Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Noble Energy, Inc. (NYSE:NBL)

Q3 2008 Earnings Call Transcript

October 29, 2008, 10:00 am ET

Executives

David Larson – VP of IR

Chuck Davidson – Chairman, President and CEO

Chris Tong – SVP and CFO

Dave Stover – EVP and COO

Analysts

Ellen Hannan – Weeden & Company

Joe Magner – Tristone Capital

Michael Jacobs – Tudor, Pickering, Holt

Dave Kistler – Simmons & Company

Brian Singer – Goldman Sachs

Irene Haas – Canaccord Adams

Dan McSpirit – BMO Capital Markets

Gil Yang – Citi

Howard Flinker – Flinker Investments

Operator

Good morning and welcome to Noble Energy’s third quarter year 2008 earnings call. As a reminder, this call is being recorded. I would not like to turn the call over to David Larson. Please go ahead, sir.

David Larson

Thanks, Sean. Good morning everyone. Welcome to Noble Energy's third-quarter 2008 earnings conference call and we thank you for joining us here as we go through what you think was pretty strong quarter.

I'd like to start out with a few introductions. On the call today, we have Chuck Davidson, Chairman and CEO; Chris Tong, CFO; and Dave Stover, Chief Operating Officer.

We hope everyone has had a chance to see our earnings release reaching this morning. The agenda for the call includes some opening comments from Chuck, Chris will provide those more detail on the items affecting the results for the quarter, and Dave will finish up read the discussion of our awe burning highlights. We do plan to leave time for Q&A but we want to try to wrap up the call in less than an hour.

Later today we expect to be filing our 10-Q with the SEC and it will be available on our website at www.nobleenergyinc.com.

Before we get started, I want to remind everyone that this conference call contains projections and forward-looking statements based on our current views and most reasonable expectations. We provide no assurances on these statements as a number of factors and uncertainties could cause actual results in the future periods to differ materially from what we discuss today. You should read our full disclosures on forward-looking statements in our latest news release and the SEC filings for a discussion the risk factors that influence our business.

On another note, we will be referencing certain non-gap financial measures such as discretionary cash flow in the call today. When we refer to these items it is because we believe that they are metrics for us and our stakeholders to use in evaluating the company’s performance. But be sure to see the reconciliation in our earnings release to GAAP measures.

With that, and return the call over to Chuck.

Chuck Davidson

Thanks, David, and good morning everyone. Just to reflect back, I just want to mention and remind everyone during our second quarter conference call we talked about how important it was to remain focused on operational performance in this volatile markets. Despite the clients that we've seen in the commodity markets as well as the overall weakening economy, our teams have been doing exactly that. So we stayed focused on the things we can control which resulted in a very, very good quarter for Noble Energy on a variety of fronts.

Adjusted earnings were $395 million for the quarter, or $2.08 per diluted share, clearly a quarterly record for the company. There were a few adjustments to the GAAP earnings for the period that will help you get to this number and Chris will explain each while walking through the high points for our quarterly results.

Sales volumes were very strong at 211,000 barrels of oil equivalent per day and that was despite the loss of significant volumes from hurricanes that impacted the Gulf of Mexico and Gulf Coast regions during the third-quarter. We saw a record production and record realized prices in the Israel during the quarter and we were able to bring our second phase of development at Dumbarton in the North Sea online a little earlier than we had anticipated. And finally we had tremendous success in our exploration programs during the quarter and we’ll have more on that in a minute.

Unfortunately, the chaos has been running through the financial equity and commodity markets. Past several months has been the headline news and individual company’s performance ignored for the most part. It appears that may be beginning to change now as investors think harder as to which companies will be the winners versus the losers in the new economic environment we find ourselves in. The real stretch for me to be thinking of winners when faced with equity valuations just a fraction of what they were just a few months ago, I do believe, from a relative performance perspective, there will be winners.

Keeping relative performance in mind, I'm confident that we've positioned Noble Energy to perform very well in this environment and I thought I would spend just a few minutes on this call to elaborate why I feel this way.

I believe we are well positioned for the current environment for three critically important reasons and these really come from the business strategy that we developed several years ago. These are our, number one, our focus on investment discipline and following that our focus also on fiscal discipline, and finally our diversified portfolio of assets that was designed to be durable in a variety of environments.

On the first, on the investment side, we've consistently used conservative price assumptions to evaluate and justify our budgets and investments. We never headed down the path as so many did of pursuing projects that were highly dependent on prices at the higher end of the curves. It meant that we avoided a few high profile plays along the way that appeared close to the edge and costly, and it also meant that we drove by a lot of acquisition opportunities that were being sold at very high prices. So we never took the approach of trying to fund everything but drew the line at the level that gave us a comfortable margin of error. And finally, he managed to risk, especially in exploration where we diversify the program and brought in partners to help spread that risk.

On the second point regarding fiscal discipline, we are always of the view that we are in a commodity cycle and we are experiencing prices that have never seen or perhaps even imagined before. We did not overspend, but instead strengthened the balance sheet, reducing debt, and building a healthy cash reserve, all doing a time when the cycle was swinging up, spending less of our cash flow. We hedged appropriately to help mitigate the swings driven by commodity prices. Our view has always been it would be shame on us if when the cycle turns, which it now has, that we do not have our company and a very strong position. Today, with nearly any billion dollars in cash, our debt (inaudible) cap in the mid-20s, and no long-term bond debt due until close to the middle of the next decade. I believe we are in that very strong position that we wanted to be in.

And finally, on the third point, we built a portfolio of assets designed to be durable in a variety environments, able to self fund reinvestment opportunities, to generate growth over the long term and resilience to price volatility. They’re high-quality assets, we have a large inventory of opportunities, and also a low cost structure which ultimately allows them to generate superior margins.

We deliberately diversified the portfolio. We are not a single play company nor are we over exposed to any individual market. It's a portfolio of opportunities throughout the world with a nice balance of both liquids and natural gas which we believe gives us lots of options for optimizing the value of the portfolio and delivering consistent growth. We have enough choices to effectively allocate capital and realign things when required.

