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4Q 2007 Earnings Conference Call Remarks
Howard J. Thill January 31, 2008
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, Phil Behrman, senior vice president Worldwide Exploration, Steve Hinchman, senior vice president Worldwide Production, Dave Roberts, senior vice president Business Development, 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 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, 2006, and subsequent Forms 8-K and 10-Q, 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 and 2007. As shown on slide 4, adjusted Net Income for 2007 decreased 19 percent from the 2006 level to $3.8 billion dollars, while the fourth quarter 2007 was down 40 percent compared to the same quarter 2006. As shown on slide 5, on a diluted per share basis, Adjusted Net Income for 2007 was down 15 percent from 2006, compared to the decrease of 19 percent just discussed, reflecting the lower average diluted share count outstanding during 2007 due to our share repurchase program. The fourth quarter Adjusted Net Income per diluted share was down 41 percent from the fourth quarter 2006, reflecting somewhat higher average share count for that period due to the Western Oil Sands acquisition completed October 18, 2007. We recommenced our share repurchase program late in the fourth quarter following the close of the Western transaction and made minimal repurchases during that period. Moving to slide 6, the year over year decrease in Adjusted Net Income was largely a result of a lower refining and wholesale marketing gross margin and lower upstream sales volumes, partially offset by lower income taxes. As shown on slide 7, the year over year decrease in fourth quarter Adjusted Net Income was largely a result of a lower refining and wholesale marketing gross margin, partially offset by higher liquid hydrocarbon realizations in our upstream segment and lower income taxes. Fourth quarter 2007 results were also negatively impacted by higher exploration expense, which was primarily related to expensing non-commercial wells on the Flathead prospect in the Gulf of Mexico, and a loss in our Oil Sands Mining segment. The Oil Sands Mining segment reflects results since October 18, 2007, which, as I mentioned earlier, was the closing date for the transaction. This new segment reported a loss of $63 million for the quarter, including a $39 million after-tax unrealized loss on crude oil derivative instruments held by Western at the date of acquisition. Segment income was also impacted by a mid-November fire and subsequent curtailment of operations at the Scotford upgrader during the fourth quarter. The upgrader returned to operation in late December. Slide 8 compares Adjusted Net Income for the fourth quarter 2007 to the third quarter 2007 and shows the decrease was primarily a result of a lower refining and wholesale marketing gross margin, as well as the previously mentioned higher exploration expense and Oil Sands Mining segment loss, partially offset by higher upstream liquid hydrocarbon and natural gas realizations and lower taxes. Turning to slide 9, the $274 million decrease in upstream segment income for 2007, compared to 2006, was primarily a result of lower liquid hydrocarbon sales volumes and higher exploration expense, partially offset by lower income taxes and higher realizations. As detailed on slide 10, upstream segment income for the fourth quarter decreased $14 million from the third quarter 2007. The quarter-over-quarter performance was negatively impacted by higher income taxes due to a higher percentage of income from international locations and the higher exploration expense previously mentioned, and positively impacted by higher liquid hydrocarbon and natural gas realizations. As shown on slide 11, worldwide sales volumes decreased 17,000 barrels of oil equivalent, or BOE, per day in the fourth quarter 2007 as compared to the third quarter 2007, largely a result of downtime at the Equatorial Guinea LNG facility due to warranty work. Also, the average realized price per BOE increased $10.35 per from the third quarter 2007 to the fourth quarter 2007. Moving to slide 12, domestic upstream income for the full year 2007 decreased $250 million from the year 2006, largely as a result of lower sales volumes and the higher exploration expense, partially offset by higher liquid hydrocarbon realizations and lower income taxes. Moving to slide 13, while domestic upstream income for the fourth quarter was up only slightly from the third quarter, there were two large swings from the previous quarter with higher sales price realizations essentially offset by the higher exploration expense. As shown on Slide 14, the NYMEX prompt price for WTI crude was up $15.35 per barrel from the third quarter while our average domestic realized liquid hydrocarbon price was up $10.63. Our lower realizations