes use letters of credit, prepayments and master netting arrangements to mitigate credit risk with counterparties that both buy from and sell to us, as these agreements permit the amounts owed by us or owed to others to be offset against amounts due us.
Certain of our derivative instruments contain provisions that require us to post collateral if the derivative exposure exceeds a threshold amount. We have contracts with fixed threshold amounts and other contracts with variable threshold amounts that are contingent on our credit rating. The variable threshold amounts typically decline for lower credit ratings, while both the variable and fixed threshold amounts typically revert to zero if we fall below investment grade. Cash is the primary collateral in all contracts; however, many also permit us to post letters of credit as collateral.
The aggregate fair value of all derivative instruments with such credit-risk-related contingent features that were in a liability position on June 30, 2012, and December 31, 2011, was $238 million and $237 million, respectively. No collateral was posted for June 30, 2012, and $3 million was posted for December 31, 2011. If our credit rating was lowered one level from its A rating (per Standard and Poors) on June 30, 2012, we would be required to post no additional collateral to our counterparties. If we were downgraded below investment grade, we would be required to post $238 million of additional collateral, either with cash or letters of credit.
Note 15Fair Value Measurement
We carry a portion of our assets and liabilities at fair value that are measured at a reporting date using an exit price (i.e., the price that would be received to sell an asset or paid to transfer a liability) and disclosed according to the quality of valuation inputs under the following hierarchy:
The classification of an asset or liability is based on the lowest level of input significant to its fair value. Those that are initially classified as Level 3 are subsequently reported as Level 2 when the fair value derived from unobservable inputs is inconsequential to the overall fair value, or if corroborated market data becomes available. Assets and liabilities that are initially reported as Level 2 are subsequently reported as Level 3 if corroborated market data is no longer available. Transfers occur at the end of the reporting period. There were no material transfers in or out of Level 1.
Recurring Fair Value Measurement
Financial assets and liabilities reported at fair value on a recurring basis primarily include derivative instruments and certain investments to support nonqualified deferred compensation plans. The deferred compensation investments are measured at fair value using unadjusted prices available from national securities exchanges; therefore, these assets are categorized as Level 1 in the fair value hierarchy. Level 1 derivative assets and liabilities primarily represent exchange-traded futures and options that are valued using unadjusted prices available from the underlying exchange. Level 2 derivative assets and liabilities primarily represent OTC swaps, options and forward purchase and sale contracts that are valued using adjusted exchange prices, prices provided by brokers or pricing service companies that are all corroborated by market data. Level 3 derivative assets and liabilities consist of OTC swaps, options and forward purchase and sale contracts that are long term in nature and where a significant portion of fair value is calculated from underlying market data that is not readily available. The derived value uses industry standard methodologies that may consider the historical relationships among various commodities, modeled market prices, time value, volatility factors and other relevant economic measures. The use of these inputs results in managements best estimate of fair value. As reflected in the table below, Level 3 activity was not material.
The following table summarizes the fair value hierarchy for gross financial assets and liabilities (i.e., unadjusted where the right of setoff exists for commodity derivatives accounted for at fair value on a recurring basis):
Non-Recurring Fair Value Measurement
There were no significant non-recurring fair value measurements as of June 30, 2012.
Reported Fair Value of Financial Instruments
The following are the valuation techniques and methods used to estimate the fair value of financial assets and liabilities reported on the balance sheet:
The following table summarizes the net fair value of financial instruments (i.e., adjusted where the right of setoff exists for commodity derivatives):
At June 30, 2012, commodity derivative assets and liabilities appear net of $28 million of obligations to return cash collateral and $202 million of rights to reclaim cash collateral, respectively. At December 31, 2011, commodity derivative assets and liabilities appear net of no obligations to return cash collateral and $244 million of rights to reclaim cash collateral.
Note 16Accumulated Other Comprehensive Income
Accumulated other comprehensive income in the equity section of the balance sheet included:
*The beginning balance of retained earnings has been restated primarily to reflect certain intercompany loans as permanently invested in 2004 and prior periods, which resulted in a $160 million increase in Foreign Currency Translation and Accumulated Other Comprehensive Income, a $15 million decrease to Total Liabilities, and a $145 million reduction in Retained Earnings. The impact on net income and earnings per share was deminimis for the three- and six-month periods ended June 30, 2012 and 2011.
There were no items within accumulated other comprehensive income related to noncontrolling interests.
Note 17Cash Flow Information
Note 18Employee Benefit Plans
In connection with the separation of the Downstream business, ConocoPhillips entered into an Employee Matters Agreement with Phillips 66, see Note 2Separation of Downstream Business, which provides that employees of Phillips 66 will no longer participate in benefit plans sponsored or maintained by ConocoPhillips. Upon separation, the ConocoPhillips Pension Plan transferred assets and obligations to the Phillips 66 Pension Plan resulting in a net decrease in sponsored pension plan obligations of $1,098 million, a corresponding decrease in deferred income taxes of $335 million and a decrease in other comprehensive income of $570 million.
Pension and Postretirement Plans
During the first six months of 2012, we contributed $167 million to our domestic benefit plans and $103 million to our international benefit plans. In 2012, we expect to contribute approximately $540 million to our domestic qualified and nonqualified pension and postretirement benefit plans and $210 million to our international qualified and nonqualified pension and postretirement benefit plans.
