Hess Q4 2006 Earnings Call Transcript

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Hess Corporation (NYSE:HES)

Q4 2006 Earnings Call

January 31, 2007 10:00 am ET

Executives

Jay Wilson - VP of IR

John Hess - Chairman and CEO

John O'Connor - President Worldwide Exploration and Production

John Rielly - SVP and CFO

Analysts

Arjun Murti - Goldman Sachs

Nikki Decker - Bear Stearns

Doug Leggate - Citigroup

Bruce Lanni - AG Edwards

Paul Sankey - Deutsche Bank

Mark Flannery - Credit Suisse

John Herrlin - Merrill Lynch

Robert Kessler - Simmons & Company

Mark Gilman - Benchmark Company

Paul Cheng - Lehman Brothers

Kate Lucas - JP Morgan

Bernard Picchi - Wall Street Access

Daniel Volpe - Barclays Capital

Presentation

Operator

Good day, ladies and gentlemen and welcome to the Fourth Quarter 2006 Hess Corporation Earnings Call. My name is Kelly and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of this conference. (Operator Instructions).

I would now like to turn the presentation over to your host for today's call, Mr. Jay Wilson, Vice President, Investor Relations. Please proceed, sir.

Jay Wilson

Thank you, Kelly. Good morning everyone and thank you for participating in our fourth quarter earnings conference call. Our earnings release was issued this morning and appears on our website www.hess.com. Today's conference call contains projections and other forward-looking statements within the meaning of the federal securities laws. These statements are subject to known and unknown risks and uncertainties that may cause actual results to differ materially from those expressed or implied in such statements. As usual, with me today are John Hess, Chairman of the Board and Chief Executive Officer; John O'Connor, President Worldwide Exploration and Production; and John Reilly, Senior Vice President and Chief Financial Officer. I will now turn the call over to John Hess.

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John Hess

Thank you Jay, and welcome to our fourth quarter conference call. I would like to make a few brief comments highlighting some key achievements of 2006 and provide some guidance for 2007. John O’Connor will then discuss our Exploration and Production business, after which John Rielly will review our financial results.

2006 was a year of record financial performance for our Company. Our results benefited from the strong commodity price environment which existed for much of the year. Consolidated net income was $1.9 billion. Exploration and Production earned nearly $1.8 billion, and Marketing and Refining earned $390 million.

Capital and exploratory expenditures in 2006 amounted to just under $4.1 billion, of which about $3.9 billion was related to Exploration and Production activities. For 2007, our capital and exploratory expenditures are budgeted to be approximately $4.0 billion, of which about $3.9 billion relates to Exploration and Production, including our acquisition of a 28% working interest in the Genghis Khan Field in the Gulf of Mexico.

We enhanced the strength of our financial position during the year, with our debt to total capitalization ratio improving to 31.7% at the end of 2006 versus 37.6% at the end of 2005.

During 2006, our operational achievements included; growing our proved reserves to 1.24 billion barrels of oil equivalent, replacing approximately 230% of production, at a FD&A cost of about $12.55 per barrel, lengthening our reserve life to 9.3 years, marking the fourth consecutive year in which we have lengthened our reserve life, increasing our crude oil and natural gas production by 7% versus the prior year, bringing four field developments into production, creating significant value from our high impact exploration program, and continuing the selective expansion of our Retail and Energy Marketing businesses.

With regard to crude oil and natural gas production, in 2006 our production averaged 359,000 barrels of oil equivalent per day. In 2007, we forecast that worldwide crude oil and natural gas production will average between 370,000 and 380,000 barrels of oil equivalent per day, which is within our long-term guidance of 3% to 5% production growth per year.

As to our major field developments, we made significant progress during 2006, including four field start-ups, ACG Phase 2, Atlantic/Cromarty, Phu Horm, and Okume. During the year, we sanctioned the Shenzi development project located in the Green Canyon area of the Gulf of Mexico and advanced the Pangkah oil development in Indonesia and the Seminole Residual Oil Zone project in the Permian Basin, all of which are scheduled to begin production in 2009.

