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Chevron Corp (NYSE:CVX)

Q4 2008 Earnings Call

January 29, 2009 11:00 a.m. ET

Executives

Dave O'Reilly, Chairman and Chief Executive Officer

Pat Yarrington, Vice President and Chief Financial Officer

Jim Aleveras, General Manager Investor Relations.

Analysts

Mark Flathery -Credit Swiss

Robert Kessler – Simmons & Company International

Erik Mielke – Merrill Lynch

Michael LaMotte – JPMorgan

Neil McMahon – Sanford Bernstein

Arjun Murti – Goldman Sachs

Paul Cheng – Barclays Capital

Jason Gammel – Macquarie Research Equities

Paul Sankey – Deutsche Bank

Mike Mathis – Merrill Lynch

Mark Gilman – Benchmark

Operator

Good morning. Welcome to Chevron's Fourth Quarter 2008 Earnings Conference Call. (Operator Instructions). I will now turn the conference call over to the Chairman and Chief Executive Officer of Chevron Corporation, Mr. Dave O'Reilly, please go ahead, sir.

Dave O'Reilly

Thank you, operator, and welcome to the Chevron's fourth quarter earnings conference call and webcast. On the call with me today are Pat Yarrington, Vice President and Chief Financial Officer, and Jim Aleveras, General Manager Investor Relations.

Pat took over as CFO from Steve Crowe who retired last month and as extensive experience in all aspects of Chevron's financial operations. Most recently Pat has been our Vice President and Treasurer and prior to that was Vice President of Government and Public Affairs and before that Vice President of Strategic Planning.

You'll have an opportunity to meet her at our meeting in New York on March 10th. Pat, I'll turn the meeting over to you.

Patricia Yarrington

Thanks, Dave. Let's turn now to Chevron's financial and operating results for the fourth quarter of 2008. We'll refer to the slides that are available on the Web. Before we get started please remember that this presentation contains estimates, projections, and other forward looking statements.

We ask that you review the cautionary statement on slide two. I'll begin with slide three which provides an overview of our financial performance. The company's fourth quarter earnings were $4.9 billion or $2.44 per diluted share. Our total fourth quarter 2008 earnings were about the same as fourth quarter 2007.

Earnings per share, however, were up about 5% due to our share repurchase program. Comparing the fourth quarter 2008 to the same period a year earlier, lower crude oil and natural gas prices reduced upstream results while falling prices improved profits in the downstream segment.

To recap the balance of slide three, return on capital employed for the year was nearly 27%, under scoring Chevron's financial strength the debt ratio was below 10% at the end of the year and cash balances exceeded debt by $700 million.

Share repurchases were $8 billion for the year. Our latest share repurchase program was authorized by the Board in September 2007 for up to $15 billion over a period of up to three years. We have now repurchased $10.1 billion of the $15 billion authorized.

We do not anticipate repurchasing shares in the first quarter of 2009. Finally Chevron's 2008 TSR of negative 18% compares favorably to the S&P 500s return of negative 37% and a 37% decline in the MX oil index.

Turning to slide four, our total capital spend for 2008 was $22.8 billion compared with our budget of $22.9 billion. Upstream spending accounted for $17.5 billion of that total. Our cash C&E which excludes our equity share of affiliate outlays was $20.5 billion.

Our announced capital program for 2009 of $22.8 billion is unchanged from 2008 expenditures. However, about 10% of the total 2009 budget relates to large one-time payments for concessions in the partition neutral zone and Jong Dong Bay (ph) gas field.

Excluding these items underlying spending in the upstream segment is budgeted to be lower than last year. Of the overall 2009 capital program 77% is for upstream activities reflecting the capital intensive phase of some of our long term growth projects. Another 19% is earmarked for the downstream for a number of investments to upgrade our refining network.

Jim will now take us through the quarterly comparisons. So Jim over to you.

James Aleveras

Thanks, Pat. My remarks compare results of the fourth quarter 2008 with the third quarter 2008. As a reminder our earnings release compared fourth quarter 2008 with the same quarter a year earlier. Turning to slide five, fourth quarter net income was about $3 billion lower than the third quarter.

Starting with the left side of the chart lower crude oil and natural gas prices caused (inaudible) to decline by more than $3 billion. Similar to the prior quarter falling commodity prices benefited the downstream segment in the fourth quarter. The variants in the other bar reflects lower chemical earnings and higher corporate charges.

Slide six summarizes the results for our U.S. upstream operations. Lower crude oil and natural gas prices reduced earnings by $1.6 billion. Chevron's average U.S. crude oil realization was down about $61 per barrel between quarters similar to the average WTI change of about $59 per barrel between the periods.

Production (inaudible) were down 4% mainly due to the full quarter impact of September hurricane shut-ins. The violent impact reduced fourth quarter earnings by $100 million. As mentioned in the interim update lower charges related to the hurricanes benefited earnings by about $350 million in the fourth quarter compared to the third.

The fourth quarter included a gain of about $600 million from an exchange transaction which included the company's interest in a producing property in Utah. For comparison asset sales added about $350 million to third quarter profits.