compared to the NYMEX were primarily the result of weaker differentials for Gulf Coast Sour and Wyoming Asphaltic crudes. The Bid Week Natural Gas price was up $0.81 per million BTUs from the third quarter, while our domestic natural gas realizations were up $0.56 per million cubic feet, or mcf. Our lower 48 realizations were up $0.61 per mcf. Turning to slide 15, fourth quarter domestic upstream expense, excluding exploration expense, was $0.71 per BOE lower than the third quarter, while domestic upstream income per BOE increased $0.63 quarter over quarter. On slide 16 you will see that international upstream income for 2007 was essentially flat compared to 2006 with lower liquid hydrocarbon sales volumes being mostly offset by lower income taxes and lower exploration expense. Slide 17 shows international upstream income for the fourth quarter decreased slightly compared to the third quarter as lower liquid hydrocarbon and natural gas sales volumes and higher income taxes were offset by higher realized prices. As shown on Slide 18, our international liquids realizations increased $14.27 per barrel, basically in-line with Dated Brent which increased $13.70 per barrel. International natural gas realizations increased $1.58 per mcf compared to the third quarter, largely as a result of seasonally higher spot natural gas prices in Europe and lower gas volumes of gas sales to our LNG facility in Equatorial Guinea due to the plant shutdown from early October to mid-November. Please remember that our LNG business is reported through the Integrated Gas segment, so there is additional uplift in value realized by the EG LNG facility that is not reported through our upstream business. Turning to slide 19, fourth quarter international upstream expense, excluding exploration expense, increased by $2.34 per BOE over the third quarter 2007, largely a result of lower production and higher operating costs, while total income per BOE increased $0.11 to $15.76 primarily due to the higher realizations. Slide 20 shows our upstream reserve replacement for the past four years, including the rolling three-year averages. The proved bitumen reserves associated with the Athabasca Oil Sands Project are not included in these numbers. I will now turn the call over to Steve Hinchman to provide more details around our 2007 reserve replacement as well as our 2008 production and cost forecasts for the upstream segment. Thank-you Howard. In 2007 Marathon added 88 million barrels of oil equivalent of net proven liquid hydrocarbon and natural gas reserves while producing 125 million barrels of oil equivalent, resulting in a reserve replacement ratio of 70%. The reserve additions consist of 37 million barrels of oil equivalent in the US and 51 million internationally, in both areas about equally split between liquid hydrocarbon and natural gas. The additions are primarily a result of drill bit activity including onshore US, Alvheim/Vilje development drilling, and infill drilling activity in Libya. At the end of 2007 our total proven reserves are 1.225 billion barrels of oil equivalent, 879 million (or 72%) are proven developed. This compares to total proven reserves of 1.262 billion barrels of oil equivalent at the end of 2006 of which 68% was proven developed. Over the 3 year period ending in 2007 Marathon's average reserve replacement ratio, excluding dispositions, is 135%. The lower replacement ratio in 2007 reflects a year in which we did not sanction any new major development projects. Our reserve replacement expectation, on a rolling average basis, remains at greater than 100%. Our cost incurred will be available in mid-February so any discussion of finding and development cost will need to be deferred until then. Our production guidance for 2008 is 380 to 420 thousand barrels of oil equivalent per day. This falls short of the guidance given in November 2006 which was 450 to 480 thousand. The short-fall is not due to our base production, which has consistently performed within expectation, but is caused by delays in production start up of development projects. The most significant are the delays in the Alvheim and Vilje projects in Norway and the Neptune project in the Gulf of Mexico. In the November 2006 guidance the Alvheim and Vilje projects were to start production in the first quarter 2007. We now expect start up at the end of the first quarter 2008. The initial expectation would have resulted in nearly a full year of production in 2008 at FPSO capacity. Now we have both the delayed start up and the production ramp up as we tie wells in and optimize the operations all occurring in 2008. We expect to move the FPSO out of Haugesund in mid February. We will need to stop in Amoyfjord were we can install the thrusters and do some additional commissioning that also requires deeper water. We expect this will take about 10 days and then we will sail to the field. The biggest