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Noble Energy, Inc. (NBL)

Q1 2009 Earnings Call Transcript

April 30, 2009 10:00 am ET

Executives

David Larson – VP, IR

Chuck Davidson – Chairman, President and CEO

Chris Tong – SVP and CFO

Dave Stover – EVP and COO

Analysts

David Kistler – Simmons & Company

Brian Singer – Goldman Sachs

Michael Jacobs – Tudor Pickering Holt & Co.

Irene Haas – Canaccord Adams

Bill Young – Citi

Joe Allman – JP Morgan

Operator

Good morning and welcome to Noble Energy’s first quarter 2009 Earnings Call. As a reminder, this call is being recorded. I would now like to turn the call over to your host, Mr. David Larson, Vice President of Investor Relations. Please go ahead, sir.

David Larson

Thanks, Margie [ph]. Good morning, everyone. Welcome to Noble Energy's first quarter 2009 earnings conference call and web cast, and thanks for joining us today. I'd like to start out with a few introductions. On the call with me today is Chuck Davidson, Chairman and CEO; Dave Stover, President and COO; and Chris Tong, CFO.

The agenda for the call today includes some opening comments from Chuck. Chris will then provide a little more detail on the items affecting the results for the quarter. Finally, Dave will finish up with a discussion of our operating highlights for the quarter and the program for the remainder of the year.

We will leave time for Q&A and try to wrap up the call in about an hour. Should you have any questions that we don’t get to in this morning's call, I’d encourage you to call Brad Whitmarsh or myself and we will do the best we can to answer your questions.

We hope everyone has seen our earnings release that we issued this morning. 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.

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

We will reference certain non-GAAP financial measures as adjusted net income or discretionary cash flow on the call today. When we refer to these items, it is because we believe they are good metrics to use in evaluating the company’s performance. Be sure to see the reconciliations in our earnings release.

With that, let me turn the call over to Chuck.

Chuck Davidson

Thanks, David, and good morning everyone. I have to say to begin with the start of the 2009 certainly has provided plenty of challenges to our industry as we grapple with the struggling economy. Low commodity prices, which extended into 2009 made their impact felt in the first quarter.

Fortunately, Noble Energy has hedges in place and a diversified product and market mix that mitigated some of the effects of price volatility, and certainly helped to stabilize our cash flows. Even with that, Noble Energy saw its earnings and cash flow decline from last quarter as well as compared with the first quarter of 2008.

The decline in natural gas prices was significant enough to cause us to take a sizeable impairment on our Granite Wash property in the Mid-Continent area in the quarter. As you know, we reduced investments in that play, beginning a couple of years ago because even at that time the returns look marginal. But we still ended up with a substantial amount of capital on the books. We looked at this property carefully at the end of 2008, but it passed the impairment tests at that time.

Unfortunately, with the continued decline in natural gas prices since the end of 2008, we had taken an impairment this quarter. And Chris will be providing a bit more detail on the impairments later.

We do continue to believe we have made the right moves over the last several years to prepare Noble Energy for today's environment. With the investment discipline we have talked about in the past, with balance sheet management, and portfolio diversification. And these measures are greatly helping us today. However, we remain concerned about the extent and depth of the downturn. As a result, we will remain focused on the things we can control such as cost and capital allocation.

Our initial capital program was set at $1.6 billion plus or minus 10% to 15% based on how the year progressed. Certainly today our program is tilting towards the lower-end of that range or about $1.4 billion as we are continuing to constrain investments, particularly in US gas developments. We continue to allocate 2009 capital only to the best projects of being especially sensitive to the soft US natural gas markets that cannot handle significant incremental supply.

In the end, it is a whole lot less painful to stop drilling versus keep spending and have to shut due to a loss of markets. As a result, we are shifting capital into areas such as exploration, and longer dated growth projects. An example of this would be we're based on our exploration success at Tamar in Israel, we and our partners immediately committed to 2 additional wells in the region as well as a very substantial 3D seismic program. These incremental investments were sourced by funds we originally were intending for near-term US onshore projects.

Regarding the US natural gas projects, we are remaining very patient in this environment, building our inventory for future projects. We will wait for the market signals that encourage to increase our activity level, but our expectations are that we may not see a real recovery there until sometime in 2010.

Given the environment we find ourselves in, our first quarter results were good, but I would say it is certainly tough to look at the financial statements, and make the comparisons versus last year. However, comparisons to our internal forecasts look much better as operations are generally performing well within our expectations.

We do have some challenges on the production side, but many of those things are out of our control, and Dave will provide more details later. We do believe the outlook is much better for later in the year, but in the deepwater Gulf of Mexico, we have continued to see downtime impacts from last year's hurricanes.

And in Israel, milder weather conditions impacted our volumes and the overall economic slowdown has had a negative impact on power demand, which in turn affects our natural gas sales. The lower sales in Israel hit us twice, once in volume and also in price, since excess gas sales volumes of which there was almost none in the first quarter in Israel carry a premium price.

Our initial expectation was that Israel would have converted their Hagit power plant to natural gas by now, but a labor dispute in the country is slowing that process down, and that labor dispute has also delayed repairs at one of the existing natural gas fired plants. The good news is there is plenty of gas demand building up in Israel, although predicting the timing this year is turning out to be a bit of a challenge.

Here in the US, our onshore volumes appear to be coming in as expected even with our lower activity levels. Everyone at Noble Energy is aware that execution is extremely important in these situations. In fact, a number of our internal corporate goals for 2009 directly address it, and you'll hear more about our focus on execution in Dave’s section later.