In terms of exploration, we continued to have good success in the deepwater Gulf of Mexico during 2006. We made a potentially significant discovery at our Pony prospect, on Green Canyon Block 468, and drilled a successful appraisal sidetrack, which confirmed our pre-drill estimate of 100 to 600 million barrels of oil equivalent on our acreage. We have a 100% interest in the Pony prospect. In addition, successful appraisal drilling at our Tubular Bells prospect, on Mississippi Canyon Blocks 683 and 726, in which we have a 20% interest, has been very encouraging. Appraisal drilling at both these discoveries will continue in 2007.

With regard to Marketing and Refining, our businesses were negatively impacted by margin pressures and milder than normal weather. Our refineries operated reliably with the exception of some unplanned downtime at our HOVENSA joint venture early last year. We successfully completed low sulfur fuel projects at both HOVENSA and Port Reading during the year.

In Retail Marketing, our annual convenience store revenues in 2006, excluding petroleum products, exceeded $1 billion for the first time. Energy Marketing achieved increased sales of both natural gas and electricity, as a result of both organic growth and selective acquisitions, building a stronger and more profitable business for the future.

In summary, we are pleased with the performance of our assets and the strength of our organization. We remain confident that the investments we are making for the future will sustain profitable growth and create significant value for our shareholders.

I will now turn the call over to John O’Connor.

John O'Connor

Thank you, John. Good morning everybody. In the fourth quarter of 2006, production of 366,000 barrels of oil equivalent a day was up 16% versus the fourth quarter of 2005. Two new Hess-operated fields, Okume Complex and Phu Horm, started up ahead of schedule and on budget. In the Gulf of Mexico, we drilled and cored a successful appraisal well to our Pony discovery and we announced the acquisition of a 28% interest in the Genghis Khan Field, which is the western portion of the large Shenzi developments in which we also have a 28% interest.

Overall, 2006 was a year of strong operational performance for exploration and production. We produced 359,000 barrels of oil equivalent a day, up 7% from 2005. More importantly, we replaced about 230% of production with new proved reserves of 310 million barrels of oil equivalent. Reserves growth year-on-year was 14% resulting in year end 2006 proved reserves of 1.24 billion barrels of oil equivalent and a reserve life of 9.3 years.

Over the past 3 years, we have replaced 162% of production at an average FD&A cost of $12.50 of barrel of oil equivalent. During 2006, we continue to actively high grade our asset portfolio by selling non-core properties in the Permian and U.S. Gulf Coast and by entering the West Med Block offshore Egypt and reentering Libya. In 2007, we expect production to be in the range of 370,000 to 380,000 barrels of oil equivalent a day net of planned asset sales and within our 3% to 5% per annum growth initiative. Okume Complex production will step up through the year with the addition of some 5 new wells per quarter, achieving plateau production in early 2008.

In the second quarter of 2007, we'll start gas production from Ujung Pangkah in Indonesia and in the third quarter, we expect to start production from Genghis Khan. Gas production from the JDA fields will also increase in the second half of 2007, with the addition of some 200 million cubic feet a day gross of early Phase II gas, to the current Phase I volumes of 350 million cubic feet per day. Full production from Phase II of the JDA is schedule for first quarter 2008.

In 2007, our drilling activity in the Gulf of Mexico will focus on the development and appraisal of our three Miocene discoveries in the Green Canyon and Mississippi Canyon areas. Development drilling will continue on Shenzi and on Genghis Khan, while appraisal drilling is underway at both Pony and Tubular Bells.

2006 was certainly a year of high activity and of significant execution. And 2007 promises to be just as active. I will now pass the call over to John Rielly.