This difference of $250 million is shown on the chart. The other bar is comprised of a number of items. The largest of which was related to a change in natural gas inventories. Turning to slide seven, international upstream earnings for the fourth quarter fell nearly $2 billion from the third quarter's results.

Lower oil and gas prices reduced earnings by $2.8 billion. Our average realization per liquids fell about $56 per barrel between sequential quarters compared to the $59 per barrel decline in the average (inaudible) price.

Higher liftings benefited fourth quarter earnings by $430 million. Liftings were higher in Kazakhstan due to the ramp up of the Tengiz expansion and completion of the third quarter facilities turnaround there.

The ramp up of Agbami in Nigeria was also a significant factor. The $210 million favorable variance in tax items shown in the slide reflect various issues in several countries. Exploration expense was higher between quarters reducing earnings by $140 million. This is a result of several well write-offs along with higher geological and geophysical expenditures.

The other bar is primarily an increase in foreign currency gains. Slide eight summarizes the quarterly change in the worldwide oil equivalent production including volumes produced from oil sands in Canada.

Production increased by 97, 000 barrels per day or 4% between periods. Though our fourth quarter prices benefited buy-in by 73,000 barrels per day primarily due to production strain contracts and variable royalties.

External constraints such as mandated curtailments by opaque member host governments and lower natural gas demand reduced production by 51, 000 barrels per day. As mentioned earlier the fourth quarter was impacted by the September hurricanes in the Gulf of Mexico.

The volume metric effect was an adverse variance of 27,000 barrels per day. Base business declines of 17,000 barrels per day were more than offset by the ramp up of production from the Tengiz expansion, Agbami, Blind Faith, and the Northwest Shoal on G-Train 5.

Slide nine compares full year 2008 OEG production including volumes produced from oil sands in Canada to that of 2007. Price impacts on production sharing contracts and variable royalties reduced production by 72,000 barrels per day.

WTI prices averaged $72 per barrel in 2007 in contrast to $100 per barrel in 2008. For the year 2008 external constraints such as mandated curtailments by opaque member host governments and lower natural gas demand reduced production by 13,000 barrels per day.

The full year impact of Gulf of Mexico hurricanes was 35,000 barrels per day. Our base business decline was 78,000 barrels per day, a drop of about 3%. I'll discuss our outlook for the base business decline in a moment. Finally our major projects, primarily the Tengiz expansion, Agbami, and the further ramp up of our 2007 Bibyana (ph ) in Banglodesh added 109,000 barrels per day to 2008 production.

Blind faith come on extremely late in 2008 and did not have a large impact the full year. 2008 production of 2.5 free million barrels per day came in at 120,000 barrels per day lower than the element we provided at the beginning of the year.

The original 2008 outlook of 2.65 million barrels per day assumed crude prices for the year would average $70 per barrel, instead of the $100 average that actually occurred. Price effects along with external constraints and then September hurricanes noted here were the primary reasons for the difference.

Our base business performed solidly better than we assumed, offsetting this we experience a six-month delay in the in the (inaudible). The rest of our projects started on time but some ramped up more slowly than originally planned.

Slide ten shows our production outlook for 2009. We had previously provided (inaudible) for 2008 that each dollar change in crude prices would inversely change our production by about 2,000 barrels per day due to effect of production sharing and variable (inaudible) agreements.

Because of certain thresholds have been reached under these agreements, our rule of thumb for 2009 is each dollar change in crude prices affects production by roughly 1,200 barrels per day. As before, I caution you that this rule of thumb is very approximate and actually results will differ each of the underlying contracts as different.

On this basis comparing 2009 at an assumed price of $50 per barrel, which this is based on last week's future prices, and 2008 at $100 per barrel, the price effects would increase production by 60,000 barrels per day as shown on the chart.

External constraints again for (inaudible) member, most Governments and market factors are assumed to reduce production by 80,000 barrels per day. Base business declines and the impact of lower investment in the base business are expected to reduce production by 188,000 barrels per day.

This amount is an implied 7% decline rate in contrast to our previous 4 to 5% base decline guidance due to lower expected oil and gas prices, spending on our base business and mitigating natural fuel declines, will be reduced in 2009.

We're still investing to mitigate these declines but at a lower level reflecting the lower level of oil and gas prices. The big (inaudible) that we do not produce in 2009 will still be there to produce when market conditions are more attractive.

Because of the temporarily higher base decline rate and market driven investment deferrals, we do not expect to achieve our full 3% compound annual production growth between 2005 and 2010. We'll update you further at our annual security analysts meeting in New York on March 10th.

Finally, 2009 will benefit from the continued ramp up and full year production in a more recent major capital projects and from the (inaudible) that come on line for later this year including (inaudible) and Brazil, Tahiti in the Gulf of Mexico, and Gonzale Luni (ph) in Angola.

Turning to slide 11, U.S. downstream operation turned to just over $1 billion essentially flat with the previous quarter. Indicator margins reduces earnings by $260 million. Our marketing margins improved lowering refinery margins on the West and Gulf Coast were a large factor.