Stepping back from the near-term look of things, truly our future could not be brighter. I'm very excited about where our business is headed, as we continue to move forward with some very important projects that will provide growth for our company for many, many years in the future.

In the quarter, we made significant exploration discoveries in three of our four key basins. In Israel, we are now two for two at Tamar and Dalit with total discovered gross mean resources between the two of 5.5 trillion cubic feet of gas, and we are continuing to gain confidence in our geologic model and seismic interpretations in this underexplored basin.

We are truly excited to be leading the efforts in opening up a new area, which certainly has the potential to become a huge natural gas resource for the country, and perhaps even beyond. In West Africa, we extended our string of successful wells to 11 out of 12 drilled with the carbon discovery, another oil discovery building on the potential that may exist on deeper horizons on blocks O and I in Equatorial Guinea.

And in the deepwater Gulf of Mexico, we had a discovery at Santa Cruz, which complements our Isabella discovery very nicely. Add to that, our success at the recent offshore lease sale, we are very pleased with our deepwater Gulf of Mexico positioning and portfolio there.

To wrap up, 2009 continues to be a challenging year. We feel strong about our current position and what we are doing to build Noble Energy for the future. Before I hand it over to Chris and Dave, I just wanted to highlight the announcement we made yesterday regarding Dave's election to the position of President as well as Chief Operating Officer. This change could not come at a better time as our exploration successes delivered a massive project growth that really requires oversight by someone at the President level, and Dave is more than ready to take that on.

And no, I'm not headed to the golf cart. For any of the unlucky ones out there that have played golf with me, no, that is not a paying job for me. It is going to be a full-time effort by all of us here on the executive team and our organization to get all these projects from process to the finish line.

So with that I will turn it over to Chris.

Chris Tong

Thank you, Chuck, and good morning, everyone. I like to spend a few minutes talking about our financial results and accomplishments during the quarter, before wrapping up with some comments on a few guidance items that have been adjusted.

Hopefully, you have had a chance to read through the earnings release and the accompanying tables we issued this morning. It is our plan to focus on some of the items that I believe are more noteworthy.

Start with the earnings release, adjusted net income for the quarter was $103 million or $0.59 per share diluted on revenues of just over $440 million. There were two items that impacted earnings for the quarter that are not typically included in analyst estimates. First these items were certain property impairments.

Because of the significant decline in the natural gas [ph] prices since the beginning of the year, we felt it was appropriate to look and see if any of our heavy natural gas weighted properties might be impaired, and Granite Wash was according to our analysis. Remaining impairment related to our last significant shelf property at Main Pass, which we are proceeding to plug and abandon.

The other item that impacts earnings every quarter is our unrealized mark-to-market gains and losses in our commodity derivative contracts. In the first quarter, we had an unrealized loss of $45 million after-tax. As we look at our first quarter results compared to the same period last year, significantly lower commodity prices was the largest single factor that impacted both adjusted earnings and discretionary cash as well.

TCF was also impacted by the reversal of an allowance for doubtful accounts that I will discuss a little later. The majority of the cash we received associated with this allowance reversal was received in the second quarter. We provided some explanation of volumes and cost variances in the earnings release. Instead of spending time walking through each of these comparisons, I thought it would be more beneficial to discuss the major variances between our performance and our expectations to date.

Sales volumes for the quarter were 210,000 barrels of oil equivalent per day, 3000 barrels a day lower than our production due to underliftings in certain of our properties. In Israel, natural gas sales were impacted from downtime associated with the combined cycle gas turbine at the (inaudible) plant, coupled with milder than expected weather conditions. And in the North Sea, all production in the original Dumbarton Wells was slightly lower than expected due to facilitate handling restrictions.

An item which came in below our guidance was income from equity method investments, where we saw the effects of lower methanol and LPG prices. Due to their lower income, no cash distributions were made during the first quarter. Cash costs including LOE, production taxes, transportation and G&A were $10 per barrel, and DD&A averaged $10.60 per barrel both solidly within our expectations.

While the real positives for the quarter was our drilling success, which helped first-quarter exploration expense to come in lower than expected. I also want to point out that based upon our first quarter adjusted income; we had an effective tax rate of 29% with 56% deferred.

Both of these items varied from our annual guidance, but it is early in the year there are multiple moving pieces impacting the rates. We still at this time expect full-year tax rates to be consistent with our guidance.

We had a very nice development in Ecuador during the quarter. We stated in our 2008 Form 10-K that we had reached a settlement agreement with Ecuador for past due receivables from certain power purchases, and that if we collected the funds we would apply it against our allowance for doubtful funds, which we have been building over the last few years.

We received payments in March of this year, and we reduced the allowance for doubtful accounts by $46 million in the first quarter. Because these allowances were reported in operating expense, the collections were reflected in our financial statements as a reduction to other operating expense. This was somewhat offset by various other expenses incurred in the quarter, including a lower cost to market expense on pipe inventory, and deferred compensation expense associated with our rabbi trust.

I also want to update you on our commodity hedging activities. Since our last call, we have layered in some additional hedges, both on the crude oil and natural gas side, primarily utilizing collars intended to reduce cash flow risk. Our Form 10-Q that we intend to file shortly will have the full detail of our hedges. So please make sure you look at those for current information.