So these are the reasons why I believe we have Noble Energy well-positioned to deliver positive differential performance over the coming months and years. We are now hearing of competitors that are announcing major capital cutbacks to their programs. Some of these cuts are driven by economics and others by histories of overspending cash flows, a strategy that's clearly not sustainable in the current environment.

Noble Energy will not finalize its 2009 budget till the end of the year but we currently don't envision major changes to our plans from what we've outlined and discussed in the past. We’ll make the necessary cuts in them, we’ll make the necessary tweaks and tighten the screws a bit in some areas but we plan to continue with all the major programs and I think most importantly we plan to continue the major investments for future growth such as what we have been doing with explorations.

The recent Gunflint announcement should be a strong reminder that Noble Energy is an exploration company with significant option value in the portfolio. The Gunflint discovery is additional confirmation that our exploration process is not only working but may also be approaching best in class. It also adds support for the strategy shift we made a couple of years ago to focus on more material opportunities. We have something very material at Gunflint, which Dave will cover in a moment, and a nice inventory of similar deep water prospects as well. The excitement is already building around next year's program where we expect to drill two to three exploration wells in the deep water Gulf of Mexico as well as multiple tests in West Africa.

And were not quite finished in exploration in 2008. We have a drill ship arriving offshore Israel next month to spot another very significant exploration well. It could open up a new play concept in the eastern Mediterranean where we've assembled 2 million net acres in that region.

Mar [ph] is a pretty exciting prospect and one that makes sense given the growing demand for natural gas in that region. Should it be successful, we have other prospects that will be de-risked and are excellent follow-on opportunities.

I will finish up with just a couple of comments on the Rocky Mountains. We continue to invest in the Rockies and in particular, in the Wattenberg field which makes up about 75% of our Rocky Mountain volumes. With its low cost profile and large inventory of reinvestment opportunities, Wattenberg continues to generate good investment returns.

Just as a reminder, we have hedged a large portion of our 2009 Rockies gas production with NYMEX Colors [ph] that have floors averaging $9.15 and then we have tied to that related CIG basis hedges that net us back to the Rockies at about $6.50. So we are very pleased with our position there. It will be an area where we will look carefully at take away gas capacity and there may be some areas in the Rockies where we will reallocate capital in 2009 for best man's market capacities.

In summary, we find ourselves in an environment where fundamentals really do make a big difference. The fundamentals that we put in place several years ago are still what direct our business today and we believe those same principles and strategies will allow Noble Energy to continue to perform well in these volatile markets. With that, I'll turn it over to Chris to go over some of the details on the quarter.

Chris Tong

Thank you, Chuck, and good morning everyone. Hopefully you had a chance read through the earnings release and the company tables before the call so I'll just focus on a few noteworthy items, touch on the balance sheet and liquidity, then make a few brief comments on our expectations for the fourth quarter.

As Chuck mentioned, adjusted net income for the quarter was a record $395 million, or $2.08 per share diluted. Our supporting schedule warmed to our earnings release, we've listed several adjustments in net income and like to briefly mention cause these items are typically not included in that list estimates.

First off, there is a significant decrease in commodity prices during the quarter. We recorded on unrealized marked to market gain of $637 million after-tax. Since this amount represents prospective future gains or losses, assuming forward commodity prices remain at the estimated value, as of September 30, we exclude these amounts in determining adjusted net earnings.

The second adjustment in the schedule represents an impairment on our last remaining Gulf of Mexico shelf properties which suffered significant hurricane damage in 2004 and 2005 and have undergone repair and cleanup activity. We anticipate the sale of these assets will result in a loss and as a result we recorded an after-tax impairment of approximately $26 million. In addition, we recorded a loss on involuntary conversion in the amount of $6 million after-tax upon resolution of our insurance claims relating to the hurricane damage sustained on these assets.

The final reconciling items relate to Cemcrude, one of our crude oil purchasers that filed for bankruptcy protection in July. As of September 30, we have a receivable of approximately $71 million. Based on our assessment of the bankruptcy, consultation with council, we currently estimate that a portion of the amount is uncollectible, so we recorded a $26 million after-tax charge for this probable loss.

One other item worth mentioning that impacted our deluded earnings-per-share this quarter has to do with Noble Energy's stock, held in a rabbis trust benefit program. This trust was assumed in a past acquisition and holds about a million shares of Noble Energy stock. Each quarter its values are marked to market. As equities declined in the third quarter, they resulted in a $47 million pretax gain. In accordance with GAAP, when diluted, the gain is removed from the numerator and the shares are included in the denominator of the calculation. So as a result, our adjusted EPS has been reduced $0.16 for this item.

As to look at our results versus the same period last year, strength in commodity prices were the primary driver of our high revenues, operating income, adjusted earnings, and discretionary cash flow. A specific note to our crude realizations in the quarter, in the US we had a differential of about a $1.80, so the daily WTI average for the quarter. Our differential is lower than we guided to mainly due to change in production mix caused by hurricane shut-ins. As we had a larger percentage of our daily volumes in July and August versus September, coupled with higher prices earlier in the quarter, our overall average realization for the quarter was higher.

On the gas side, our realized US natural gas price was up 25% over last year to an average of $8.48 for the quarter. Due to the impact of the deep water shut-ins, the mix of our production shifted more towards Rockies gas ultimately resulting in a larger than anticipated US gas differential which approximate $1.50 per MCF for the quarter.

Also of note on gas prices, record volumes in Israel resulted in record pricing averaged $3.57 per MCF. As Chuck mentioned, sales volumes were very strong at 211,000 barrels of oil equivalent a day. Domestic volumes were up over 4% from the same period last year despite temporary shut-ins in production due to hurricanes Gustav and Ike, which reduced volumes on average 7500 barrels of oil equivalent per day for the quarter.