In addition, pursuant to the Employee Matters Agreement we made certain adjustments to the exercise price and number of our stock-based compensation awards with the intention of preserving the intrinsic value of the awards prior to the separation. Outstanding options to purchase common shares of ConocoPhillips stock that were exercisable prior to the separation were adjusted so the holders of those options would then hold options to purchase common shares of both ConocoPhillips and Phillips 66 stock. Nonexercisable stock options were converted to those of the entity where the employee is working post-separation. In addition, former employee holders and a specified group of holders of stock options and restricted stock units who retired or terminated employment upon or shortly after the separation, received both adjusted ConocoPhillips awards and Phillips 66 awards. ConocoPhillips restricted stock and performance share units awarded for completed performance periods under the Performance Share Program, as well as restricted stock units held by current or former directors, were adjusted to provide holders one restricted share or restricted stock unit of Phillips 66 for every two restricted shares or restricted stock units of ConocoPhillips. Each employee holder of restricted stock and restricted stock units awarded under all other programs were adjusted to provide holders restricted shares or restricted stock units in the company that employs such employee following the separation. Adjustments to our stock-based compensation awards did not have a material impact on compensation expense.
Note 19Related Party Transactions
Significant transactions with related parties were:
* We paid and/or received interest to/from various affiliates, including FCCL Partnership. See Note 6Investments, Loans and Long-Term Receivables, for additional information on loans to affiliated companies.
Note 20Segment Disclosures and Related Information
We explore for, produce, transport and market crude oil, bitumen, natural gas, LNG and natural gas liquids on a worldwide basis. We manage our operations through six operating segments, which are defined by geographic region: Alaska, Lower 48 and Latin America, Canada, Europe, Asia Pacific and Middle East, and Other International. This is a change in our reportable segments, and, as a result, all prior periods presented have been restated.
On April 30, 2012, our Downstream business was separated into a stand-alone, publicly traded corporation, Phillips 66, and has been reported as discontinued operations in all periods presented. Commodity sales to Phillips 66, which were previously eliminated in consolidation prior to the separation, are now reported as third-party sales. For additional information, see Note 2Separation of Downstream Business.
Our LUKOIL Investment represents our prior investment in the ordinary shares of OAO LUKOIL, an international, integrated oil and gas company headquartered in Russia. We completed the divestiture of our entire interest in LUKOIL in the first quarter of 2011.
Corporate and Other represents costs not directly associated with an operating segment, such as most interest expense, corporate overhead, ongoing costs associated with the separation and certain technology activities, net of licensing revenues. Corporate assets include all cash and cash equivalents, short-term investments and restricted cash.
We evaluate performance and allocate resources based on net income attributable to ConocoPhillips. Intersegment sales are at prices that approximate market.
Analysis of Results by Operating Segment
Note 21Income Taxes
Our effective tax rate from continuing operations for the second quarter of 2012 was 57 percent compared with 49 percent for the second quarter of 2011. The increase was primarily due to a larger proportion of income in higher tax rate jurisdictions in 2012.
Our effective tax rate from continuing operations for the first six months of 2012 was 53 percent compared with 50 percent for the first six months of 2011. The increase was primarily due to a larger proportion of income in higher tax rate jurisdictions and asset impairments in 2012, partially offset by gains on asset dispositions in 2012.
For both the second quarter and the first six months of 2012, the effective tax rate in excess of the domestic federal statutory rate of 35 percent was primarily due to foreign taxes.
In the United Kingdom, legislation was enacted on July 17, 2012, restricting corporate tax relief on decommissioning costs to 50 percent, retroactively effective from March 21, 2012. We anticipate our third quarter 2012 earnings will be reduced by approximately $175 million due to the remeasurement of deferred tax balances.
Supplementary Information Condensed Consolidating Financial Information
We have various cross guarantees among ConocoPhillips, ConocoPhillips Company, ConocoPhillips Australia Funding Company, ConocoPhillips Canada Funding Company I, and ConocoPhillips Canada Funding Company II, with respect to publicly held debt securities. ConocoPhillips Company is 100 percent owned by ConocoPhillips. ConocoPhillips Australia Funding Company, ConocoPhillips Canada Funding Company I and ConocoPhillips Canada Funding Company II are indirect, 100 percent owned subsidiaries of ConocoPhillips Company. ConocoPhillips and ConocoPhillips Company have fully and unconditionally guaranteed the payment obligations of ConocoPhillips Australia Funding Company, ConocoPhillips Canada Funding Company I, and ConocoPhillips Canada Funding Company II, with respect to their publicly held debt securities. Similarly, ConocoPhillips has fully and unconditionally guaranteed the payment obligations of ConocoPhillips Company with respect to its publicly held debt securities. In addition, ConocoPhillips Company has fully and unconditionally guaranteed the payment obligations of ConocoPhillips with respect to its publicly held debt securities. All guarantees are joint and several. The following condensed consolidating financial information presents the results of operations, financial position and cash flows for:
This condensed consolidating financial information should be read in conjunction with the accompanying consolidated financial statements and notes.