Looking now at the balance sheet, our cash was just over $1 billion as we ended the period. During the first quarter, we decided to repatriate $180 million of our international cash that we identified, could be brought back with very minor incremental taxes. So we went ahead and took the opportunity to do so.

We did not have immediate needs to use this cash internationally. So we brought the money back for corporate purposes and working capital needs. Total debt at the end of the quarter was $2.4 billion, and our debt to cap was 28%. Once you factor in the cash balance, our debt to cap net of cash was only 18%.

At the end of the quarter, we had about $1.4 billion in remaining committed availability under our revolving credit facility, which has a current maturity date of December 2012. We have been watching debt markets pretty closely, and saw the opportunity to further enhance our financial flexibility by terming out several of our existing bank debts.

As we looked at our debt portfolio with a focus on our long-term growth projects and the development of significant resources we had discovered, it made sense for us to go ahead and lock in some longer-term financing. We used the proceeds from our $1 billion ten-year senior unsecured note offering to pay down the revolver.

So if you combine the amounts available on our credit line with our current cash balance, we have about $2.4 billion of liquidity.

Given the state of the credit markets over the last six months, we were certainly glad to be investment-grade. On the day of our bond offering, we are very pleased to see that S&P upgraded us to BBB stable. We have been talking with the rating agencies for some time, and we believe that upgrade is in recognition of our strong balance sheet and capital discipline.

Now, let us talk about our updated guidance matters. Chuck previously mentioned to you our capital program was moving towards $1.24 billion for the year on the lower end of the original range. While the capital reduction will slightly impact ’09 volumes, we are not changing our full-year guidance range at this point, other than to say our best estimates have us towards the lower portion of the annual range of 212,000 to 220,000 barrels equivalent per day.

Second quarter ‘09 production is now expected to range from 204,000 to 212,000 BOE per day. And we still expect to see a stronger half for the year. We are comfortable with the majority of our cost guidance at this point. A couple of guidance updates I mentioned, exploration expense has been lowered primarily as a result of our successful exploration drilling, interest expenses been increased due to the company's bond issuance. And we have lowered our equity method investment margin with the reductions coming primarily from lower commodity prices.

So for those of you with financial models, you want be sure to take a look at the details from our earnings release to incorporate these changes. That concludes the financial review, and now I will turn the call over to Dave.

Dave Stover

Thanks Chris and good morning everyone. As Chris commented, our sales volumes for the first quarter were 210,000 barrels of oil equivalent per day, but our production volume was 213,000 barrels of oil equivalent per day. Based on our lifting schedules, I anticipate we will make up the difference in the second half of the year.

I like to start off with comments on our US onshore business. This is an area where we are adjusting our activity levels based on commodity prices and focusing most of our drilling activity on projects with a nice contribution of liquid production. At the same time, we are closely managing our costs and working with our service providers, continuing bringing them down to a level more consistent with the current commodity markets.

We think we will see more benefit from these cost decreases as we go forward through the year. Our programs over the last year in our northern region increased this area’s volumes by 4700 barrels of oil equivalent per day, over 6% from the first quarter of 2008. Production from our largest onshore asset, Wattenberg, was up 3% from the first quarter of 2008, despite the impact of a third-party processing plant fire, which reduced our volumes nearly 1000 barrels equivalent per day in this quarter.

We are gradually reducing rig count in this field from 6 to 4 rigs as we enter crop season, but we expect we will be back to 6 rigs by the fourth quarter. Our first horizontal Niobrara well was recently completed, and we now have alliance [ph] formation wells also online. Results from these new projects are encouraging with combined steady production of 460 barrels oil equivalent per day.

Overall in Wattenberg, we saw record production in the last week at over 280 million cubic feet equivalent a day. Outside of Wattenberg, we are currently operating four rigs in the onshore US, and we continue to test the few new concept ideas that allow us to further position ourselves for future opportunity. We anticipate bringing in a rig to start our operations at East Texas Haynesville program in June.

Moving offshore, late last year we were very close to selling our last significant shelf property, the Main Pass, but the acquirer ran into problems obtaining funding to post a bond and cover insurance. As a reminder, we had retained these properties to complete the salvage and the abandonment of the four platforms toppled by the hurricanes of 2004 and 2005.

Given the current pricing environment, exposure to further wind storm damage, and the increasing cost of insurance, we have decided to move forward with the plugging an abandoning the remaining three platforms.

In the deepwater Gulf of Mexico, production from the first quarter was about 21,000 barrels of oil equivalent per day despite the continued impact of last year's hurricanes. Ticonderoga remained off-line for the entire first quarter. We don't expect the field will return to full production until late in the second quarter. When the downstream gas line is repaired and the field comes back online, we should see a net impact of around 55 barrels of oil equivalent per day.

It was certainly an outstanding quarter for us on the exploration front. We had great results from the central Gulf of Mexico lease sale, where we a high bidder on 24 blocks, which will add over 119,000 net acres to our current leasehold position. The blocks if awarded, include our top three targets in the sale, and will add over 27,000 million barrels of oil equivalent to our unrisk net resources potential.

Our focus continued on targeting (inaudible) prospects that have provided a good track record of success for us. We now have a successful well at Santa Cruz, which we operate with a 23% working interest. Total we found about 250 feet of net play, both gas [ph] and oil from multiple high-quality reservoirs.

Combined with our 2007 discovery at Isabella, we estimate over $100 million barrels equivalent growth for this area, with about two thirds of that being oil. We are moving forward with plans for 2010, which included drilling the offset San Diego appraisal and completion work on both Santa Cruz and Isabella.