Internationally, natural gas sales in Israel were a record 155 million cubic feet per day, up 18% versus the third quarter of last year. Overall, international volumes were down versus third quarter of ‘07 primarily due to lower West Africa and North Sea volumes as well as the impact of Argentine [ph] properties that sold earlier this year.

In West Africa, operations were impacted by facility maintenance resulting in lower natural gas sales. North Sea oil lines were lower due to field declines in the original phase development at Dumbarton.

As mentioned in our last conference call, we expect earnings for our equity method investments to be lower. Facility downtime at the methanol and LPG plants cause the earnings from equity investments to decline $40 million in the third quarter.

Looking at costs, our oil and gas operating costs averaged just over $5 per BOE in the third quarter. Our unit leased operating cost versus the third quarter of last year will primarily result in increased operating and maintenance costs at North Sea.

DD&A for the quarter averaged right at $10 per barrel equivalent. Volume growth from our low-cost Israel asset included a lower DD&A on a unit basis.

I want to continue and remind everyone that when we talk about per barrel unit cost we consider all volumes including our equity method volumes for the LPG plant.

Production may have lowered [ph] taxes for up versus the third quarter of last year due to higher oil, natural gas, and natural gas liquid revenues. GNA expenses increased due to costs associated with higher staffing levels. And exploration expense is a little lower than last year and hopefully for those of you that use forecasting models, you were able to adjust exploration expense down from earlier estimates after we announced the exploration success at Gunflint.

Other operating expense was higher than the third quarter last year mainly due to the impairment of the remaining shelf properties as well as the allowance for the Cemcrude receivable. Our adjusted third-quarter effective tax rate was 34% with 40% deferred, both consistent with our annual guidance and subsequent quarters.

Looking now at the balance sheets. Our cash balance was just under $1 billion at the end of quarter. As we mentioned before, we could repatriate some or all of this cash but right now it's more tax efficient to leave those monies overseas in anticipation of the upcoming international development projects.

Total debt at the end of the quarter was $2.1 billion. Our debt balance is up from year-end and in the previous quarter largely due to the western Oklahoma acquisition that closed early in the third quarter. Our principal source of liquidity is a $2.1 billion credit facility due December 2012. As of September 30, we had a $1.4 billion in borrowings leaving approximately $700 million available.

Bank group is comprised of 24 commercial lending and situations none holding more than 7% of the total facility. Due to recent consolidation in the banking sector, the number lenders and their effective commitment levels within our credit facility may be reallocated over time. Debt to cap at the end of the quarter was 26%. Once you factor in the cash balance, our debt to cap net of cash was 16%.

As we close in on the end of the year, just a couple of comments on expectations for the balance of the year. In July, we updated our sales volumes guidance for the year to be toward the upper end of the range which was increased in May to between 210,000 and 220,000 barrels equivalent on a daily basis. Even with the negative impacts of the hurricanes in the third and fourth quarters of the year, we still believe that we’ll be at the upper end of our guidance range for the year, reflecting better performance in other areas of our diversified portfolio.

In EG, volumes in the fourth quarter should rebound from the third quarter down time and be closer towards second-quarter levels. We expect to see continued impact from the Dumbarton development in RC that came online late in the third quarter. Also of note, internationally, our best expectations are that natural gas sales in Israel will decline in the fourth quarter primarily due to seasonal factors and the potential impact of gas supplies from Egypt. In the US, fourth-quarter volumes should be up from the third quarter primarily due for further growth in our onshore development programs.

For the year, our expense items generally remain within our annual guidance ranges. Year-to-date, LOE is at $4.50 per BOE. We still expect it to be at the upper end of our guidance for the year. DD&A for the year is averaged approximately $10 per barrel equivalent and estimate we’ll come in under the low end of the range for the year. Based on our exploration success throughout the year, we now think the exploration expense will be in the lower half of our range while G&A will remain in the high end. Transportation, interest expense, and taxes should remain within the previous guidance.

That concludes the financial review and now I'll turn the call over to Dave.

Dave Stover

Thanks, Chris, and good morning everyone. Third-quarter was another very active quarter for our worldwide portfolio. I'll cover some of the highlights starting with the onshore United States.

Good growth continues at our largest onshore US assets with production at Wattenberg up 7% over third quarter last year. We continue to see strong project returns in Wattenberg with its low operating cost, diversified product mix, and large inventory of reinvestment opportunities. With six growing rigs and 15 completion units in the field, we are managing a very active program there and expect to at least maintain our activity level into 2009.

Our other Rockies production is also growing with volumes up 30% from the third quarter last year. In the Piceance basin, we continue to hook up new wells and should see continued production ramp up.

From our high activity level of five rigs early in the year, we have moved one rig to Iron Horse in Wyoming, released another rig, and we’ll drop an additional rig when it finishes its current pad drilling in November. This will set us up with two modern flex rigs for our base program. Overall, our drilling activity in this basin will decrease in 2009 as we concentrate on only drilling with the more efficient flex rigs and look ahead to timing supply with pipeline capacity.

In the eastern part of the DJ basin, in the Niobrara trend, we continue to progress this project. We are currently operating to rigs and this is the play where we plan to pace our level of development early in the year and see how the gas market is responding before accelerating further. As a side note on the Rockies, he did experience some third party facility downtime which impacted us by around 2000 barrels of oil equivalent per day for the quarter.

Early in the third quarter, we closed on the acquisition of the western Oklahoma property and we've now brought a second rig into the field with a third expected by early 2009. Results from the wells continue to be encouraging with current production at around 25,000,000 cubic feet equivalent per day.

Turning to the deep water Gulf of Mexico, our operations were certainly impacted by hurricanes Gustav and Ike during the quarter as Chuck and Chris both mentioned. All of our offshore production, approximately 26,000 barrels of oil equivalent per day, was shut in at the end of August. Swordfish, our largest producing deep water property, making about 60% of our offshore volume, was our first property to come back online. It was back to full rate by the latter part of September.