The change in the company's realized margins tracked the change in indicator margins. WHI prices fell more than $56 per barrel from the end of the third quarter to the end of fourth quarter. This exceeded the $39 per barrel drop that occurred during the prior quarter.

The sharply falling prices caused the downstream to have a large favorable timing effect in both quarters. Timing effects were $80 million more favorable in the fourth quarter than the third. On an absolute basis, timing effects in the fourth quarter were about $700 million.

The largest factor was provisionally priced or improved which was $370 million in the fourth quarter, about the same it was in the third quarter. In the previous conference call, I mentioned that the company revised their primary long haul crude supply agreement to the West Coast refineries starting in October.

However, August and September liftings were still final (inaudible) in October and November, and prices were about $35 per barrels lower than at the end of the third quarter. We do not expect a material timing effects for provisionally appraised crude in the first quarter for U.S. operations.

The balance of the timing effects was primarily due to inventory, derivative gains associated with shale refined products, a favorable lag in aviation pricing, and other supply related factors. Finally operating expenses declined largely from lower fuel costs.

Turning to slide 12, international downstream earnings improved by $230 million and more than $1 billion. Defining margins were lower in the fourth quarter. Our marketing margins were mixed. Overall our realized margins fell $205 million between the sequential quarters.

Volumes were simply lower during the fourth quarter partly reflecting planned maintenance and a (inaudible 00:16:45) refinery in the UK. The volume effect was an average strand of $30 million. Timing effects added $525 million to the fourth quarter earnings, compared third quarter earnings.

The absolute amount of timing effects in the fourth quarter was roughly $850 million. Nearly half of the increase between sequential quarters was related to derivative gains and long haul crude new refined products such as PMJ crude, templar exports, and crude sales to equity affiliated refineries.

As I mentioned during the last few quarters, we often use derivatives to lock in a margin above the cost of transportation which result in gains when prices decrease and vice versa. The balance of the timing effects between quarters resulted in gains in derivatives used to convert crude pricing to the time of refinery run.

And a favorable lag in aviation pricing as well as other supply related timing factors. The other burr on this chart reflects an adverse change of $50 million between quarters. Lower operating expense was more than offset by an adverse swing in point price index.

On slide 13 shows that earnings from chemical operations were $28 million the fourth quarter, compared to $70 million in the third quarter. Results for all (inaudible) due to lower volumes in prices. (inaudible) range fell primarily because of a one time impairment charge. The other bar reflects higher additive range.

On slide 14 covers all other net charges. Before the quarter results, net charges of $365 million, comparable to net charges at $190 million in the third quarter. $310 million of the swing reflects higher corporate charges across a number of areas, $70 million of the change stems from a favorable variance of two tax items.

The other bar on slide 14 includes the net of many unrelated items which were $65 million payroll variance between the sequential quarters. Before turning it over to Dave, I'd just like to briefly recap the fourth quarter.

Upstream earnings fell significantly in line with the interim updates. Downstream continues to benefit from sizable derivative gains due to the declining prices, also noted in the interim update. And last as projected chemical earnings were lower and all of these charges exceeded the guidance range.

Dave O'Reilly will now summarize our 2008 strategic progress and provide some thoughts about 2009. Dave?

Dave O'Reilly

Well, thank you, Jim. And turning to slide 15, in 2008, we focused on execution and succeeded across the board. For several years, we’ve made improvements on our safety performance and were among the best in class.

In our upstream business, we committed starting to on three major Chevron operated projects, adding significantly to our long-term production. The Tengiz expansion like Agbami and Blind Faith are all online and performing well.

We also started the first phrase of the North Duri steam flood in Indonesia and achieved first production at five partner operated projects. We've talked about our exploration success for many years in a row and 2008 was another banner year for exploration, which we'll discuss further at the March Security Analysts Meeting.

WE told the investment community that our reserve replacement ratio would improve and on a preliminary basis, we estimate that we replaced 146% of our production in 2008.

Now our downstream business we placed to improve refinery reliability. We delivered on that pledge in 2008 and we had our best fuelization rates on record. 2008 represented a 6.5% improvement in refinery utilization over the base year of 2005.

Our downstream portfolio rationalization has continued in 2008 as we exited a number of non-strategic markets. Finally, we rewarded our shareholders with another double digit increase in our dividends and repurchased $8 billion of our shares.

We did so while funding our robust capital program and maintain the balance sheet with more cash than debt at the end of the year. So we enter these challenging times with the financial strength and flexibility to succeed in the years ahead.

Turning to slide 16, let's just look at 2009 briefly. In our upstream business we're on track to start up three more Chevron operated projects further demonstrating our organic growth potential. We are also focused on the work needed to continue to advance in our strategically important projects in core areas such as Australia and the deep water Gulf of Mexico.

In the downstream business, we're maintaining our focus on refinery utilization to capture the most margin that the market will permit. And we're continuing to rationalize our portfolio to focus on our strongest markets and those with the most potential for long-term value creation.

Across the enterprise we're focused on managing our costs in the same world class process as we used to manage costs when they are rising are now critical to realizing maximum savings on materials and services in a softening market.