First production by subsea completion by infrastructure is expected in 2011, where we could see initial production from 2 to 3 wells with potential for additional development default.

Our next exploration test will be late in the year at Deep Blue in the Green Canyon area. It is in very exciting prospect and represents our largest deepwater Gulf of Mexico test to date. Similar to our (inaudible) discovery, this is a sub salt test, 32,000 feet total depth, and over 5000 feet of water, and it is in a nice neighborhood with some very attractive industry discoveries nearby.

Currently, we are evaluating partnering proposals for the prospect, and we will likely sell down our 75% interest to something under 50% working interest.

Now let us move on to international. We will start in China, where we recently redrilled two existing wells as long reach horizontals, with approximately 640 feet lateral in each well. These wells have significantly increased field production, and this is an area where we made some additional 2009 capitals for further horizontal redrills.

We continue to work with our partner of further expansion of the field through additional facilities, construction and drilling, and we expect to substantially grow our current net oil production of 4500 barrels per day over the next couple of years.

Moving to the North Sea, production has been impacted by fluid handling constraints, delaying gas exports, and a revised drilling schedule. We are working closely with the operator to revolve these issues. Currently we are drilling the development well, (inaudible), prior to completing subsea construction work necessary to tie into the FPSO at Dumbarton later this year.

Once that work is completed, we do expect to exit the year with strong volumes, setting us up for a nice production increase in 2010. Turning to Israel, we have now announced two successes at Tamar and Dalit. With a strong floor test results at Dalit, we have confirmed significant resources as well as impressive quality and productivity of the reservoir.

In fact, the well at Dalit is capable of producing about 200 million per day, has even better rock quality than what was discovered at Tamar. We expect to begin shooting a very large 3D program around midyear, which will likely cover about 1200 square miles over multiple additional leads. Based on the course 2D we currently have, the leads identified vary in size with some potentially even larger than Tamar.

Given the positive results of the seismic program, we may move a rig to the area to conduct further exploration in the second half of next year or early 2011. The Tamar appraisal well spud earlier this week, and we should have results sometime early in the third quarter. First production is targeted for 2012 period where the demand in country is expected to really exceed available supply.

Based on development options that we have looked at, we think 2012 is very attainable. The likely scenario of the phased development, where we bring a certain number of wells on, and then further develop based on market demand. As a reminder, when we first discovered Mary-B in 2000, there was no existing natural gas usage, no pipeline infrastructure, and we bought Mary-B to first production in only 4 years.

Despite very favorable long-term outlook for natural gas in Israel, short-term demand has been pressured by a number of factors. Natural gas usage in the first quarter was impacted by warmer than usual weather, and turbine downtime in the Ashdod [ph] Power station. In addition, Israel electric labor sanctions have prevented the start-up of the (inaudible) power plant, delayed maintenance at a number of plants as well as completion of the repairs at Ashdod.

Current plans are for the Ashdod facility to fully operational by the end of the second quarter. Finally near-term gas demand has been impacted by the overall slower economy. Until the effects of the labor issue are resolved, we expect production will continue to lag of our original expectations, but we potentially still have time in the year to make up the shortfall.

Now over in West Africa, development plans at Benita continue, and we still expect to sanction this project by midyear. As we mentioned before, we have gone out for bids on several components of the project, and as you would expect, we have seen costs continue to come down reflecting the current environment.

We are also beginning to look hard at the potential to accelerate the Belinda project with a gas cycling scenario, whereby we initially stripped liquids as we did at the Alba field. This could potentially be the next EG [ph] project following Benita.

The rig that we are currently using in Israel is scheduled to come back to us in early 2010 to start the Benita development, where we still plan for first production in 2012. We have now gone out for a tender for additional rig resources for 2010 and 2011 to supplement our development and exploration plans for this region.

To wrap up, as Chuck and Chris both mentioned we started out the year managing our overall capital program towards the lower end of our range about $1.4 billion. We're moving capital around to those projects to make the most of them from the current environment, and as a result more capital is being reallocated away from our US onshore programs to things such as China development and Israel exploration.

The success in Israel alone has accounted for a shift of close to $85 million to this region. Some of the capital allocation decisions will have a modest impact on this year's volumes, but we still expect to be within our full-year guidance range. We also believe we will exit the year substantially higher than our first-half volumes as Ticonderoga returns to production, Israel gas demand increases, and we bring on new wells in the UK and China.

The first quarter has provided a tremendous momentum for Noble Energy. This year's exploration successes Santa Cruz, Tamar, Dalit, and (inaudible) provides a portfolio of multiple development projects in each of our high impact programs in the deep water Gulf of Mexico, Israel and West Africa to go along with our extensive exploration inventory.

These development projects, along with expected individual well flow rates ranging from 10,000 barrels of oil per day to 200 million cubic million feet of gas per day will start to add volumes as early as 2011, and continue to ramp up for a number of years.

At this time, Margie, we would like to go ahead and open the call for questions.

Question-and-Answer Session

Operator

Thank you, sir. (Operator instructions) We will now take our first question from David Kistler with Simmons & Company.

David Kistler – Simmons & Company

Good morning guys.

Chuck Davidson

Good morning.

Chris Tong

Good morning.

David Kistler – Simmons & Company

Congratulations Dave on the promotion. Really quickly, you’ve reduced the capital spending, and you're also reallocating capital from US, probably gas levered projects to the international portfolio. Can you kind of basically walk us through step-by-step those capital reallocations so we have a sense of magnitude?