John Rielly

Thank you, John. Hello everyone. In my remarks today, I will compare fourth quarter 2006 results to the third quarter. Net income for the fourth quarter of 2006 was $359 million compared with $297 million in the third quarter. As indicated in the press release, third quarter 2006 results included a charge of $105 million for the additional 10% supplementary tax in the United Kingdom that was enacted in the July, with an effective date of January 1. The third quarter charge represented incremental income taxes of $60 million on operating earnings for the first half of the year and $45 million to adjust the Unites Kingdom deferred tax liability.

Turning to Exploration and Production. Income from Exploration and Production operations in the fourth quarter of 2006 was $350 million compared with $311 million in the third quarter, excluding the United Kingdom tax charge. The after-tax components of the increase are as follows; lower crude oil selling prices reduced earnings by $97 million. Higher crude oil and natural gas sales volumes increased earnings by $110 million. Lower exploration expenses increased income by $47 million. Higher operating expenses reduced earnings by $39 million. All other items net to an increase in earnings of $18 million for an overall increase in fourth quarter adjusted income of $39 million.

Our E&P operations were overlifted compared with production in the fourth quarter, resulting in increased income in the quarter of approximately $35 million. For the full year, sales volumes approximated production.

The Exploration and Production effective income tax rate for 2006 was 54%, excluding the effect of the adjustment to the U.K. deferred tax liability of $45 million in the third quarter. The E&P effective income tax rate in 2007 is expected to be in a similar range of 52% to 56%.

Turning to Marketing and Refining. Marketing and Refining earnings were $67 million in the fourth quarter of 2006 compared with $153 million in the third quarter. Refining earnings were $45 million in the fourth quarter of 2006 compared with $64 million in the third quarter. The Corporation’s share of HOVENSA’s results, after income taxes, was income of $20 million in the fourth quarter of 2006, compared with $43 million in the third quarter. During the fourth quarter, the Corporation received a distribution from HOVENSA of $100 million. Port Reading earnings amounted to $22 million in the fourth quarter of 2006 compared with $18 million in the third quarter. The decrease in refining earnings in the fourth quarter was due to lower refining margins at HOVENSA. The balance of the PDVSA note at December 31 was $137 million, and principal and interest payments are current.

Marketing operations had income of $17 million in the fourth quarter of 2006 compared with income of $63 million in the third quarter, principally reflecting lower margins. After-tax trading income amounted to income of $5 million in the fourth quarter of 2006 compared with income of $26 million in the third quarter.

Turning to corporate. Net corporate expenses amounted to $27 million in the fourth quarter of 2006, slightly lower than the third quarter amount. Net corporate expenses for the year 2006 were $110 million and are expected to be in the range of $115 million to $125 million in 2007.

Turning to interest. After tax interest expense was $31 million in the fourth quarter, comparable to the third quarter amount. For the full year of 2006, after-tax interest expense was $127 million. After-tax interest in 2007 is expected to be in the range of $170 million to $180 million, primarily reflecting an anticipated decrease in capitalized interest due to the completion of several development projects.

Turning to cash flow. Net cash provided by operating activities in the fourth quarter, including a decrease of $67 million from changes in working capital was $779 million. The principal use of cash was capital expenditures of $961 million. All other items amounted to an increase in cash flow of $19 million, resulting in a net decrease in cash and cash equivalents in the fourth quarter of $163 million.

At December 31, 2006, we had $383 million of cash and cash equivalents. Our available

revolving credit capacity was approximately $2,700 million at year-end. The Corporation’s debt-to-capitalization ratio at December 31, 2006 was 31.7% compared with 37.6% at the end of 2005. Total debt was $3,772 million at December 31, 2006 and $3,785 million at December 31, 2005. The Corporation has long-term debt maturities of $27 million in 2007 and $28 million in 2008.

This concludes my remarks. We will be happy to answer any questions. I will now turn the call over to the operator.

Question-and-Answer Session

Operator

(Operator Instructions). And your first question comes from the line of Arjun Murti of Goldman Sachs.