Combined with capital discipline, our attention to every element of our cost structure will ensure us success during this economic slowdown. Rewarding our share holders, continuing our disciplined growth, and maintaining our financial strength are all objectives we have been pursuing and will continue to pursue in 2009.

Meeting our commitments to our investors, our communities and a world that has long-term need for our products and services has been and will continue to be our priority. I look forward to discussing the challenges and opportunities of 2009 and the years ahead at our meeting on March 10th in New York City.

That concludes our prepared remarks. We'll now take your questions. So that everyone has an opportunity to participate, please try to limit your follow up questions to one or two. So, operator, please open the lines for questions.

Question-and-Answer Session

Operator

Thank you. (Operator instructions). And our first question comes from Mark Flatery from Credit Swiss. Your question please.

Mark Flathery -Credit Swiss

Thank you. My question is on the reserve replacement and I know you have only preliminary numbers and you'll give more details in March but can you give us an early feel for how much the net pricing impact was on these India reserve replacement and whether it was net positive, net negative roughly how big?

Dave O'Reilly

Well Mark, thank you. We've had a great success with our reserves replacement this year in a number of areas. Some of the projects that we started up where we had conservatively booked reserves, we were able to rebuy numbers because we now demonstrated through production more confidence in the reservoirs.

We've also had some additions from contract extensions such as the PNZ and those will be disclosed in somewhat more detail when we get to our March meeting.

We did benefit, obviously, from price and my recollection is that we're in the 80 – the organic replacement for one year was above 80% or around 80%. The balance comes from price. So we've gained back in price some of what we lost – a lot of what we lost over the last few years as the numbers went in the other direction, as price went upwards and reduced those reserves.

So now that I look over the last ten years it's very gratifying to see that we are at greater than 100% reserve replacement over that long spread of time. So I feel good about where we are and we'll be covering that in more detail obviously in March.

And you'll see a lot more disclosure in the 10-K as well. So thank you for the question.

Unidentified Analyst

Great, thank you.

Operator

Our next question is from Robert Kessler from Simmons and Company, your questions please.

Robert Kessler – Simmons & Company International

Good morning and Pat welcome to your new role. My question relates to your production guidance for 2009. Looking at the new implied base business decline rate of 7% and comparing that to your recent experience of 3 to 4% I recognize you said there was a gap associated with lower spending.

And if I look at your CapEx plan it looks like excluding the one time payments it would have been down about $2.8 billion. Is that the order of magnitude spending that you estimate would be required to flatten our mitigate that decline rate down to the 4% figure you typically experience?

And why given, I would assume you would expect resilence in your portfolio down to $50 a barrel at least, why would you not go ahead and spend that amount in a deflationary oil field service environment?

Dave O'Reilly

Okay a lot of questions there but let me – generally your observations are on the right track. But let me give you a reason why I think the primary reason why and maybe even an example of why we think it's unwise to chase after barrels in this environment.

We have – we're clearly pursuing our long term strategic projects that require continued investment over the long term and I cited a number of examples of those. But let me talk about a very specific example of where we have consciously slowed down and that's in the Peonce (ph).

And there are two reasons for it, one is Colorado has instituted some pretty onerous environmental regulations that have made it a lot more difficult to get permits in a timely manner. So we’ve reduced – we were planning – we were in the process of reducing our plans just from an environmental permitting stand point.

Also the pricing outlook is looking a little tenuous in that area so we've slowed it down. In the meantime we expect – we do expect costs to come down in the good and services and supplies and oil field services area.

And as those costs come down we'll obviously have a chance to re-evaluate our portfolio and make decisions to add more investment if we think it's appropriate. But in this environment we think we're doing the right thing to back off the particularly the opportunities that we can come back to later because they're in this case on fee land.

And we're conscious here of the capital discipline that we need to exercise in order to make the right value decision. So there are a number of those decisions that we've taken. We think they're the right thing to do in this market and we expect as prices -- as costs come down that we'll be – and permitting requirements are met that we'll be able to reevaluate our position in the future.

But I think in current circumstances this is the right thing to do.

Robert Kessler – Simmons and Company International

Thank you for the color.

Dave O'Reilly

Thank you.

Operator

Our next question is from Erik Mielke from Merrill Lynch. Your question please.

Erik Mielke – Merrill Lynch

Yes, good morning. I'd also like to congratulate Pat on her new role and welcome to the quarterly conference circus. I'd like to ask a question on the production outlook, as well.

Given the experience you've had in 2008 are you being more conservative in your guidance in 2009? Particularly with respect to the ramp up from the major capital projects out on execution? And is there anything on the external factors that you can help us understand that number at least a little bit better? Is that 60,000 barrels per day based on the current run rate or is that project for the contract by opaque?

Dave O'Reilly

Well I think we are taking, I think, a realistic view as best we can of what is happening in the market place with Opaque and some market impacts. We show an 80,000 barrels per day negative on what we call external factors, and basically that’s roughly what we see. About half of that’s market effects. Half of it is OPEC, but the OPEC impact’s primarily in Venezuela and some in Angola and a little bit in Nigeria. The balance is market effects in gas in Asia.