threat at this time is having the necessary weather window when we move and position the vessel. In the 2006 guidance the Neptune project in the Gulf of Mexico would start production at the beginning of 2008. The operator now expects first production will occur at the end of the first quarter. The timing of delivery of major projects has proved difficult in today's volatile environment. These large projects if missed by even a few months can have a significant impact on our quarterly and annual production estimates, but we remain confident that our growth guidance from 2006 to 2010 of 6 to 9% is achievable. Now turning to cost guidance. The 2007 operating costs, excluding FAS 144 impairments, production tax, foreign royalty, and exploration fell within the guidance provided. For 2008 we expect operating cost, on a similar basis, for the US to range between $23.50 to $26.00 per barrel of oil equivalent and for International between $16.00 and $18.25 per barrel of oil equivalent. I will now turn it back over to Howard. Thanks, Steve. We appreciate that update. Moving to our downstream business and slide 21, full year 2007 segment income totaled $2.1 billion compared to $2.8 billion in 2006. This decrease was largely a result of the challenging refining and wholesale marketing gross margins in the last two quarters of 2007, which lowered our annual average margin 4.4 cents per gallon year over year. Turning to slide 22, downstream fourth quarter 2007 segment income totaled $4 million compared to $533 million earned in the same quarter of 2006. Because of the seasonality of the downstream business, I will compare our fourth quarter results against the same quarter for 2006. The average LLS 6-3-2-1 crack spread for the quarter on a two-thirds Chicago and one-third U.S. Gulf Coast basis was weaker in the fourth quarter 2007 compared to the fourth quarter 2006, decreasing 25 percent from $3.19 per barrel to $2.39 per barrel. The most significant factor contributing to the downstream segment's results quarter to quarter was that the Company's average wholesale sales price realizations in the fourth quarter 2007 did not increase over the comparable prior year period as much as the average spot market prices used in the LLS 6-3-2-1 calculation. The most significant difference was the average price of all the products we sell, other than gasoline and distillate, only increased about $0.28 per gallon from the fourth quarter 2006 to the fourth quarter 2007, whereas the average 3 percent residual fuel oil price used in the 6-3-2-1 calculation increased by almost $0.67 per gallon, on average, quarter to quarter. In addition, our crude oil costs increased substantially more than the quarter-to-quarter change in the average price of LLS would indicate. The primary reason for this increase was that the market structure for crude oil changed from a contango market, which averaged about $1.83 per barrel in the fourth quarter of 2006, to a backwardated market in the fourth quarter 2007 which averaged about $1.33 per barrel. The change in the market structure substantially increased our acquisition cost for crude oil, compared to the change in LLS prices, quarter to quarter. We also incurred a loss of $42 million on our foreign crude oil in-transit inventory in the fourth quarter 2007 versus a gain of about $14 million in the same quarter of 2006 due to the change from falling crude oil prices in the fourth quarter 2006 compared to rising crude oil prices in the fourth quarter 2007. We also incurred substantially higher operating and administrative costs in the fourth quarter 2007 primarily due to higher planned turnaround expense and other maintenance and salaries. Marathon's refining and wholesale marketing gross margins included pre-tax derivatives losses of $427 million for the fourth quarter and $899 million for the full year, compared to pre-tax derivative gains of $194 million and $400 million in the same periods of 2006. The derivative changes reflect both the realized effects of closed derivative positions as well as unrealized effects as a result of marking open derivative positions to market. Most of our derivatives have an underlying physical commodity transaction; however, the income effect related to our derivatives and the income effect related to our underlying physical transactions may not necessarily be recognized in Net Income in the same period. Partially offsetting these negative results was a positive impact from our ethanol blending program due to the relatively lower ethanol prices compared to gasoline prices during the fourth quarter 2007 versus the prior year quarter. We completed major turnarounds in the fourth quarter at our Catlettsburg, Robinson and St. Paul Park refineries primarily involving our fluid catalytic cracking units at all three plants. Therefore, while crude oil throughputs improved from the fourth quarter 2006, our