Florin [ph] and Tycon Deroga [ph] continue to be shut in, however we do anticipate some of this production to be back online before year end. These expectations are dependent on pipeline and third-party facility repairs are.

Our net production impact from the hurricanes was around 7500 barrels of oil equivalent per day for the third quarter and we expect an impact of around 8000 to 8500 barrels of oil equivalent per day in the fourth quarter. Also of note, concerning deep water production, we still expect the Raton gas development will be online by year end at around 18,000,000 cubic feet equivalent per day in net to Noble Energy.

In addition, we had two successful deep water wells during the quarter. At South Raton, our up structures sidetrack appraisal was successful and we recently finished completing this well in anticipation of initial production by early 2010. The second success was at our Gunflint exploration prospect and we are thrilled with the results of this oil discovery. At this location, we found greater than 550 feet of net pay is more than twice that pay thickness we originally expected. We can assume that the pre-drill resource range of 45 to 175 million barrels of oil equivalent were certainly going higher.

The combination of open hole logs, pressure testing, fluid samples, and rotary sidewalk cores all indicate multiple high-quality reservoirs. Based on these early tests, flow capacity should be similar to other high quality deep water Gulf of Mexico Miocene production. We've also sidetracked and taken a whole core for further analysis. A wide asthma seismic survey has been conducted and will be used to better define the structural and stratigraphic aspects of this discovery.

We are excited about operating the Gunflint development and we’ll be preparing a work program to appraise and develop the discovery with drilling expected to resume in late 2009 or early 2010 depending on rig schedules. One of the other real encouraging things about this discovery is that Noble Energy generated this prospect. We bought the lease in 2006 with a partner as we continue to focus additional effort on larger prospects including sub-salt [ph] opportunities.

Our acquisitions in this year's lease sale further expanded this effort and provide us an extensive portfolio of over 1 billion barrels unrisk net inventory. Going forward, our plans are to continue with the two to four well exploration8 program on an annual basis.

So now we have two very exciting development projects in the deep water Gulf of Mexico. The Isabella Galapagos area and Gunflint and we have rigs contracted to carry out both our deep water Gulf of Mexico development and exclamation programs.

So, let's turn to international. Starting in the North Sea, and brought the Dumbarton phase 2 initial development online a little earlier than expected. Two wells were completed and increased our share of the total field production over 12,000 barrels of oil per day net. Further drilling in the field, including at the satellite Lochranza, discovery should commence towards the end of this year with five production wells expected to come on line late next year.

Moving to Israel, as we’ve mentioned before, the third quarter of the year is typically the strongest in terms of seasonal demands. We also saw the impact of the start up of the Gezer power plant which we expect will continue to ramp up throughout the fourth quarter. Construction to bring the Hagit power plant online is nearing completion. We anticipate tie-end by the end of the year. For the fourth quarter, we would expect volumes to be closer to second quarter levels due to the seasonal swings for natural gas demand and continued uncertainty regarding additional supply from Egypt.

We're very excited by getting back to exploration in Israel. The rig should be arriving tomorrow at prospect site in mid-to-late November. The end it having results from the well some time in the first quarter of 2009.

As a reminder, tomorrow is a 3+TCS growth prospect with a chance of geologic success in the range of 35%. We operate the prospect of 33% working interest. With success, we have the option to utilize the rig for a second prospect immediately following tomorrow.

Moving to West Africa, we mentioned at last quarter’s call that we experienced some downtime in the early part of the third quarter due to maintenance at the Alba field in the methanol and LPG plants. All operations are back up and running and we expect fourth-quarter volumes to be around our second-quarter levels.

During the quarter, we announced very exciting results from our Diega oil test on Block I. Based on the modeling that's been done to date, we think that the Diega wells will produce at about 10,000 barrels of oil per day, making a very nice compliment to the Benita oil discovery.

Development plans at Benita continue and we've already gone out for bids with several firms on an FPSO design that would be able to handle the oil discoveries as well as the liquids from our rich gas condensate discoveries in the region. The plant is still to sanction the Benita oil development in early 2009.

Looking at future exploration in the area, the strong production test in the lower Miocene at Diega provides additional momentum to our program. We are continuing to develop our plans for 2009 by anticipate will drill at least a couple of exploration tests along with preparing for the Benita development.

Overall, it was another excellent quarter for Noble Energy. We've made great progress this year as we continue to create additional value for the future. At this time, Sean, we'd like to go ahead and open the call for questions.

Question-and-Answer Session

Operator

(Operator instructions) We'll go first to Ellen Hannan of Weeden & Company.

Ellen Hannan – Weeden & Company

Hi. Good morning, Chuck.

Chuck Davidson

Good morning.

Ellen Hannan – Weeden & Company

Couple of questions for you. Putting aside your stock price performance and in that of the sector, in the current environment and what you see maybe for the next six to nine months or, is there anything going in 2009 that you would do that's really different than what you might have planned six months ago?

Chuck Davidson

Well, as we look at 2008 and the environment we’re in, first of all, in the major programs, as we’ve mentioned, we see those all moving forward. One of the benefits of, I think, we really have with Noble Energy is we’ve got the ability to continue to make these investments for future growth, and that means the exploration programs, the developments in West Africa.

But, you know, as Dave mentioned and I refer to, we will look at the pace of development in certain areas, particularly in the Rockies, to see how the pipeline infrastructure moves forward might make sense will be in this environment that pipeline infrastructure investment will go more slowly than what may be the industry had been anticipating before. We want to make sure we don't get ahead of those. So we would probably adjust the pace of development in some of those areas especially where there is sensitivity to infrastructure capacity. But, not dramatically different although we would probably also say that there will be some opportunities that will come about in 2009 as well that we may want to take advantage of as well. We want to make sure we have the capacity to go after those if they make sense. So it's a very dynamic period.

Ellen Hannan – Weeden & Company

Okay. Thank you. Just another question, kind of operationally. Any timing on the production from the Diega discovery. Thoughts on that?