We saw a deterioration in gas demand in Thailand, for example, late in the year. And we just think that it’s not wise for us to count on those markets bouncing back very quickly. They’re still good for the long-term, but in the near-term in ’09, I think what we’ve done is give you the most realistic assessment that we can of what we call external factors. It’s very hard to predict this with accuracy. But that’s our best shot at it as we see it today.

Erik Mielke – Merrill Lynch

Okay, thanks. Can I ask a follow-up on foreign exchange? There was quite a bit of noise in the quarter from foreign exchange. Are there any handy rules of thumb that you can give us that we can use to try predict some of the overall exposure for group?

Jim Aleveras

Erik, I’m afraid that’s a very, very difficult challenge for us. Obviously, different factors come into play depending on the timing on our acquisition of goods and services, depending on the net monetary asset and liability positions in different parts of the company. In general, what we saw overall, the benefit in the fourth quarter was the strengthening dollar.

But obviously it hit different segments in different ways. I wish I could provide better guidance in that, but again, because of the mix of components that goes into that, both what we buy, what we sell, as well as the assets and liabilities in our different international businesses, it’s very, very difficult to give anything other than guidance that suggests that strengthening or weakening dollar would help or hurt our clients exchange rates.

Erik Mielke – Merrill Lynch

Okay, and finally, was there any significant over or under-lift in international upstream in the fourth quarter?

Jim Aleveras

In the fourth quarter we had a under-lift relative to our production of about %. For the year as a whole, we were essentially in balance.

Erik Mielke – Merrill Lynch

Thanks very much.

Dave O’Reilly

You’re welcome.

Operator

Your next question’s from Michael LaMotte with JPMorgan. Your question please.

Michael LaMotte – JPMorgan

Thank you. Good morning. The question I have is for Dave. The ministry of petroleum in Iraq seems pretty committed to moving forward with MSEs and awards in June of ’09. I was wondering if you could give us your thoughts on what that might mean for Chevron this year.

Dave O’Reilly

Well, I have just been in the Middle East this month, and there is certainly motivation on their part to move to some agreements, I think, in this year. So there’s been a pick-up in the pace. It’s very hard to predict. Despite the good intentions by the government there to move prospects forward, there are limitations in the capacity of the ministries that just handle the volume of activity.

So this could be a year in which some opportunities will get firmed up, but I don’t know how to predict it really. I would hate to go on record and say yes something will happen this year, but we’re clearly interested as many others are. We’re clearly interested as many others are and we’re clearly buying the appropriate packages and ready to move forward and make the appropriate proposals as the opportunities arise.

Michael LaMotte – JPMorgan

Thank you for that. I understand that it is difficult to predict, but just the fact that you are staying close to it is (inaudible).

Dave O’Reilly

We are staying close to it. I can assure you of that.

Michael LaMotte – JPMorgan

Very good, thank you.

Operator

Your next question’s from Neil McMahon with Sanford Bernstein. Your question please.

Neil McMahon – Sanford Bernstein

Hi, just a few of them (inaudible) just a question on projects. Could you give us any update on Jack and St. Malo and the current challenging times? I’m just wondering if you’re doing the sensible thing and renegotiating any potential engineering contracts that you’ve awarded on those projects in terms of feed and rig contracts and also an update on where you are with the Reliance Petroleum option for John Negara (ph)?

Dave O’Reilly

Let me start with the Jack and St. Malo and the lower tertiary in the deep water Gulf of Mexico. This is a very, very important trend and one that we’re really focused on. We had a lot of success in the leasing rounds that just happened this year in the Gulf of Mexico and we have a fine portfolio of prospects in that trend.

We are continuing to move forward with Jack and St. Malo and we’re just now at the very early end of the front end engineering works, so this is an ideal time, we think, to be moving into the market as the cost of goods and services are coming down.

This is a great opportunity for us and we’ll certainly talk more about it in-depth at the March analyst meeting, but let me assure you, this is one of our top priorities for the long-term and one that’s getting a lot of our attention and we think it’s a good time for us to be starting to move into the market on these opportunities.

On Reliance, we are discussing with Reliance the opportunity there at the John Negara Refinery. These are sensitive commercial discussion and I’d prefer not to comment on the at the present time. But this is a year which the situation there will clearly become clarified as we’ve been predicting for some time.

Neil McMahon – Sanford Bernstein

Just a quick follow-up on Jack and St. Malo, too, given the fact that you’re entering this, it seems, in a very logical, sensible manner, are we to presume then middle of the decade before we see any significant production coming on from any of those lower tertiary developments?

Neil McMahon – Sanford Bernstein

Well, it will be in the next decade since we’re almost there. I would hope that we would have production before the middle of the decade at this point. This year, though, will be clearly one with a lot of engineering work and I think we’ve come very close to selecting the optimum conceptual development plan. So I would hope that by the middle of the decade we would have good production there, but I think we’ll try to predict that a little better for you in March when we see you all.

Neil McMahon – Sanford Bernstein

Thanks.

Operator

Your next question is from Arjun Murti with Goldman Sachs. Your question please.

