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2Q 2008 Earnings Conference Call Remarks
Howard J. Thill July 31, 2008
Welcome to Marathon Oil Corporation's second quarter 2008 earnings Web cast and teleconference. The synchronized slides that accompany this call can be found on our website Marathon.com. On the call today are Clarence Cazalot, president and CEO, Janet Clark, executive vice president and CFO, Gary Heminger, Marathon executive vice president and president of our Refining, Marketing and Transportation organization, Dave Roberts, executive vice president, upstream, and Garry Peiffer, senior vice president of finance and commercial services downstream. Slide 2 contains the Forward Looking Statement and other information related to this presentation. Our remarks and answers to questions today will contain forward-looking statements subject to risks and uncertainties that could cause actual results to differ materially from those expressed or implied by such statements. In accordance with safe harbor provisions of the Private Securities Litigation Reform Act of 1995, Marathon Oil Corporation has included in its Annual Report on Form 10-K for the year ended December 31, 2007, and subsequent Forms 10-Q and 8-K, cautionary language identifying important factors, but not necessarily all factors, that could cause future outcomes to differ materially from those set forth in the forward-looking statements. As most of the numbers we will discuss today are Adjusted Net Income, Slide 3 provides a reconciliation of Net Income to Adjusted Net Income by quarter for 2006, 2007 and 2008. Slides 4 and 5 provide Adjusted Net Income and Adjusted Net Income per diluted share by quarter for 2006 through the second quarter 2008. Moving to slide 6, the year over year decrease in Adjusted Net Income mainly resulted from the steep decline in downstream earnings and the derivatives impact in Oil Sands Mining, partially offset by strong upstream income, largely a result of higher upstream liquid hydrocarbon and natural gas price realizations, and lower taxes. Production available for sale increased 29,000 barrels of oil equivalent per day, or boepd, year over year largely as a result of a full quarter of gas sales to the EG LNG plant, the start of production at Alvheim, and ramp-up in the Bakken Oil Shale resource play. As shown on slide 7, the second quarter 2008 Adjusted Net Income increased almost 12% from the first quarter 2008, a result of higher upstream realizations and the quarter-over-quarter improvement in the refining and wholesale marketing gross margin, partially offset by the significant decline in the oil sands mining segment. The oil sands mining segment was negatively impacted by the steep rise in crude oil prices which resulted in a $250 million after-tax loss on derivative instruments, of which $220 million was unrealized. Turning to slide 8, upstream segment income for the second quarter was up $144 million over the first quarter 2008, reflecting higher realizations. While production available for sale was relatively unchanged quarter to quarter, the timing of liftings in Gabon, EG, and Libya, and the seasonal injection of gas into storage in Ireland and Alaska lowered sales volumes in the second quarter, partially offsetting the impact of higher realizations. Slide 9 shows the production available for sale and sales volumes just discussed. Average realizations increased 25 percent, or $14.53 per barrel of oil equivalent, or BOE, between the first and second quarters to $73.26 per BOE. Moving to slide 10, domestic upstream income increased $115 million from the first quarter on higher realizations as well as higher oil volumes in the Bakken Oil Shale resource play and Ewing Bank Block 963 (Arnold). This increase was partially offset by lower gas sales volumes in Alaska, Oklahoma and East Texas. As noted on Slide 11, both our domestic liquid hydrocarbon realizations and WTI increased by almost $26. Our natural gas realizations in the Lower 48 lagged Henry Hub bid week pricing primarily due to weaker basis differentials for gas sold in the mid-continent and Rocky Mountain regions. Domestic sales volumes were down in the second quarter largely due to seasonally lower natural gas sales in Alaska. Turning to slide 12, second quarter domestic upstream expense, excluding exploration expense, increased by $4.54 per BOE from the first quarter, primarily as a result of increased production taxes and increased development activity. Domestic upstream income per BOE increased $10.48 quarter over quarter, reflecting the impact of higher realized prices. Moving to slide 13, the $29 million increase in international upstream income was the result of higher realizations, partially offset by lower sales volumes, which were impacted by the timing of liftings and seasonal gas injection as previously discussed. As shown on Slide 14, our total international liquids realizations for the second quarter increased less than Dated Brent. While our international crude oil prices actually increased slightly more than Dated Brent, NGL realizations did not keep up with the price of crude. Our international natural gas realizations decreased $0.61 per MCF due to the higher proportion of natural gas sales in Equatorial Guinea and lower European volumes. International sales volumes decreased quarter over quarter to 215,000 boepd and were impacted by the timing of liftings as well as a seasonal decline in natural gas sales in Ireland. Third quarter international sales volumes are anticipated to increase, reflecting a full quarter of production from the Alvheim/Vilje development. Additionally, the third quarter is expected to include a makeup of a portion of our underlift position in EG, Gabon, Libya and at Foinaven. Turning to slide 15, international upstream income increased $3.42 per BOE primarily due to higher liquids realizations, partially offset by lower sales volumes and higher income taxes. Turning to slide 16 and the Oil Sands Mining segment, the $157 million second quarter loss was primarily the