Chris Tong

I think, Ellen, if you look at it, Benita would probably come on first and we're still talking that 2012 type timeframe. And I would anticipate it would probably a year or two to tie in Diega behind that.

Ellen Hannan – Weeden & Company

Great. Thank you very much.

Chuck Davidson

Thank you.

Operator

Our next question comes from Joe Magner of Tristone Capital.

Joe Magner – Tristone Capital

Good morning. This might be a question for Dave. You touched on a little bit with respect to the downtime from Rockies expressed that US oil and gas volumes are both down sequentially even after adjusting for the hurricane downtime. Aside from REX-West, was there anything else going on onshore that may have led to those sequential declines?

Chris Tong

I think probably the bigger impact on the Rockies was really some compression downtime. We saw that Piceance and then some plant maintenance going on up there, those were the two bigger things that we’ll see pick back up here in the fourth quarter.

Joe Magner – Tristone Capital

Give an estimate for what that might have been?

Chris Tong

I think that was the majority of that couple of thousand barrels a day equivalent in the Rockies. We didn't really see that much of an impact from the REX piece on our own production.

Joe Magner – Tristone Capital

Okay. Great. And, Chuck, just a quick question. Touched on a little bit on the last – your answer to the last question that with your cash balance and understanding some of that is going to be for future development – offshore West Africa. But the current test balance, availability on your backlines, expected free cash flow even under much lower commodity price assumptions or currently looking at, what are your thoughts about the current acquisition market and maybe how opportunities might set up in over the next three months or throughout 2009?

Chuck Davidson

Well, and I think it is that the focus on, perhaps, anywhere from three months to a year out to see how things unfold. Right now, it's – there's a lot of moving pieces but I think we expect to see some opportunities arise and what we'll carefully look at is if they make sense based on valuations, to take advantage of those, or how we allocate capital internally and on our own programs. But, this is the position you wanted to get ourselves in where we have that kind of flexibility from a financial standpoint and operational standpoint to take advantage of some things that have the price cycle and the valuation cycle changed on us.

I think the other thing is that there may be some opportunities to do some joint venture things where some of the companies that don't have the financial flexibility we do may be looking for some partners. And if, again, we see those as attractive investments will engage in discussion to see if we can't take advantage of that. See what unfolds over the coming months, Joe.

Joe Magner – Tristone Capital

Okay. Thanks for your thoughts.

Chuck Davidson

Yes.

Operator

And we’ll go next to Michael Jacobs – Tudor, Pickering, Holt.

Michael Jacobs – Tudor, Pickering, Holt

Thank you. Good morning

Chuck Davidson

God morning.

Michael Jacobs – Tudor, Pickering, Holt

Chuck, earlier on the call you mentioned that the cycles turned. Can you share your longer-term view on the markets and service costs and what do you see 2009 shaping up?

Chuck Davidson

Well, everybody's crystal ball is really hazy right now. So, I have to put that caveat and I think it's very risky to start predicting 2009 right now. I do think that we are moving into a period where we've seen the commodity prices come down, we'll see other costs start to move down as well. There's always a lag effect but we have to expect it as well. And how long it lasts is anyone's guess right now because I do believe we are being driven by economic factors that are lowering the demand for energy and it's putting pressure on the system and its having an effect on all of us.

The liquidity issues are a bit unusual and I'm hopeful that the financial systems will go get back in better shape over the coming months. So, we'll probably see in our industry better flow of capital and availability to capital. It really doesn't impact's as much as perhaps some others. But, in the meantime is going to have a dramatic impact on the spending programs on some of these companies that were overspending their cash flows.

So we are going to see a slowdown in activity. It will have an impact on cost. I can't predict prices. We have typically tried to look at our programs on a long-term basis at prices that are much lower than what the strips have been the last couple of years and that will continue to be the case and as a result that's why we continue to justify investing in these programs even today.

But that's about as far as I can go on a forecast. I wish I had a better but this is a very unpredictable environment we're in.

Michael Jacobs – Tudor, Pickering, Holt

True. Recognizing – appreciate your comments earlier on potential acquisitions and recognizing that there may be JV, there may be on the assets side. There's just too many moving pieces but thinking about your 19,000 net acres in East Texas that you disclosed, and the NO stay and how that's kind of cropped up 1000 to 2000 acres per quarter roughly. Now that that assets are filling for $0.30 to $0.50 of the June ’08 dollar, how do we – could you give us some context as to how big you'd like to see these (inaudible) yet ultimately within Nobel portfolio. Do you think about it in terms of inventory potential or acreage size?

Chuck Davidson

I think when we look at in an area such as East Texas or other areas and I'd say primarily outside the Rockies. The Rockies is clearly already a core area for us. We want to, hopefully, build a position that we can call another core area and that means it has to have the potential to deliver substantial production into the future whether that comes through properties or acreage, that's just dependent on the nature of what becomes available. But we'd like to make sure that if it's an area we like it and you think the projects are appropriate, that we build it into something that has that potential to be a core area. Is there a magic number for it? I don't think so.

I would say right now our acreage position in East Texas is a nice position but it's not at that level yet so if we wanted to get it up to that level, we would definitely be looking to increase it over time. And the environment we're in right now may give us that opportunity to do that, do it at a price that is more reasonable because quite honestly be passed on a number of things earlier this year that had to do with East Texas because we just said it was too rich for our long-term view of where the market was.

Michael Jacobs – Tudor, Pickering, Holt

That’s great. Thanks. I have a exploration question for Dave, just thinking ahead to 2009 program you mentioned 2 to 3 prospects for ’09. Have you decided on which prospects you want to drill on the deep water dom [ph] and from a timing standpoint, where Sabin [ph] and Deep Blue fall into the program?