Arjun Murti - Goldman Sachs

Thank you. A couple of questions. First one on the production guidance of 370 to 380, you alluded to I think net of planned asset sales, do have an amount that you are assuming for asset sales that you can share with us?

John Hess

John?

John O'Connor

Good morning, Arjun.

Arjun Murti - Goldman Sachs

Hi.

John O'Connor

One of the asset sales that we have clearly identified is the residual equity we have at Scott and Telford. We basically have a purchase and sale agreement for that and that asset is currently producing net of about 9,000 barrels a day.

Arjun Murti - Goldman Sachs

Terrific. And are you assuming any additional asset sales beyond that or is that really the one you were talking?

John O'Connor

I think that with respect to production guidance for the year, Arjun, we have to be cognizant of the fact that we have really three new field startups incorporated in our projection for the year, the Phu Horm startup in late November, then Okume in December and then looking to April-May time for Pangkah in Indonesia. Given all the moving parts, I think there is even less certainty with respect to the range of production guidance for this year than would normally be the case. There is no question, but there is significant additional production potential being added to the developments. How the drilling progresses on these new fields and how the wells perform as we bring them on and how new facilities operate, how much up-time we get are all moving parts that influence the guidance. To the extent, however, that we have opportunities to sell further assets to continue with the high grading of the portfolio, we would look at that in the context of that guidance.

Arjun Murti - Goldman Sachs

That makes a lot of sense. Is Genghis Khan not going to produce any volumes this year, I just thought there were some early oil going through in Anadarko and I think Marco Polo facility?

John O'Connor

We expect that we'll see startup of Genghis Khan into the third quarter, Arjun.

Arjun Murti - Goldman Sachs

Okay. And I apologize, this is the final one. Tubular Bells there was previously a pretty wide range, I think 75 to 350 million barrels, sounds like this appraisal went well and I recall it being a fairly decent step out. Can we have confidence in the upper or at least middle portion of that range now, or can you provide any color around that?

John O'Connor

We are actually -- it's drilling currently the down deep sidetrack from the number two well and drilling operations are still in progress there. Certainly, I think as John said in his script that we have been very encouraged by the number two well, the number two sidetrack, but beyond that I would rather wait for the operator to put out some interpretation of how they feel about the range of guidance on completion of operations here.

Arjun Murti - Goldman Sachs

That is great. Thank you very much.

John O'Connor

Welcome.

John Hess

Thank you.

Operator

Your next question comes from the line of Nikki Decker of Bear Stearns.

Nikki Decker - Bear Stearns

Morning everybody.

John Hess

Morning.

Nikki Decker - Bear Stearns

I just wanted to ask a little bit more about your reserve bookings, if I could. The numbers went by pretty quickly, but it sounds like your reserve replacement was quite decent. Do you say that you had booked 310 million barrels of new proved reserves?

John O'Connor

Yes, we did Nikki. And I should give that some color commentary by saying that we also sold 27 million barrels.

Nikki Decker - Bear Stearns

Sold 27 million, were acquisitions a part of that 310 million?

John O'Connor

It depends how you want to classify Libya. We booked Libya in 2006, if that is organic, in other words returned to prior ownership, then all 310 would be organic. If you care to categorize it as an acquisition, then 310 less about 125 would be the organic guidance.

Nikki Decker - Bear Stearns

Wanting for upgrade. And were there negative revisions in there John?

John O'Connor

Not really. I mean there always are -- once you choose these, ups and downs which net out. But they are -- as we continue to improve the capability of rest of our management folks, negative revisions occur less than this quite frankly.

Nikki Decker - Bear Stearns

Great. And on the FD&A, I think I heard a three-year figure of about 12.57, did you provide 2006 data?

John O'Connor

John did in his text, and the 12.55 was for 2006. The average for the three years is actually co-incidentally a little less then that at $12.50. 50.

Nikki Decker - Bear Stearns

Wonderful. That will do for me. Thank you.