result of the previously discussed derivative activity. The last of these derivative instruments is set to expire in the fourth quarter of 2009. As you can see in the slide, the derivative losses had a significant impact during the quarter. Net bitumen production before royalties was 24,000 barrels per day for the second quarter, which was less than previous guidance due to a revised plan to manage the disposal of tailings that resulted in mining a lower grade ore, as well as planned and unplanned maintenance at the mine. As shown on slide 17, when you combine our upstream production available for sale and oil sands mining bitumen production, our total production for the second quarter was 398,000 BOE per day, an increase of about 15 percent from the second quarter of 2007 and on par with the first quarter of 2008. Moving to our downstream business, as noted on Slide 18, second quarter 2008 segment income totaled $158 million compared to $1.25 billion for the same quarter last year. Because of the seasonality of the downstream business, I will compare our second quarter 2008 results against the same quarter in 2007. The primary factor contributing to downstream's lower earnings was the significant reduction in the Light Louisiana Sweet, or LLS, 6-3-2-1 crack spread. On a two-thirds Chicago and a one-third U.S. Gulf Coast basis, the average LLS 6-3-2-1 crack spread decreased by $13 per barrel. In addition, during the second quarter, the Company's per-gallon wholesale sales price realizations did not increase over the comparable prior-year period as much as the average spot market price for the products in the LLS 6-3-2-1 calculation. For example, the average price of the products we sell other than gasoline and distillate increased by less than $0.70 per gallon, whereas the price of 3 percent residual fuel oil used in the 6-3-2-1 calculation increased by an average of $0.82 per gallon quarter to quarter. Total refinery crude oil throughput was down almost 50,000 barrels per day from the same quarter last year and total throughputs decreased 77,000 barrels per day. We also incurred higher expenses compared to the year ago period primarily due to higher natural gas prices and maintenance activities. Finally, due to the fact that the cost of our foreign term crude oil purchases rose more in the second quarter of 2008 than in the prior year period, we incurred a pre-tax loss of $156 million on our foreign crude in-transit inventories compared to a loss of only $25 million in the same quarter last year. Partially offsetting these negative factors were several positive quarter-to-quarter variances. First, our crude oil and other blendstock costs did not increase as much as the change in the average price of LLS during the second quarter of 2008 compared to the prior year period. In addition, primarily because of the widening differential between gasoline and ethanol prices in the second quarter 2008, we had a positive variance in our ethanol earnings during the quarter as compared to the second quarter of 2007. And finally, we improved the volume of refinery gains in our plants in the second quarter of 2008 which, along with the higher refined product prices, improved the value of our volumetric gains quarter to quarter. The refining and wholesale marketing gross margin for second quarter 2008 includes a pre-tax derivatives-related loss of $187 million compared to a loss of $139 million in the second quarter of 2007. Approximately half of the second quarter 2008 derivative losses were incurred in April as Marathon transitioned away from the practice of using derivatives to mitigate crude oil price risk on our domestic spot crude oil purchases. The downstream business segment will selectively continue its practice of using derivatives to protect the carrying value of seasonal inventories and long haul foreign crude oil spot purchases. As shown on Slide 19, SSA's gasoline and distillate sales were down approximately 40 million gallons, or a decrease of 4.8 percent, compared to the second quarter of 2007, while merchandise sales were up 1.0 percent. SSA's gross margin for gasoline and distillate was 8.62 cents per gallon compared to 10.29 cents per gallon in the same quarter of 2007. Slide 20 provides a summary of segment data, along with a reconciliation to Net Income. The increase in unallocated administrative expenses is primarily due to mark-to-market adjustments on legacy stock appreciation rights awarded and increased pension expense due to the revision of certain actuarial assumptions. The effective tax rate for the second quarter was 51% compared to a rate of 44% in the first quarter. The increase was primarily driven by income mix in the Upstream Segment, where Libya took a more prominent percentage in the second quarter compared to the first. The second quarter rate also included a first quarter catch-up for the change in rate, and an increase in the deferred tax balances related to a change in the Canadian exchange rate. This exchange rate fluctuation was a benefit in the first quarter. Slide 21 provides selected preliminary Balance Sheet and Cash Flow data. Cash-adjusted debt to total capital at the end of the second quarter remained unchanged from the first quarter at approximately 24%. As a reminder, the cash-adjusted debt balance includes $488 million of debt serviced by U.S. Steel. Year-to-date preliminary cash flow from operations was approximately $3 billion, and preliminary cash flow from operations before working capital changes was approximately $2.9 billion. Slide 22 provides a summary of sources and uses of cash for the first six months of the year and the impact on our outstanding cash-adjusted debt balance. Operating cash flow for the first half of 2008 was just under $3 billion, while capital spending during the period was approximately $3.4 billion. We also spent $295 million on share repurchases and $342 million on dividends. Our net debt increased by $1 billion during the first half of the year. Clarence will provide some comments on the second half of the year later.