Dave Stover

No. I mean, the nice part when we're looking at our 2009 portfolio, Mike, is there's probably seven or eight projects that are vying for those two to four spot right now both from operated by us and operated by partners. Now there's still a number of things that we're going to have to sort out between partners and ourselves as to which ones really leap to the forefront. We probably have more choices than we've ever had going into the year as far as quality prospects.

Michael Jacobs – Tudor, Pickering, Holt

Are you managing that program from a dry hole suppose you're or are you looking at it – are you targeting the conventional deep water? You one of those sub-salt [ph]? How do you think about that program?

Dave Stover

I mean, there will be a mix of some salt in their obviously. There's a nice blend of prospects both some that would be tie backs and some that obviously have a larger standalone size that we’re looking at. So, it probably a nice mix of that and then we'll probably want to make sure that we are exposed to both types of prospects in the next year.

Michael Jacobs – Tudor, Pickering, Holt

Okay. And just one final one hand out hopped off. Just thinking about the Diega float test, can you show any flowing pressures, properties –

Dave Stover

I don't have that handy with me right off hand. I just have to go back to what we put out in the press release but maybe a follow-up question.

Chris Tong

I do think – I'm on a blank to in terms of flowing pressures although it doesn't make a whole a lot of sense because this was test equipment off a rig and most of our work has been based on permeability data in those flow results and extrapolating it to a real producing condition the way we reconfigure the wells. And I think that a fluid data was similar to what we saw in Benita. Actually, maybe might be a teeny bit better but for all practical purposes (inaudible) same.

And just as a follow-up on the deep water, a lot will depend in this coming years as Dave referred to it as getting our interest and partner interest aligned. Because I can imagine – that's why we're so careful about not (inaudible). Okay make sure everybody's on the same boat with everybody changing their capital programs around. One area that we would like to see if we could get another test in is the area around Isabella because we got a couple of discoveries and that area. We've got, I think Santa Cruz and Santiago there as additional prospects and would like to get one of those tested. But again, we've got partners there and make sure we got the rigs scheduled lined out.

But there's more to come on that, Mike.

Michael Jacobs – Tudor, Pickering, Holt

Great. Thanks for answering all my questions.

Operator

Our next question comes from Dave Kistler, Simmons & Company.

Dave Kistler – Simmons & Company

Good morning guys

Chuck Davidson

Good morning.

Dave Kistler – Simmons & Company

Real quickly, just on efficiencies in the Rockies. As you move in the Piceance, if I did the math correctly from five rigs to ultimately to flex rigs. Can you talk a little bit about what that means to total well count out of the Piceance?

Chuck Davidson

Yes, Dave. I think probably what you're looking at as a base program that somewhere plus or minus half the number of wells next year that we drill this year and then we'll continue to monitor that and see how we want to ramp that from there.

Dave Kistler – Simmons & Company

Okay. Great. So, essentially taking up almost 30% efficiency gain.

Chuck Davidson

Yes.

Dave Kistler – Simmons & Company

Okay. And then jumping internationally for one quick question about Israel. Can you talk a little bit about the environment there are, gas demand, how that looks going forward? Obviously the production results out of there were very impressive.

Chuck Davidson

Dave may want to jump in on this as well. The gas demand itself has been growing nicely because of the continued conversion of these power plants and there's also been some other industrial demand that had started to connect into the system as well. And so, from that standpoint we are potentially approaching a point where our facilities are going to be reaching their maximum deliverability but the wild card which we – and you referred to is imports from Egypt and how that might enter into the system. The nice thing which I note, that you noted and others noted is that the pricing has continued to move up. As we've seen global energy prices grow this year, that has been realized in Israel and as a result, some of the incremental volumes that we deliver (inaudible) at much higher prices than historical and that has raised our blended average gas price here.

So, that's very encouraging to us, seeing that demand grow is very encouraging, and it certainly both the pricing and the demand is what led us to make the decision to return to exploration there.

Dave Kistler – Simmons & Company

Great. Thanks for that additional color. One housekeeping item, just on your hedges and hedging counter parties. Can you talk about how many you have, whether they’re involved in your credit facilities, what kind of margining might be required or not required? Just to get us comfortable there.

Chuck Davidson

I think we had the hedges with 14 different counterparties, 13 of them are lenders to us in our credit facility and we have no margin requirements. That was something that we put in our credit facility about three or four years ago. No margin is posted at all. You'll see reference in the Qs and Ks in some small margin amounts. Those are very small marketing type volumes that are done on a different basis. So you may see $1 million or $2 million of margin referencing Qs and Ks. Those are not corporate hedges.

Dave Kistler – Simmons & Company

Great. Thanks so much for the additional color guys.

Chuck Davidson

Thank you.

Operator

We’ll go next to Brian Singer of Goldman Sachs.

Brian Singer – Goldman Sachs

Thank you. Good morning.

Chuck Davidson

Morning.

Brian Singer – Goldman Sachs

Most of my questions have been answered but just one, Chuck. Thinking about cash flow versus CapEx next year in this environment, obviously you have a number of growth opportunities from various exploration successes. Is it the counter cyclical opportunity in a down market to spend more than cash flow and given how more conservative you have been in the past or how do you think about the timing of future projects with current commodity prices and capital markets?

Chris Tong

I think right now – with at least, kind of a consensus projections are for commodity prices next year as I think we can continue to make significant investments in these growth areas and probably be very close to our cash flow. I don't view this as – certainly from our operating programs as a timer, we just want to swing the other way and overspend cash flow. I think this is a time though that you want to look for incremental opportunities outside your programs and that's maybe where the odds look to use some of your financial flexibility you've got. But, you know, we tend to run the business carefully and right now, as most companies would say is, we don't want to lose that financial flexibility that we’ve spent so – worked on so carefully in the last couple of years to build up. So, I think we'll be able to manage within our means and still do a lot of investments for this future opportunities. We don't see the high maintenance capital needs and so we’ve got a lot out of cash flow that you can direct towards the incremental growth opportunities.

So, we’ve mentioned we’ll continue deep water exploration. We're working hard to try to accelerate the West Africa development. That will continue in 2009.