John Hess

Thank you.

Operator

Your next question comes from the line of Doug Leggate of Citigroup.

Doug Leggate - Citigroup

Thanks, good morning everybody.

John Hess

Good morning.

Doug Leggate - Citigroup

John O'Connor, on the reserve replacement, you mentioned to Nikki's question there, the answer rather that you had some sales. I guess that was the swap with Apache, will that be part of that?

John O'Connor

Yeah, the way the thing worked out has actually shown as disposals. So that was -- part of the 27 was the sale as a quid pro quo of our acquisition of West Med to Apache at the Permian. And the other part is the exit from Gulf Coast near shore, offshore Louisiana.

Doug Leggate - Citigroup

Right. Well, I guess that where I am going with this is, that clearly there seems to be quite a lot of western reserves that you [spotted] upon in the terms of what -- where your bookings can come from next. Could you maybe lay out for us how you see '07-'08 in terms of how deep the portfolio is? Or maybe comment of BP's discovery this morning and how that might impact your clients in the region, in the Med obviously?

John O'Connor

Yeah. Obviously we are very pleased basically to confirm what we believe to be the deeper exploration potential on the very sizable West Med Block. So that was good neighborliness on behalf of BP and its partner in the West Med Block. We are encouraged by that. We continue to work our development options to optimize what we are looking in West Med. So it's all -- after all a good new story.

In terms of forecasting reserves for '07, '08, I mean I think it's fair to say as you look at the full categorization of our resource base, I think at the time of the May investor conference, we talked in terms of 6P of 3.5 billion barrels and I think at the end of the day, we've shown our reserves situation to the Board next week. That number will be over 4 billion barrels in terms of 6P. So the question then is at what pace do they move into SEC proved reserves, but the resource base is very substantial.

Doug Leggate - Citigroup

Okay. I guess a couple of just additional questions from me. The exploration program. The read through, I guess, from me anyway is that you are moving into a fairly heavy appraisal period. How do you see the volatility, let's say of the dry hole costs as we move through the year in '07?

John O'Connor

I think you're right. Given that we have two rigs under contract in the Gulf of Mexico and that's where the both of our exploration and appraisal stand occurs. As we switch efforts to funding the appraisal, Pony we believe will be -- on appraising the Pony prospects for the full year. There is still continuing work to be done on Tubular Bells. Of course, we have drilling activity both development in terms of Shenzi and later on year in Genghis Khan. We also have some production work to do regarding Banks area, which will use the rig experience of Jack Hays. So, it goes without saying that the capacity to drill wildcat wells this year is reduced by comparison with 2006, but maybe this is the consequence of success when one explores and find something, the next phase is appraisal. And, so it's appropriate for us so we move into the appraisal phase with Gulf of Mexico.

In the international arena, of course we are looking forward to drilling our wildcat on Block 54. We have shown it in the late fourth quarter of this year, but given the exigencies with which drilling rigs become available from others on and off as the case may be, it’s conceivable that will slide over in to the early part of 2008.

We have a couple of wildcat wells in West Africa were we are fully carried by partners, so they are not contributing to the expense. So all in all, although we don’t forecast exploration expense, while we will have an increase in our acquisition and processing of seismic particularly in the Gulf of Mexico, I think you can see that my comparison with the high activity on wildcats last year, this year it will be less though.

Doug Leggate - Citigroup

Just on the [Tertiary] in that case you have a full carry result?

John O'Connor

Yes, that’s correct.

Doug Leggate - Citigroup

Final one from me, cost guidance, John, cash and non-cash for 2007 please?

John Rielly

Sure, 2006 unit costs were $19.80. That was $10.90 for cash operating cost and $8.90 for DD&A. Our guidance for 2007 is a range of $12 to $13 for cash operating cost and a range of $10 to $11 for DD&A.

Doug Leggate - Citigroup

Great, okay. Thanks a lot.

John O'Connor

Thank you.