Chris Tong

Yes David. I think what – on the ones I mentioned that was prior and most significant was the follow-up to the initial Tamar success in Israel, and I talked about was probably moved close to little under $100 million. I think it is at $85 million for the follow-up completion of the original Tamar well, the drilling of Dalit, and then the seismic program we’re getting started there. So that's probably the biggest peace. I think when you look at some other pieces internationally we see, we are going to put a little more money into China. When we look at some of these horizontal redrills, for example we can drill a well for $10 million to $12 million, pickup 2 million barrels of reserves and bring them on at 1500 barrels to 3000 barrels a day.

So that makes a lot of sense to put a little more money there. So that will probably go up $20 million to $30 million, $40 million. You know, we get two or three or four wells additional wells drilled over there. I think when you look at US, why the price has gone down and some of the gas drilling particularly in the Rockies area. As we mentioned earlier, we are going to keep our focus on US onshore mainly in the projects that have you know, a nice mix of liquid. That would be our western Oklahoma and Wattenberg programs. I think that's probably we’re seeing most of the shifts from US onshore gas drilling over to some other things like the Israel, and some of these projects in China.

David Kistler – Simmons & Company

Okay, and then the $200 million reduction in Capex, is that essentially is that cap fragment service cost reductions, because it just seems like some capital is getting reallocated internationally, but then there is another chunk that is just getting slashed.

Chris Tong

Yes, I think as much as anything we just never ramped up. We kind of started the year under the expectation that if we were going to keep that flexibility, you know that plus or minus 10% to 15% from that 1.6 we originally talked about. We needed to start the year at 1.4 type program and then see how things moved through the year. So, you know, we kind of started the year out on that note, and then the real difference from where we started then was moving that close to $100 million from the US onshore over to Israel.

David Kistler – Simmons & Company

Okay, that's helpful, and then on the same famous service cost, can you talk a little bit about what you are experiencing on service cost internationally versus the US?

Chuck Davidson

Yes, I think, you know service cost internationally, our projects on the international side are more capital intensive rather than you know, the day-to-day service cost because as you know we don't do a lot of day-to-day drilling. So where we are really seeing the impact of a lower-cost environment is in some of the big projects. This word, as Dave mentioned we are getting ready to sanction Benita, and we are clearly seeing the major components for that as we are out for bid.

They are coming down and we are talking 20%, 30% type reductions. But that's more likely to affect capital, in fact our view is more likely to affect the capital spend in 2011, 2012 is some of those big projects rather than the current year, but you know, Israel our cost is so low to start with. We have almost no service cost to go along with it. In EG, it’s somewhat the same. So, as a result when we talk about international, we really focus in on the major capital projects and their costs, and obviously as we are looking at obtaining additional drilling services for the Benita development as well as the follow-up in Israel, we are seeing, you know, proposed rig rates coming down as well.

Chris Tong

And I guess to follow on with that I mean as Chuck mentioned, you know on the big projects you're seeing this 20% to 30%, on some of the bids coming in from things lower than what I would have seen obviously last year, and we'll see that role through over a number of years out over time as we implement those projects, and that corresponds pretty well with what you are seeing in some of the US cost decrease this year.

You know, we are seeing that ranges from 20% to 40% depending on what type of service and location and so forth. So, you know, it seems like they are falling fairly close of line. Just the big projects, will get the benefit from that over a number of years there.

David Kistler – Simmons & Company

Great, and then last question just tying that to $2.4 billion in liquidity looking out to, you know, 2011 and 2012 with the cost reductions. Any concerns that you'll have to kind of step outside that $2.4 billion range to fund a lot of that development between here and there?

Chris Tong

Well, I think right now as we look at it, we have a really nice space to approach these projects. You know, Dave mentioned in Israel, where you bring on some wells for the initial market, then you go forward. So, you know, I think it is all a – from our plants we see today and the latest cost we see it a very manageable program. There will be a year or two in there where we will have higher capital needs, but we think we have plenty of sources to provide that capital.

So, right now it is – it looks very encouraging but again it is because of how we have faced these projects and clearly with the potential for Israel coming on in 2012, some deepwater coming on in 2011, say Isabella, Santa Cruz, and Benita coming in there as well. Those then start funding some of the follow on things such as what Dave was talking about the Belinda project, which we might move up in the queue but it will target funding from some of these others, and of course (inaudible) in the deepwater will be a little bit later. So that's the key is the sequence.

David Kistler – Simmons & Company

Great. I appreciate the additional color guys. Thanks so much.

Chris Tong

Thank you.

Chuck Davidson

Thank you.

Operator

Thank you. We will take our very next question from Brian Singer with Goldman Sachs.

Brian Singer – Goldman Sachs

Thank you. Good morning.

Chuck Davidson

Good morning.

Brian Singer – Goldman Sachs

Following up on one of the previous questions, when you look at Tamar, Dalit, EG, at what point in the process would you actually lock in some of the elements of development cost of the big capital items to take advantage of some of the cost decreases that you highlighted earlier, and I guess based on what you see now in terms of where costs have fallen. What do you see as development cost for some of those key projects?