Brian Singer – Goldman Sachs

Great. Thanks. Along the lines in west Africa, what is the timing of when the contracts would need to be signed for the steel heavy portions of the development and what are your expectations for how quickly lower global steel prices would trickle down to your ability to actually see lower costs and what you would have otherwise thought previously.

Chuck Davidson

Well, I'd say that right now we've got a request out for proposals and we’ll see if one of our contractors can come up with something creative such that we would be able to benefit from the improving markets there. We would like to see lowering costs passed through last and so it will be part of the contracting strategy but until we really see their proposals, it'd be premature to speculate on how much we’ll gain from that.

But, clearly we are aware of where the market's going in that area and we want to take advantage of it.

Brian Singer – Goldman Sachs

I guess, does it make sense to you delay things if you don’t see that as long as steel prices are falling globally or do you just keep moving as on track.

Chuck Davidson

My sense is that with the impact on the overall project you’ll keep moving because of the value of the project. This has such huge value that you're probably going to be losing more in terms of present value by doing that than trying to gain a small incremental amount on steel prices. But that's the analysis that we had to deal with. We maximize present values so we'll go through and we’ll look at time versus dollar and see what makes sense. But I think right now we are seeing such high-value on moving this project forward. We'll keep it moving.

Brian Singer – Goldman Sachs

Great. Thanks.

Chuck Davidson

Thank you.

Operator

We'll go next to Irene Haas of Canaccord Adams.

Irene Haas – Canaccord Adams

Hi, Chuck. Congratulations on the Gunflint prospect. Just wondering, can you lay out so that the timeline, this was a really big prospect, really discovery you guys have big partners at one of the along, so what’s on your play for next year, the following year? First production is it four years out, roughly?

Chuck Davidson

First of all, we’ve got to appraise this. This is a larger structure, so it’s – and I think right now, looking at the rigs that would be required to do that, we would probably not start appraisal until at the earliest late next year or early 2010. And there are multiple partners involved, so the other thing is with its size, we’re clearly thinking down the path that this is going to be a standalone development. So, it’s not unusual for both on standalone to be 5 years. There’s a range around that number, clearly, and we always have a bias to try to accelerate things but – well, we’ve always said the good news from the bad news and it has to do with large discoveries. The good news is they’re large and the bad news is they take longer to develop and bring up. So, we’re in the process now of just understanding what size a project we’ve got here. We know it’s meaningful and it’s very material, we want to do it in a very thoughtful way that doesn’t throw capital away but it’s going to take some time.

Irene Haas – Canaccord Adams

And any satellite structure close by?

Chuck Davidson

I’m not sure. The big discovery that was to the north is Kodiak but that’s probably a stand alone too. So, this one’s a pretty good size so it’s probably – you’re not going to be looking at and doing a lot of sub-sea tie back, somewhere. There may be some other things that may ultimately tie-in to (inaudible) but right now, it looks like it’s headed down the path of standalone but, got to be careful. As you very well know, you need to give one or two appraisal wells down before you start getting too excited about design and spars and stuff like that.

Irene Haas – Canaccord Adams

Great. And would you be able to book some reserve by year end ‘09?

Chuck Davidson

We would have to wait until a sanction on that and so my guess is there won’t be enough appraisal drilling to book it ’09.

Irene Haas – Canaccord Adams

Great. Thank you.

Chuck Davidson

Thank you.

Operator

Our next question comes from Dan McSpirit of BMO Capital Markets.

Dan McSpirit – BMO Capital Markets

Good morning, gentlemen.

Chuck Davidson

Good morning.

Dan McSpirit – BMO Capital Markets

You highlight the Wattenberg in your discussion on the Rockies operations. Can you review for me the drilling economics there, the targeted economics, reserves per well, and drilling complete cost per location and efficiency gains here going forward that you might see in lowering the economic break even of the play? And also, what is the price at which you phase the drill or no-drill decision in the Wattenberg?

Dave Stover

Well, I’ll give you an example of some of the sensitivities that we have put out there and without getting in to a lot of details on break even. One sensitivity that we’ve looked at on just an overall program in Wattenberg that says basically that, you know, kind of trend prices in the middle 7s on gas and 70 trend prices on oil. And, again, we’ve shown some of this in some of our (inaudible). It’s in the 30s.

Chris Tong

30% to 40%

Dave Stover

Yes. 30% to 40% rates of return.

Chris Tong

I’m (inaudible) after tax basis too.

Dan McSpirit – BMO Capital Markets

Okay.

Dave Stover

So, if we get some cost improvements along the way, it makes it even better but it’s been a very strong program for us that’s why it’s so resilient to swing commodity prices.

Dan McSpirit – BMO Capital Markets

Okay. Perfect. And, I guess it’s safe to assume that if it’s not working in the Wattenberg, it’s not working in the Rockies for you period. Is that a fair assumption? Is that (inaudible)?

Dave Stover

I think as long as we’ve got the current relationship between liquid prices and gas prices, that’s right because it has the higher liquid content (inaudible)

Dan McSpirit – BMO Capital Markets

Right.

Dave Stover

So, that’s probably a fair assumption especially if we get into bottlenecks on gas so it takes away capacity.

Dan McSpirit – BMO Capital Markets

Wonderful. Thank you.

Operator

And we’ll go next to Gil Yang of Citi.

Gil Yang – Citi

Morning. You’ve probably never mentioned this before but following in on some of the questions about costs, you mentioned steel. You have any idea yet what’s going to happen to rig cost and franking cost as we go to ’09?

Chris Tong

It kind of goes back to Chuck’s comment, Gil, as to how much do these costs decreases lag the current market and what can we get really pushed into 2009 for how much of the year. I think when you look at the rig pieces as contract start to roll off, obviously, especially on the onshore rig arena, there’s obviously more pressure on the downward side. I think it’s still too early to tell as to how much pressure be on some of that. A lot of what we’re doing is we’re going to utilizing just the more modern rigs and really focusing on the efficiency gains on that piece.