Arjun Murti – Goldman Sachs

Thank you. Perhaps it’s a little bit of a follow-up on the question on the base declines and the decision to spend less there, and I appreciate part of it’s the environmental regs, but also service costs are still high and oil prices have come down.

You still have, otherwise, a very robust capital program and it seems like costs have been inflated in industry across the board. Perhaps some of those major development projects you can’t stop at this point because you’re already in the middle of them, but if there’s perhaps cost concerns in going through with the base business, wouldn’t that also be true of the growth projects that you’re not really slowing those down? I’m just trying to reconcile those two things.

Dave O’Reilly

Well, thank Arjun, let me comment on that. We sanctioned very few projects in 2007 and 2008. Many of the projects that came on stream in 2008 and are coming on in 2009 were sanctioned and most of the expenditures and commitments to spend were made in the 2003, 4, 5 period. So while yes, there has clearly been some cost escalation, none of these projects were launched and made major commitments to at the peak of cost.

So we are in fact, I think, in a very good position because the next projects that we sanctioned in our queue will be going out for repress for proposal in ’09 and in 2010. And this, we think is a good window for that because costs are clearly softening.

There’s a little bit of a lag, but on the other hand we’ve seen costs come down quite a bit faster than they have in the past, which tells you that we could be hitting a sweet spot here for some of these projects. It’s hard to predict, but clearly that’s going to be part of our thinking, and we believe that these major projects that are good for our long-term will be cost-competitive in this environment.

Now, obviously if we are wrong about that, we have the flexibility to go back to investing more into the base business if those costs justify. But we think we’re making the right, balanced decision here. And given the slack in the market, I think it's good timing.

Arjun Murti – Goldman Sachs

Dave, that’s actually really helpful comment and I really appreciate that. Are you confident that you’ll be able to sanction these and that the negations and in this very uncertain environment can get done to then be able to sanction them and move forward or is the ’09 budget perhaps a higher than likely level of spending and as you get through these negotiations and sanction the products, it’s more the ’10 and ’11 CapEx that will be more robust? If it is still a very high level of CapEx, I don’t have an issue with it. I hear you, but we are still spending a decent amount in ’09.

Dave O’Reilly

Well, yes, look, clearly if we can’t justify and don’t feel comfortable with the costs relative to the outlook for the business, we would wait; I think is the best way of putting it. We have some flexibility on some of these major projects, but I think the reality that we see in the market place right now is we think this is a good time to be going back in the market.

So if we’re wrong, well then obviously these numbers are too high and we’ll back off. But I think we’re seeing signs that this market is changing more rapidly than it has in the past. I think the suppliers of goods and services to our industry realize that they’re in a different environment as well. The ones that are in it for the long-term clearly want our business and they’ll be modifying their pricing appropriately, so I think some of that’s going to occur.

Arjun Murti – Goldman Sachs

Thank you very much. I appreciate it.

Dave O’Reilly

You’re welcome Arjun.

Operator

Your next question is from Paul Cheng from Barclays Capital. Your question please.

Paul Cheng Barclays Capital

Thank you. Good morning, guys. When you’re talking about the cost reduction that you’re expecting, how has is that so far with your negotiation with your wind men ? Are they receptive and recognize that that change is coming down? And how quickly do you think that the lower cost may start to flow through and to benefit you guys and from that aspect when you’re talking about lower treasury, I’m wondering if you can talk about the (inaudible) George was thinking about extending it potentially in the second half of 2009 and if the market conditions may have changed that expectation at this point.

Dave O’Reilly

I think I’ve commented on the lower tertiary already, but let me just talk about Australia and Gorgon for a moment. We are on track to sanctioning that project late in the year. Again, we think this is good timing. We are currently in the market with our FPs. The Australian dollar has weakened significantly. There’s a lot of capacity now in the labor force in Australia as many of the resource industries have deferred activity in mining and other activities.

So there’s a lot of interest in this project and I think this is a good time for us to be out in the market beginning to assess and call for prices for equipment and for services and construction. So how it will turn out will remain to be seen, but we’re bullish on Gorgon and believe that’s one that we hope we’ll be able to tie up and create something long-term for the company sometime late in the year.

Paul Cheng Barclays Capital

Can I have a follow-up Dave? In the last three years, rightfully, after your Unicom acquisition, the company has been focusing on organic projects and not really looked that much on the M&A markets. I’m wondering if the wheel had changed now the market condition had changed (inaudible) and sometimes people will say that you want to be a cognizant buyer. Nothing specific, I just wanted to see what is the management’s view about that subject?

Dave O’Reilly

Well, two answers to that question. First of all, we clearly have a great organic queue of projects here that we’re continuing to pursue and invest in and we believe that, certainly compared to our size, we are among the best in the industry in that area. And then we’re fueling that in the background with continued success in our explorations program.

Look we’re not blind to what’s going on in the world around us, and we make assessments of the opportunities. But those are hard to predict and I prefer not to comment on them, but clearly we’re not blind to looking for other opportunities as well. But our priority in 2009, I think, is going to be on advancing these projects and bringing them to market as well as starting up the ones that are in the commissioning phase that Jim referred to in his remarks a few minutes ago.