Chuck Davidson

So, I think in terms of where you lock in, obviously the project sanction is going to be a key part of that. We’re working very aggressively now you know, for our Israel development plan. So we've also started looking in the rig market. So, as you know, once you make a contract for a deepwater rig, you pretty much lock in its cost depending on the timeframe used and that may be a decision that is made later this year, and potentially we could start you know, looking along these lines, but again we've got one key thing that has to be done first and that is to complete and carry out some discussions with our major gas customer there in Israel.

And until we get a level of comfort as to what their needs are going to be and their ability to make a commitment for gas and we know the pricing. You know, we have to be careful about the sanctioning the project. Along that line, we've been very careful about you know, discussing returns or project economics on Tamar, because you got imagine this is a very sensitive negotiation in terms of basically one gas supplier and a one gas customer.

So, you know, it is fair to say with the productivities we have seen at Tamar and Dalit, this is going to be a very efficient development, but the amount that we have to put in initially will depend on our key customer and what their demand commitment will be for that early period of time.

Brian Singer – Goldman Sachs

Thanks. And any thoughts on EG from a development cost perspective, maybe that's a little less competitive.

Chuck Davidson

Yes, that's and again that's where we've seen I noted maybe 20% to 30% reduction in costs from what some of our earlier estimates are. Some of that Brian is still being bid right now. So I don't want to comment on any individual items but there is no question we've seen the EG net cost come down about in that range just due to the environment.

Brian Singer – Goldman Sachs

Thanks, and switching back to Israel, you’ve highlighted some of the issues that impacted Israeli production, might be well in the second quarter and nevertheless seem to be one time in nature with maybe at least temporarily the exception of the slower economy. Can you provide any more color on what do you think the economic impacts specifically has been on Israeli demand, and if you see that turning and when?

Chris Tong

I think some of the projections have shown maybe that they are this year anticipating a 2% to 3% decline versus before, it was a low single-digit increase. So, you know, that does translate in the power demand, but from our perspective that's fairly small compared with what the real factors are, which are these big power plants and their conversions from using oil to natural gas and so you know, I would say right now that the factors that we are seeing there, they are mostly driving demand in Israel are one, weather, which is truly. You know, that's – as we see it here in the US that will swing your demand, but it is not an economy driven factor. And then conversions of these power plants as well as the maintenance of some of these plants.

Chuck Davidson

Yes, and Brian if you recall from some of the things we've talked about before. Once they go ahead and get (inaudible) up and running and converted the gas their peak capacity will be about double what it was this time last year. We just need to get some of these projects on and set up.

Brian Singer – Goldman Sachs

Great, thank you.

Chuck Davidson

Thank you.

Operator

Thank you. Our next question comes from Michael Jacobs with Tudor Pickering Holt & Co.

Michael Jacobs – Tudor Pickering Holt & Co.

Thank you. Good morning.

Chuck Davidson

Good morning.

Chris Tong

Good morning.

Michael Jacobs – Tudor Pickering Holt & Co.

Congrats as well to Dave. Just want to follow on the Granite Wash comments. Trying to reconcile that with what we have heard from other operators from a compilation technique standpoint or perhaps there is something in the reservoir difference. But what is one- time that you are seeing in that cost, the write-off and maybe if you could give us a little color on F&D cost that you are seeing in the Granite Wash.

Chuck Davidson

Yes, I will start and then maybe turn it to Dave to talk about, you know, our perspective on it, but you have to keep in mind that for us this is an older play. So, you know, we had to deal with the capital we had on our books, basically the fields, Buffalo, Wallow, and Billie Rose, and really what we saw when we looked at that program and this goes back to 2007. We are drilling vertical wells there. That was a very complex reservoir to interpret and in some instances, you know, lot of water production difficult to get the completion at the right spot, and so when we looked at that program drilling vertical wells, Granite Wash and those properties, we were seeing marginal rates return at that time, and as a result we cut the drilling program.

We had – at one time we had I think five or six rigs running in those fields and we slashed it back. And so we are dealing with that inventory of reserves in production and capital that we had to test against impairment. Now, you know Dave might talk about some of the recent things, but again that was the experience on our properties.

Dave Stover

I mean to follow on with that, the Chuck’s point, you know, we drilled pretty close to 100 wells in 2006, and it was priced similar to that in 2005, but you know as we looked at and looked at the other opportunities for investment that we had, we really ramped that program down, really started in 2007. We probably cut that drilling in half and then in 2008 almost nothing.

I think we drilled three wells in the Granite Wash in 2008. Now, we do have some other acreage out there that isn't fully developed that we are keeping an eye on with some of the offset operators, and what's going on. I know some folks are doing some horizontal drilling. We actually drilled one well late last year, horizontal Granite Wash to get our own data point on that. We'll keep an eye on that, but you know it's just not an area that we’ve seen relevant to some of our other investments that you know, we want to put a lot of money in at this point, and you know will kind of watch what the other folks are doing.

Chuck Davidson

And I think also, you know, we don't throw rocks at other folks. So our acreage might be in the wrong zip code, and we’ve seen that in other places. Well, fortunately we recognized it fairly early, but we had a sizable amount of capital on the books, and unfortunately it's basically all gas. When the gas prices dropped, we took the impairment.

Michael Jacobs – Tudor Pickering Holt & Co.

That's a good color. Thanks. If I could sneak in one more. Just thinking about Israel over the past few years, demand directionally is moving up. I think it is safe to say demand is higher than you would have initially thought, especially with new plants coming on, and when you initially contracted, my idea was only for a percentage of the volumes, and now with demand exceeding expectations, it seems like there's a bit of a gap to fill between now and 2012. Have you renegotiated the remaining volumes and if so are we going to see any effect on pricing going forward?