On the stimulation side, we actually benefited this year from some longer term arrangements we’ve put into place at the beginning of this year that some of that carries over into next year and we’ll continue to look at the opportunities to keep those cost down but I think overall on service cost, probably onshore, I’d expect to see a continued trickle down. The question how fast do we see those kind of come in to the system.

Gil Yang – Citi

If you think that there’ll be more or less pressure on the more modern rigs? Because your preference and probably other people’s preference to use the more efficient rigs.

Chris Tong

I think those will be the ones who’ll be in greater demand. I think, no doubt about that. I think the thing where you really benefit on some of those is the combination of newer rigs and a consistent program or at least consistent base program where not only you have the newer rigs but you have the experienced work force then that’s continuing on with those rigs.

Gil Yang – Citi

Okay.

Chuck Davidson

Gil, I’d just like to follow up on that. History would show that you probably haven’t had as many examples of onshore new rigs in prior cycles but we certainly seen it offshore in the deep water where we’ve gone through cycle. It’s been the high performance rigs, the newer rigs, the more efficient rigs that have continued to work through the cycle even those we saw that fleet row in the mid-90s and then we saw commodity prices fall back in the late 90s, they remained working. Yes, prices adjusted but they remain working. It was those lower quality rigs – 3rd generation rigs – they went idle and their pricing really collapsed. So, you can a look a little bit of history to tell that operators do tend to go towards the most efficient when you’ve got excess capacity.

Gil Yang – Citi

Sure. And then, just a follow up on the Piceance, you said you’re driving a rig pretty substantially. Can you give us some insights to how you think about the numbers of wells you want to drill there in the context of basis hedging and how the basis hedging sort of mitigates the pressure to reduce activity there?

Chuck Davidson

This may be a little counter-intuitive but we view our corporate hedges as corporate hedges and then separate from that, we can make economic decisions on drilling because it will not affect the return we get from the hedges. The hedges are there to stabilize our overall cash flow and where we look for the hedges is to continue to stabilize and provide cash flow and then we set our program. When it gets to the P&L, I think that is a decision primarily driven by how we see the pipeline capacity and off-take capacity and what kind of netbacks do we get and trying to match our program and the pace of our program up to their capacity is not necessarily a switch on, switch off. We see good returns from that program, there’s probably some better returns for the incremental rigs and we’ll move the incremental rigs to where there’s better returns.

Gil Yang – Citi

Okay, that’s very helpful Chuck. Thank you very much.

Operator

And in the interest of time, we’ll go to one more question that will come from Howard Flinker of Flinker Investments.

Howard Flinker – Flinker Investments

Oh, I got lucky. In as much as it touch stones one or two questions I have, Chuck, in your calculation of 30% or 40% rates of return at $7 and, I think you said 40 in Wattenberg.

Chuck Davidson

In the mid-7s for gas and $70 (inaudible) for all.

Howard Flinker – Flinker Investments

70? I didn’t hear clearly. The arithmetic of that calculation, does it subtract interest cost?

Chuck Davidson

It is a discounted cash flow rate of return on the entire program. So, it’s more of a classic cash flow so the return is covered by the interest. So, no, interest is not included in that.

Howard Flinker – Flinker Investments

And depreciation is also not included in there.

Chuck Davidson

Not in a discounted cash flow (inaudible) fall out.

Howard Flinker – Flinker Investments

Right. Right. Otherwise your corporate return will be much higher than what it appears to be. What percentage is your gas is hedged at 9 and with the CIG differential at 6?

Chuck Davidson

We’re at – right now, $9 for 2009 is the average of our floors and we’re roughly, of North American gas, we’re about 40% hedged.

Howard Flinker – Flinker Investments

For the fourth quarter and next year?

Chuck Davidson

For next year. Average for next year and for the –

Dave Stover

I think it’s pretty close in the fourth (inaudible)

Chuck Davidson

It’s pretty close to that for the fourth quarter of this year but of course the price is lower than the quarter of this year. That’s one of the things that you get a big uplift next year is that the old Betina hedges roll off at the end of this year and we jump to some newer higher hedges in ’09.

Howard Flinker – Flinker Investments

And at what price do you decide either to shut-in or greatly reduce rigs on hand.

Chuck Davidson

Dave talked a little bit about just some of our trends on how we’re moving rigs around, but there is not a single price and I would say right now we’re not curtailing any production. What we really manage is the pace of development and that’s how we manage our programs going forward and because we have not depended on extreme high prices for prior development, we don’t get in a bind where we have very high cost production that maybe you’re uncomfortable with (inaudible).

Howard Flinker – Flinker Investments

The reason I ask is that we both know that some hubs have unbelievably low prices in the last few weeks.

Chuck Davidson

Occasionally the basis will blow out and then –

Howard Flinker – Flinker Investments

Almost zero.

Chuck Davidson

And then you do look at what protection you have and also in some instances, we have sold on first of month, we have firm transportation, so we’re not seeing that kind of blow out.

Howard Flinker – Flinker Investments

Because you have enough transportation to get your gas out, is that what you’re saying?

Chuck Davidson

We secured it through our purchasers such that we can get it out so you’re not – we try not to get caught selling very much gas on a spot daily basis. It’s usually sold ahead, first of month, with firm transportation.

Howard Flinker – Flinker Investments

Fair enough. Thanks for the info.

Chuck Davidson

Thank you.

Operator

That’s all the time we have for questions. I’d like to turn the call back over to the speakers for any additional or closing remarks.

Chuck Davidson

Thanks again to everyone for tuning in to the call and we’ll hopefully see you soon either on the road or in our offices. Thank you.

Operator

Again, ladies and gentlemen, this does conclude today’s conference. We thank you for your participation. You may disconnect at this time.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Noble Energy, Inc. Q3 2008 Earnings Call Transcript
This Transcript
All Transcripts