I will now turn the call over to Clarence Cazalot, Marathon President and CEO. Clarence Cazalot, President and CEO Thank you Howard, and Good Afternoon. Howard has just discussed our second quarter results in some detail. But I now want to comment on Marathon's ongoing plans and activities. I'll begin with the upstream business, and Dave Roberts will also provide some context here, and then I ask Gary Heminger to comment on the downstream. I'll conclude with our capital and cash flow outlook. Its clear to me that the market doesn't fully appreciate it, but Marathon's upstream business today is the strongest it's ever been in terms of secured resource and reserve potential, and a clear, well-defined production growth profile. We also have a high quality portfolio of exploration and other growth opportunities. We are delivering on our defined production growth of 7% compound annual growth rate between 2007 and 2012 and I believe both the magnitude and certainty of the growth meets or exceeds that of our peers. Since the beginning of June, we have brought on stream two major high margin projects: Alvheim/Vilje in Norway and Neptune in the GOM. Alvheim production commenced on June 8, considerably later than planned, and we recognize and accept that poor execution on this project (despite our best in class execution on EG LNG) has hurt our credibility. We have learned some costly lessons and have incorporated these learnings into our project planning and execution. But it's important that everyone also understands just how well this new asset is performing. The Alvheim/Vilje FPSO and related infrastructure have performed very well, with current gross production of almost 100,000 BPD and 30,000 MMCFD from only 5 wells. We expect to reach full capacity on the facility in the next few weeks. These are very profitable barrels with an after tax income margin of almost $60 per BOE at $125 WTI. On a total cash basis, this asset will generate after tax cash flow net to Marathon for 2008 alone of $1.25 billion. In the GOM, the Neptune project (MRO 30%) has come on stream in early July and has already reached peak capacity of the facility. Marathon's after-tax margin is $41 per BOE at $125 WTI. Suffice it to say, these two projects will make a significant contribution to Marathon's profitability in the second half of 2008 and beyond. Overall, we project a substantial increase in our net production available for sale over the second half of 2008, going from a second quarter average of 374,000 BOEPD to an exit rate in December of 425,000 to 450,000 BOEPD. I would now like Dave Roberts to provide a more detailed update on our E&P business. Dave Roberts, Executive Vice President Upstream As Clarence mentioned, we are on track to reach our target production growth of 7 percent through 2012. While Alvheim/Vilje and Neptune are the 2008 foundation assets for growth, our line of sight and future potential portfolios continue to suggest a great future for our upstream business. In terms of assets in development, Volund, our next Alvheim-area building block, is on schedule and will begin production later next year. You will have noted our announcing the sanction of the Angola Block 31 PSVM project, and that production will begin in 2012. Two projects in the Gulf of Mexico-Droshky and Ozona-that we expect to sanction this year will begin adding profitable volumes in 2010/2011. Of course there is a tremendous interest in our resource play position. Our 320,000 net acre position in the Bakken Shale of North Dakota continues to deliver. As noted, our net production has exceeded 6000 BOEPD and is expected to reach 8000 BOEPD by year end. We will drill and complete 60 wells this year bringing our total since entering the play to roughly 100 wells. In terms of our exposure to other unconventional gas resources, we have 4 rigs up in the Piceance Colorado play and will have 28 completions by year end with growing production effects in 2009 and forward. Marathon is building a position in the Marcellus Appalachia play with 30,000 acres in hand of a targeted 100,000 total by year end. Drilling on our acreage is expected within the next 6 to 9 months. We have existing positions in the Haynesville play in East Texas/North Louisiana-25,000 acres, most held by production, that drilling will start on in 2009 and the Anadarko Woodford Shale in West/Central Oklahoma where we have 30,000 acres in hand and will have 3 wells drilled this year. Outside North America, we have utilized our experience with coal seam gas plays to capture, with our partner Greenpark Energy, the largest coal seam gas acreage position in the UK at 520,000 acres-260,000 net to Marathon. We have drilled 3 test wells to date and are on the cusp of drilling up to 7 pilot production wells in 2008/2009. Finally, in the area of unconventional oil we have had encouraging results in the evaluation of 2 of our in situ oil holdings in Canada. Drilling results from this past winter have bolstered our view of the bitumen resource potential in this portfolio. As you recall, when we acquired Marathon Canada we estimated in situ resource potential at 600 million barrels net. We now believe these assets may approach 1.5 billion barrels net resource potential. In the 100% Marathon operated Birchwood assets we will likely undertake additional drilling and environmental assessments in 2009 and we expect a project feasibility study to begin in 2009 in Marathon's 20% owned Ells River project. In conjunction with our development projects, Marathon has also positioned itself for long term success in our exploration program. While we are now beginning to see the results of a