Chris Tong

Well, the answer to that is yes, and you are exactly right. We did not commit all of our Mary-B reserves under the initial contract, and I just briefly mentioned in the comment as one of the things that impacted us in the first quarter, because we do have in place an agreement for excess gas sale that basically is kept into that that those reserves that were undedicated and those go for premium prices. They can go for – again Israel is an oil index market.

So you are basically looking at contracts that are tied to oil and, but however, when demand fell in the first quarter, we really didn't have those excess gas sales, but if you look at what was happening and beginning to happen in 2008, there was a couple of quarters there, where we were substantially above our base contract value, and we would expect going forward that that would be the case as well when these plants get online and we see the demand increase. So, you know, long answer is yes. There will be a blended price increase as a result of new gas that was not dedicated before being added to the mix.

Michael Jacobs – Tudor Pickering Holt & Co.

And how should we kind of back into that blended price. Any sort of guidance, a good way to get at it.

Chris Tong

Well the – you know as we get up to a gross sales volume and you can calculate out the net by using our 47% interest on (inaudible). We will get up to gross sales volumes start to approach $280 million. That's where our first contract runs out, and I’ve always said, and again this is a formula and it is in a confidential negotiation right now, but generally the Israel gas markets right now are about a $4 gas market, and it can go north as oil prices increase. So, you might think in terms of you know, blending in prices in the $4 range against the base contract, which is about $265 (inaudible).

Michael Jacobs – Tudor Pickering Holt & Co.

Okay, thank you.

Chris Tong

Thank you.

Operator

And our next question comes from Ryan Rashad [ph] with FBR Capital Markets.

Chuck Davidson

Ryan. Operator – Margie, I think he dropped off.

Operator

Okay. We will take our next question from Irene Haas with Canaccord Adams.

Irene Haas – Canaccord Adams

Hello everybody and congratulations today, and Chuck I am glad, you are not going to be golfing. That’s good.

Chuck Davidson

I’d say it’s very good for other golfers.

Irene Haas – Canaccord Adams

Well, those outfits are funny anyways, question for you is, you know, what could be the next project in the US that could be vulnerable for impairment in your books, and secondarily, you know the Israeli off-shore gas chain, how big is it? I mean could it extend to beyond Israeli’s territorial water, and is still into other countries, just curious, and then generally your competition from the Egyptian gas market, how is that shaping up, some color?

Chuck Davidson

Well, I think you know without trying to speculate too much, we go and we look at all of our properties periodically. Certainly at the end of the year we saw them, and as we noted this quarter because of falling gas prices, we looked at predominantly our gas leverage properties of US. And I would say that Granite Wash is by far the one that is next out, based on the amount of capital there. When you start going beyond Granite Wash, you start getting into much lower levels of capital that is on the books. I would say that things like, for instance, Wattenberg has huge amount of excess value, huge amounts of excess value over book value.

So, you know, I guess, you have two be careful on forecast because we can’t forecast commodity prices, as a successful company we can't use hedges as we look at this. So we just have to look at the commodities as an FX for the particular properties, but you know, there time to time you would typically see some impairments flow of the books, but Granite Wash by far the most significant and the one that we have been watching the most closely.

On the gas play in the Mediterranean, as you know, we have secured a license in Cyprus, and we do think that this basin is fairly significant. And where it may go, Oh, gosh, we see quite an extensive inventory of leads just in the 3 million acres gross that we and our partners have accumulated. So it does have a lot of potential and a lot of running room. The areas that it goes beyond are I mean, we just to have to extrapolate on that because there is either no data, or there are licenses that are not available. So we will see, but this is kind of one step at a time with me. Two nice discoveries, one of them very large and as Dave pointed out, we see some very interesting leads off our 2-D data, some are even put potentially large than Tamara.

Irene Haas – Canaccord Adams

Okay great thank you.

Chuck Davidson

Thank you.

Operator

Our next question comes from Bill Young with Citi.

Bill Young – Citi

Good morning. Congratulations Dave.

Dave Stover

Thank you.

Bill Young – Citi

I was intrigued by the lower guidance on the exploration, because it is a pretty substantial drop. I was wondering if the exploration project was heavily weighted towards the first quarter, and the success you had reduced that cost or due to the explorations because you had in the first quarter derisked the remainder of the portfolio, and that is why the cost came down so much.

Chris Tong

Well, I think number one is we had some very expensive wells in the – as part of that program and the fact that Santa Cruz, Dalit, and Tamara were all successful and then, of course, (inaudible) and EG, just wiped out a lot of dry hole risk right there. And as we manage the capital program on the one floor, and if you look at things like what we were talking about doing or we manage the risk on Deep Blue, which is a deep water well, a very large prospect, very expensive, later in the year.

Later in the year, we think we can manage some of the cost down on that. We are managing the rest of the program very carefully. We do have some increased exploration expense with the seismic in Israel, which of course now we have the recorded expenses. The one thing that I view as a great investment, it is written off right away in terms of the books. But you know, that is just how we have scaled the program, and again it is tied to a spending program, about $1.4 billion.

Chuck Davidson

I mean, starting out the year 4 for 4, sure helps to reduce that dry hole expense.

Bill Young – Citi

So it sounded like the dry hole expense on a budgeted basis for you, on a quarter-by-quarter basis would have been a little bit higher in the first quarter than the reminder of the year.