Paul Cheng Barclays Capital

Thank you.

Dave O’Reilly

Thank you.

Operator

Your next question is from Jason Gammel from Macquarie. Your question please.

Jason Gammel – Macquarie Research Equities

Thank you. I’d like to add my congratulations to Pat on your new role.

Dave, you’ve had a lot of specific questions today relative to some of the projects you have captured, and I think you just marked your ninth anniversary as CEO, so let me just ask a little broader question. How would you assess the state of your investment opportunities now relative to where it’s been over the course of your tenure?

Dave O’ Reilly

Well, thanks Jason. I think the depth and quality of our queue of opportunities is stronger than any time it’s been in that nine years. And I say that not just based on the projects we’ve been talking about very specifically and that we’ve had a number of questions on this morning, but also the success we’re continuing to have with our exploration program that tells me that that’s going to lead to future developments in the next decade that will be value creating for the company for the long-term.

So I see us in a very, very strong position and I feel very good about the opportunities that we have in the years ahead.

Jason Gammel – Macquarie Research Equities

That’s appreciated. Maybe as a follow-up I could ask another open-ended one. What do you see as the two or three biggest challenges facing the company over the next two to three years?

Dave O’Reilly

Well, clearly managing through this uncertain period, which is something we’ve done before a number of times as a company and as an industry. We are clearly in a more challenging environment with lower demand. I think we have to go back to the early 80s to see two years of back-to-back oil demand decline. So we had a modest decline globally last year.

It’s projected that there’ll be another one this year. So managing out costs and staying focused on the long-term is clearly our objective here. And clearly we’re in a good position to do it because of our strong balance sheet and because we delivered during the good times so that we have that flexibility during the tougher times.

The second item I think is the whole issue of carbon management over the next five years or so as the world tries to struggle with how to value carbon and how that affects the business. So I see those as two challenges over the next couple of years, one we’ve been through before a number of times and we’re used to it—the cyclical activity.

But I think we’re moving into an area where we’ll be dealing with this new issue. And I don’t mean new in the European sense where we’re already managing it quite well, but I mean in a global sense as more and more countries sign up for carbon management and the impacts on business will clearly be there. And the people who manage successfully will do better than those that don’t.

Jason Gammel – Macquarie Research Equities

I appreciate that context. Thanks Dave.

Dave O’Reilly

You’re welcome. Thank you, Jason.

Operator

Your next question is from Paul Sankey from Deutsche Bank. Your question please.

Paul Sankey – Deutsche Bank

Hello everyone. I would just like to carry on a little bit on the CapEx question if I could, sort of related to what Arjun was asking. I understood that you had quite a significant ForEx benefit from a stronger dollar, perhaps as much as a 10 to 20% implied benefit given that a lot of your spending obviously is abroad, which again would have led me to think your CapEx number would come down. You’ve also, as we’ve covered, said you stepped back in the US spending. Could you just help me rationalize that particular part of the balance? Thanks.

Dave O’Reilly

I don’t think we saw a significant benefit CapEx on the strengthening dollar in ’08. A lot of that dollar strengthening occurred very, very late in the year. And so basically the ’08 numbers certainly reflect an average year. As Jim said, it’s very hard to predict this. We’re in uncharted waters. The dollar has been a safe haven at the moment and some other currencies have declined, but clearly some of these numbers could change if there were more dramatic changes in relative valuations of currencies, but I just don’t think I feel comfortable about trying to predict that 2009. But I do feel comfortable telling you that 2008 did not see significant benefit.

Paul Sankey – Deutsche Bank

David, I was really thinking about 2009 relative to 2008 and all things equal with the move that we had in foreign currencies, we would have thought your CapEx would step down, especially when you then add on a somewhat lower level of spending in the US.

Dave O’Reilly

Well, there’s perhaps a little bit of a step down in a few areas, but remember that when you look at the budget here, about 10% of that budget is for one time payments for concession extension. So the budget has come down by about 10%. And part of that is built into that 10%, our current assessment of that. But it’s a prediction and nobody really, truly knows how the relative exchange rates are going to turn out. It’s a fool’s game to try to over guess it.

Paul Sankey – Deutsche Bank

Great, thanks. And then just briefly on the buy back, I believe you said that you would not be buying back shares in Q1. Could you talk a little bit about that decision relative to obviously what we’ve said about CapEx and what we’ve said perhaps about M&A as well? Thanks.

Dave O’Reilly

I’m going to turn it over to Pat to talk about our financial priorities. She’s been sitting here patiently and you’ve all been congratulating her, but she needs to chime in here on this subject as the keeper of the balance sheet. So pat?

Pat Yarrington

Okay, well thanks Dave. I was feeling like I was turning into a potted plant here for a moment. But thanks for the question.

Our financial priorities really are from a cash standpoint sustaining and growing the dividend, then funding the capital program that we have where we’ve got projects that bring good returns over a viable vast range of commodity prices, and then maintaining our financial strength and flexibility.

So we’ve always seen the share repurchase program as sort of the discretionary part of that. And we’re just indicating certainly for the first quarter of 2009 that we’re not going to have a continuation of that repurchase program.