Operator

Your next question comes from the line of Bruce Lanni of AG Edwards.

Bruce Lanni - AG Edwards

Yeah, good morning gentlemen and congratulations on a good year.

John O'Connor

Thank you, Bruce.

Bruce Lanni - AG Edwards

Real quick, probably John O’Connor, it’s a follow-up on the previous questions more or less. The first one dealing with reserve replacement, John, you mentioned Libya being a portion of that, could you break out the balance of where the other reserves came from? That would be the first question. And the second one would be on Pony still a very wide range again similar to Arjun's comment on Tubular Bells, could you kind of break out when you think that you may be able to fine tune the Pony number and why the range is still so wide? And then, a third question would be on Libya, just not really that much mention of it, I wonder how active we are going to be in that region over the next year or two?

John O'Connor

Okay, I will -- Bruce I will talk about them in the reverse order. As you know, we have 8% equity in Libya, I think it is fair to say that things do not move in full speed in terms of the operation of the Oasis concessions and that's okay frankly. We have acquired a lot of updated information, we and our partners working with BNOC through 2006, and in fact it is about the pace that I expected. But we are a lot more knowledgeable about the assets and we are putting together the opportunity sets. So, I don't see a significant change in terms of our commitments and our spend in Libya, but I do think that for the longer term it represents a significant opportunity for us.

In terms of Pony, the original discovery together with the sidetrack, basically confirmed the lower end of the 100 million to 600 million barrel range, slightly more than that. The second well that we are currently drilling will hopefully add to that, but I think that the real narrowing of the range will occur after the third well is drilled. So, I think, unfortunately given the debt of target horizons for this well, unlike the more instant gratification that one gets from exploration and appraisal of other shallower prospect this one in going to take some patience.

Bruce Lanni - AG Edwards

And, John, where is the third well kind of located?

John O'Connor

At the present time, it is northerly located, as you know this to the northwest of the Discovery and the next one we will locate it to the northeast, but I would keep that as tentative until we find the results from the number two, together with number two sidetrack as we kind of sidetrack the number two. So we are trying to delineate that down to batches of structure as you move to the north, both at westerly and easterly directions.

Bruce Lanni - AG Edwards

Okay.

John O'Connor

Your third question was with respect to the additional reserves that’s over and above those from Libya. And I would tell you that, we added significant reserves. Shenzi upon sanction of that in the JDA on the back of an active drilling program in 2006, in the UK on the back of activity and performance in some of the core fields, they are Bittern, Clair Schiehallion and Valhall in West Africa again as a result of drilling in both Equatorial Guinea and Gabon, in the US as a result of drilling a performance at our US assets at El Gassi, El Agreb again as a result of drilling activity there. So, this sort of bears out my observations and my prepared remarks that we have had a very active year executing around our program in 2006, and of course the benefits flow through in the terms of reserves.

Bruce Lanni - AG Edwards

Well excellent, and congratulation.

John Hess

Thank you.

John O'Connor

Thanks, Bruce.

Operator

Your next question comes from the line of Paul Sankey of Deutsche Bank.

Paul Sankey - Deutsche Bank

Hello. Good morning everyone.

John Hess

Good morning.

Paul Sankey - Deutsche Bank

John O'Connor, if I could just press you a bit more on the wildcat and try and get a wildcats and get a better feel for the risk, reward that we are looking at this year as oppose to last year. It seems that you're actually carried on all the wildcats you have this year. And I was -- would be interested to know, how that compares with the number of wildcats you drilled last year. But if you could just confirm the location of those and just confirm that I am correct about the outlook for ‘07 that will be great? Thanks.

John O'Connor

It’s not true that actually Paul that we're carried on all wildcats this year. We are carried currently on the Jack Hays as well and I indicated we are currently drilling a couple of West African wells. We have got various equities in a number of wells and we have penciled in, in the Gulf of Mexico, and of course we would be a 100% in the Block 54 for Libya wildcat. The issue really is with respect to moving parts on the rig timing and the priorities that may occur. And so while we have budgeted for those wildcats, some or all may not be drilled this year. And so it’s very difficult to give you a credible forecast. I would merely indicate that with respect to exposure to wildcat drilling, it will be less in 2007, than it was in 2006.