Chris Tong

As we would have looked at it internally, there is no question about that.

Bill Young – Citi

Okay. Coming back to Buffalo Wallow, the Granite Wash, what's the – I wasn't clear of the reason for why the balance sheet capitalization was held at such a high level, was it because you acquired it at some point?

Chris Tong

Well, number one it was an asset that was part of the Patina acquisitions. Some capital of that acquisition was allocated to Buffalo Wallow, and there was a very substantial drilling program in the early years. They were in the midst of a very active program, and so that resulted in the capital. I would just say again, we're writing that off based on our reserves in the old one, and that was fine. This was not triggered by a reduction in reserves. This was triggered by the fact that commodity prices have fallen so low that weren’t able to recoup the capital when you look at it over the life of the field, and just looking at the cost of that production going forward. So it is a classic price impairment.

Bill Young – Citi

Do you know, you remember what the S&D cost in that field was 2005 and 2006 for the wells that were being drilled?

Chris Tong

Well, I would have to go back and look at that.

Bill Young – Citi

Okay. And finally, can you comment on what the results of that horizontal well were in the Granite Wash you drilled at the end of the year?

Chuck Davidson

I think we're still testing that, seeing how it points up and holds up. I mean it'll probably be another couple of months before we really have a firm idea how that is doing. That is nothing discouraging, but still encouraging.

Bill Young – Citi

All right, thank you.

Chuck Davidson

Thank you.

Operator

For the last question in the queue, we will go to David Cameron [ph] with JP Morgan.

Joe Allman – JP Morgan

This is actually Joe Allman, good morning everybody.

Chuck Davidson

Good morning Joe.

Joe Allman – JP Morgan

Hi, in terms of Israel, I know it is early days and you're working on negotiations, but what is our best guess about the initial production, when you bring these fields online in 2012, and what kind of production do you think you will see a step up to in a couple of years, maybe in another couple of 100 million a day of production or could you just give some color on that?

Chris Tong

Well again, a lot of it depends on how much demand they have ready to take. I would say conceptually, we could easily have ready to deliver anywhere from 400 million, maybe 500 million of gas. But, keep in mind these are wells that if we have 4 to 6 wells with this kind of deliverability you could have deliverability that is well in excess of that. The key is, I don't want to get caught in people misinterpreting deliverability versus what we will actually sell, because that will be dependent on the market, and what the market demand will be, but you know, with a 5 TCF resource, with this kind of productivity, kind of the sky is the limit in terms of what kind of ultimate productivity you have, it would be totally dependent and driven by market.

Joe Allman – JP Morgan

Absolutely, and it seems that the productivity, the capacity can be great, I'm just trying to figure out how much can you actually sell, and I think maybe you have spoken about the potential exporting the gas, but would Israel actually allow exports of a resource like gas?

Chuck Davidson

Well I think – I can't speak for Israel. There are no restrictions against exporting gas, and clearly there would be a lot of benefit for there country, if there was incremental volumes that were not needed by the market because of the royalty and taxes they achieve on this production. So there's a lot of benefit that would flow to the country for exports. So our view is, we will supply, hopefully supply the market that is available there, and when that market is satisfied, then we will certainly consider looking at exporting. So we can clearly monetize resources that are found.

Joe Allman – JP Morgan

Okay it is helpful. And then last, separate topic, and maybe I missed this, and I apologize if I did, but at this point in the US, are you curtailing any of your production or shutting down any of your production, and whether or not you are, are you thinking about it and what would be the driver there?

Chuck Davidson

Well, yes, the point I made is, we have taken the approach, we just don't drill the wells to start with, rather than drilling a bunch of wells and then getting caught with a market that can't take the gas. So we're not going down the path of curtailing production. As you know, what will ultimately happen is if storage gets full, the pipes just won’t take the gas. And it will be curtailed by the pipeline, and I'm hoping we don't get into that situation, but clearly the market has anticipated some risk of that, and so that – for that reason, we decided this was not the year to try to develop a lot of North American gas and supply this market. We will buy our time.

Joe Allman – JP Morgan

Okay, and if the price goes low enough, where it actually makes economic sense, to curtail or shut in how do you reservoirs respond to that, I mean are some reservoirs not responding well to shutting in, but they do okay if you curtail production.

Chuck Davidson

Well, I just think you just – you have to look at it on a case-by-case basis. You now, we don't have much in the – well, we have hardly anything in the Gulf of Mexico shelf, but that is a good example of reservoirs, strong water drives, and if you shut those wells in, the water just keeps driving in, and you end up losing reserves.

And they don't respond very well. Most of what we have now are longer life gas resources. Fortunately, most of them are very low operating losses. So you look at it, and again, if you get curtailed by the pipelines, you manage things as best you can, you may just see the whole system pressure up, and you get natural backups from the system, but we will just see how that goes. I mean it is just strictly a production management thing, right now though we are delivering our gas to the market, the markets are taking it, obviously at reduced prices and we are restricting the investment in the development.

Joe Allman – JP Morgan

Okay, very helpful. Thank you.

Chuck Davidson

Thank you.

Operator

And we have no further questions. I would like to turn the call back to our speakers for any additional or closing remarks.

Chuck Davidson

Thanks again everyone for joining us today, and we appreciate your interest in Noble Energy.

Operator

Thank you. And that does conclude today's conference. We appreciate your participation.

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Source: Noble Energy, Inc. Q1 2009 Earnings Call Transcript
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