Paul Sankey – Deutsche Bank

I guess you’d expect debt to rise even so in Q1.

Pat Yarrington

I think that that’s a reasonable expectation. As Dave said, we de-levered when the times were right giving us that flexibility now. When revenue stream has come down and our cost structure obviously is adjusting but perhaps not quite as rapidly, so I think you could expect to see a modest increase in the debt balance in the first quarter. We’re very well positioned though to, even at low, sustained prices, have a very strong balance sheet.

Paul Sankey – Deutsche Bank

Okay, Pat I didn’t congratulate you, so I will. Congratulations.

Pat Yarrington

Well, thank you.

Dave O’Reilly

Thanks for the questions Paul.

Operator

Your next question is from Mike Mathis from Merrill Lynch. Your question please.

Dave O’Reilly

Hello Mike?

Mike Mathis – Merrill Lynch

I’m sorry, it’s been answered. Thank you.

Dave O’Reilly

Okay, you’re welcome.

Operator

Your next question is from Mark Gilman from Benchmark. Your question please.

Mark Gilman – Benchmark

Folks, good morning. I have a couple of things if I could please. Was there any change in the fiscal terms that was agreed upon associated with the extension of the concession of the MZ, Dave? .

Dave O’Reilly

No, the fundamental terms are the same Mark. Okay, and the production outlook for 2009 and the price effect therein, are there any thresholds that are included in that under the $50 a barrel assumption?

Dave O’ Reilly

Well, the $50 a barrel we picked from the stripped price. We did hit some thresholds when the prices were high back in—you’re talking about production sharing thresholds?

Mark Gilman – Benchmark

Yes, cumulative capital costs recovery or rate of return or cumulative production, any of the things that went into Jim’s comments regarding the change in the sensitivity.

Dave O’Reilly

Yes, Jim, why don’t you deal with that one for me?

Jim Aleveras

Mark, the changes that we saw in 2008—and we did hit some thresholds in 2008—were why we had a higher volume impact per dollar per barrel of change in price in crude. Looking ahead to 2009, since we’ve already crossed those thresholds, we feel lower volume impact per dollar change in crude prices.

Mark Gilman – Benchmark

Yes, Jim, but what I’m asking is, are any threshold impacts built into the 60,000 a day price effect as part of your 2009 forecast?

Jim Aleveras

Not many, most of them are behind us, which is why the number has come down.

Mark Gilman – Benchmark

Okay, Dave can I infer from Jack St. Malo comments that the appraisal wells had been or have been drilling were successful?

Dave O’Reilly

Well, I think we’re going to report on the appraisal in March, but I think you can infer that we’re on the right track and we’ll give you a lot more detail in March.

Mark Gilman – Benchmark

Okay, just one final clarification Dave, regarding the 80% organic reserve replacement in ’08, does that include the reserves associated with the concession extension at the NZ?

Dave O’Reilly

Yes. And you’ll see more detail in the K.

Mark Gilman – Benchmark

Thank you.

Dave O’Reilly

You’re welcome.

Operator

Our next question is from Erik Mielke from Merrill Lynch. Your question.

Erik Mielke – Merrill Lynch

I’m sorry fellows for another question, I just thought I’d ask for an update on (inaudible) and you’ve been running through the other key projects. In your CapEx statement, you said you had an initial payment but the bonus payment also has some initial development. If you could, give us some guidance on where you expect to take that in 2009.

Dave O’Reilly

Well, yes, thanks Erik. We are progressing with the construction work in (inaudible). So it’s actively moving forward and the appropriate capital is included in our program. You view that as another long-term project that will benefit the company for many decades to come. So yes, that one is on track compared to what we told you last year. And again, we’ll be updating you in the March meeting, but thank you for the question.

Erik Mielke – Merrill Lynch

Was it part of your reserve bookings for ’08?

Dave O’Reilly

You’ll see the details in the K. I can’t answer that right now.

Erik Mielke – Merrill Lynch

Thank you.

Operator

Our final question is from Mark Gilman from Benchmark. Your question please.

Mark Gilman – Benchmark

Guys, the exploration/spend component, the 2009 capital budget versus 2008, give me an idea of what it is.

Jim Aleveras

It’s about flat between 2009 and 2008.

Mark Gilman – Benchmark

Level, Jim?

Jim Aleveras

Pretty much so, yes Mark.

Dave O’Reilly

A little bit more appraisal in balance between appraisals versus pure exploration, but we’re going to go through a very detailed review of our exploration program and our plans for ’09 very specifically in the analyst meeting.

Mark Gilman – Benchmark

Okay, thanks folks.

Dave O’Reilly

You’re very welcome. I think it’s time to wind it up Matt unless there are other questions.

Operator

At this time I show no further questions.

Dave O’Reilly

Well, thank you very much for listening. We appreciate everyone’s participation in the call. I want to thank you for your questions this morning and look forward to seeing many of you in March in New York. So, Matt, thank you.

Operator

Ladies and gentlemen, this concludes Chevron’s fourth quarter 2008 earnings conference call. Thank you for your participation. (Operator Instructions) Good day.

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