successful long term campaign in Angola, we have been active in securing new opportunities in both the Gulf of Mexico where we, along with our partners, have been awarded 42 blocks in the last two lease sales and in Indonesia where we operate the coveted Pasangkayu block and are actively looking for further options there. In the Gulf we have numerous prospects from the recent sale identified and moving toward drillable status in 2009. Similarly in Indonesia we have completed a seismic program over Pasangkayu and will drill our first well there in 2009. But we aren't waiting for the future. We continue to drill successfully in Angola, and in the Gulf we are currently participating in the BP Freedom well located in Mississippi Canyon Block 948 which will be finished drilling later this quarter. Marathon has a 12.5% interest. We are also participating in the Anadarko operated Shenandoah well located in Walker Ridge Block 8, in which we have a 10% interest. This well was spud late in the second quarter and is expected to be finished drilling late in the third quarter. Freedom is targeted at the Miocene and Shenandoah at the Paliogene. Of course, the Shell operated Stones sidetrack appraisal will be drilled in the fourth quarter of this year. It is targeted at the Paliogene and Marathon has a 25 percent interest. In addition, we continue to have an active US onshore exploration program in East Texas and Oklahoma. I remind you that no success from these wells or programs was built into our production forecasts. However, if successful they will contribute to our production growth in the future. In terms of our integrated gas portfolio, while we have made little progress in moving a Train 2 forward, as we continue to work on the commercial framework of the project with our partners our efforts continue in light of the continued success at Train 1. With outstanding reliability, the facility continues to meet nameplate expectations and sold a net 5800 metric tones per day in the quarter, delivering 14 cargoes. The facility turnaround originally scheduled for June was started July 19. Originally scheduled for 16 days, the facility has already returned to 50% capacity and should be at 100% capacity on the weekend. Quite simply, EG LNG is an industry-leading operation. Our other integrated gas businesses had solid second quarters as well. But our methanol business experienced a 30 day shutdown to begin third quarter due to process issues. The facility has been returned to production. Clarence, I am sorry for perhaps carrying on longer than expected, but we have a great story for the quarter and for the future in our upstream portfolio.
I believe Howard covered in sufficient detail the results of the second quarter. I will bring you up to date on our major projects and talk about the current market. Our first project the Garyville expansion, is approximately 60% complete as we speak today and we have a full compliment of skilled trades across the entire mechanical civil side of that construction project. We are beginning to take delivery of the major fabricated vessels. In fact our Coker as we speak is coming through the Panama Canal. And we continue to expect fourth quarter 2009 start up. And as I said we are on time and on budget. Turning to the Detroit upgrade project we received our permit on June 20 and started the construction immediately with the construction side of that project now 5% complete. But we will significantly ramp up over the coming months. Turning then to the operations, while markets have been challenging in the second quarter with a run up of $40 in the crude price, I am pleased to say that we have operated our plants above our objectives from mechanical availability standpoint and from a safety standpoint. Looking at today's markets, and looking at Speedway Super America same store sales, we believe that we have outperformed the overall market when we look at same store versus PADD II total demand. So from an operating standpoint we are operating well while we are also performing well in the marketplace and we were continuing to add new Marathon brand business which will help down the road with our major expansion program. I will turn it back to you. Clarence Cazalot, President and CEO Thank you, Dave and Gary. Our overall 2008 capital spending will be up slightly as we have reduced spending in the downstream and increased spending primarily in the upstream From a cash flow standpoint, we expect cash flow from operations in second half 2008 to eventually cover our capital spending, dividend payments and share buy-back program. In addition, our portfolio review process will result in the sale of certain assets. As announced earlier this month, we have reached an agreement with Centrica to sell our non-operated interests in the offshore Heimdal infrastructure and related fields for $416 million. We expect to announce additional sales in the third quarter. Lastly, you no doubt saw our announcement this morning that our Board is evaluating a potential separation of Marathon into two strong, independent publicly traded companies. I am sure you have some questions, and we will be as responsive as we can, but I hope you understand that we cannot be much more specific than what is in the release. I now turn it back to Howard for questions. Howard Thill, Vice President Investor Relations We will now open the call to questions. To accommodate all who want to ask questions we ask that you limit yourself to one question plus a follow up. You may re-prompt for additional questions as time permits. For the benefit of all listeners we ask that you identify yourself and your affiliation. |