average crude and other blendstock inputs were down about 3 percent for the fourth quarter 2007 compared to the same quarter of 2006. This was also the primary reason our 2007 fourth quarter gasoline production was down about 7 percent from the prior year's quarter. We did, however, have record crude oil and total throughputs for the year 2007. Moving to slide 23, Speedway SuperAmerica, or SSA, had gasoline and distillate sales for the fourth quarter 2007 which were down 6 million gallons or a decrease of 0.7 percent from the fourth quarter 2006. SSA's same store gasoline sales volumes were down 1.3 percent and same store merchandise sales increased 1.1 percent in the fourth quarter 2007 compared to the fourth quarter 2006. SSA's gross margin for gasoline and distillate sales was essentially unchanged between the quarters. Slide 24 provides a summary of segment data, along with a reconciliation to Net Income. Slide 25 provides selected preliminary Balance Sheet and Cash Flow data. Cash-adjusted debt to total capital at the end of the fourth quarter was approximately 22%. And as a reminder, this cash-adjusted debt balance includes just under $500 million of debt serviced by U.S. Steel. 2007 preliminary cash flow from operations was approximately $6.5 billion, and preliminary cash flow from operations before working capital changes was approximately $5.6 billion. Slide 26 provides selected financial and operating results for 2006 and 2007 while Slide 27 provides guidance for the first quarter and full year 2008, some of which Steve just discussed. I will now turn the call over to Clarence Cazalot, Marathon President and CEO. Thank you Howard and good afternoon everyone. It is pretty clear that the fourth quarter was a difficult one for Marathon primarily because of the impact of rising crude oil and feedstock costs had on downstream margins. We also had higher than expected exploration expense and unscheduled downtime both at EG LNG and in the Athabasca Oil Sands Projects. We're not satisfied with that performance, especially as to those areas we can control. But taken in its entirety, 2007 was a solid performance year for the company and we advanced our growth plans across the corporation. For 2008, we expect substantial growth in our oil and gas production volumes, the sanction of at least two major upstream developments, further progress on the large refinery projects at Garyville and Detroit, and a full year of operations both in EG LNG and in our oil sands business. These significant growth plans were incorporated in the $8 billion capital and exploratory expense budget we announced yesterday and I'd like to ask Janet to provide you with a comparison of that budget to the guidance we gave in November 2006 of $5.2 billion. Most of the $2.8 billion increase represents new investment opportunities including the investment in Canadian oil sands, which contributes about $900 million. In addition, the Detroit heavy oil upgrade project, which the Board sanctioned in 2007, comprises an additional $700 million in the capital budget. We were successful in the Gulf of Mexico lease sale last fall, winning 27 blocks, and $150 million of that cost is part of the 2008 budget. In addition, the significant Droshky discovery from 2007 will move forward in 2008, with $250 million in development capital. In addition, we have accelerated approximately $200 million of capital spending on the Garyville major expansion, and I would like to point out that we are still on track for $3.2 billion for the overall project cost. We will invest an additional $100 million in midstream infrastructure to support our refining operations, and an additional $125 million on appraisal and development in Angola. So less than $300 million is accounted for by smaller projects and cost escalation. In addition, this capital spending will result in increased capitalized interest of $120 million. Thank you, Janet. As Janet described, much of the increase in our capital program is due to new projects that were not in place at the time of the 2006 capital projections and several long-life projects like the refineries and oil sands mining. As we execute these plans, we will continue to remain committed to our policy of financial discipline, and I now ask Janet to speak about that. We have commenced a review of our portfolio with the intent of monetizing those assets which are mature or are otherwise non-strategic in order to redeploy our capital into the growth projects I just mentioned. We are in the early stage of this exercise so I would say that proceeds from any sales would be weighted toward the second half of the year. 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 are welcome to re-prompt for additional questions as time permits. For the benefit of all listeners we ask that you identify yourself and your affiliation.
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