Paul Sankey - Deutsche Bank

Yeah, and just to confirm the ‘06 number, which I guess we know, could you just talk about how many drilled and how much exposure you had at the end of the day?

John O'Connor

Okay. We had Ouachita, we had Alsace, we had looked down in to the Faros. We had Andros and we had Norman. That’s one, two, three, four, five, six. The total exposure, John Riley might care to comment on that?

John Rielly

$240 million, Paul.

Paul Sankey - Deutsche Bank

That’s great. Okay, I appreciate it. Thanks a lot. On -- just pressing a little bit more on the disposals question. You are saying that you have confirmed more or less a 9000 barrels a day disposal, is there a potential for a step disposal or really a large sell down, or do you still see the asset base you’ve got in front of you is the one that you are broadly speaking, happy with and eyeing for the -- the sort of trimming around the edges that you doing?

John O'Connor

Yes, I believe that the asset portfolio is significantly better and more robust than it was a few years ago. We have been continually disposing off the weaker properties over the past three to four years. And while we have got a short list of as you would say trimming around edges type property, that’s about the seismic quite frankly. We like the assets that we have got. We think we have a lot of running room with it. There obviously is room for improvement with respect to both costs and longevity. But in terms of assets sticking out, I should say, I wish I didn’t have that. We are pretty much near the end of the road in terms of (inaudible).

Paul Sankey - Deutsche Bank

Great, that’s helpful. Thank you and one final one from me as a change in direction slightly. There are some quite concerning headlines coming out of Venezuela on an ongoing basis. Could you just address the level of risk that you face regarding the potential for nationalization or other contractual changes from Venezuela? Thanks,

John Hess

Well as you know, our investment with Venezuela is not in Venezuela, it's in US Virgin Island. So in terms of nationalization risk, it's really not a risk. Number two, our joint venture there has operated very well and profitably since its inceptions, since 1998. The Venezuelans have honored their supply agreements on crude, as well as their financial commitments, and the partnership continues to be in excellent, where both sponsors are very supportive of the joint venture.

Paul Sankey - Deutsche Bank

Great that’s helpful. Thank you gentlemen.

Operator

Your next question comes from the line of Mark Flannery of Credit Suisse.

Mark Flannery - Credit Suisse

Hi, just a question John O’Connor. More of a longer-term conceptual question. You've got 165% reserve replacement over three years about $12.5 a barrel and that’s actually -- five years ago that would has been seen as a bad result. Now, it's probably going to be seen as a good result. And if you look forward with the assets that you know about, which into the resource base if you like, where -- what do you see happening to F&D over the rest of the -- let's say over the rest of the cycle. Not necessarily looking for number, but what if everything goes to plan, what kind of charges and the rest of it are going to be working their way through the portfolio do you think?

John Hess

Yes, good question Mark. I mean -- I think that generically for industry we are seeing a significant year-on-year increase in F&D as a result of cost push occurring in terms of where the industry is moving and into perhaps more challenging and even more marginal hydrocarbon resources. Obviously, rig suppliers are extracting their part of flesh from the industry. Service companies find that this is their time in the sun as well. So all of these and there is the people issue too, but as the industry loses people, we are having to compete heavily to acquire new professionals to execute on the development of your need. So my belief is that costs squeeze is going to continue to occur. And then, I leave it to other commentators as to what that means with respect to margins and prices of these.

Mark Flannery - Credit Suisse

Alright, so you are not seeing -- you don’t really see any eminent relief from any of that?

John Hess

I really don’t. So the nature of where we are exploring, where we are developing, and the fundamentals that lie behind all of that, I really don’t see a downturn, but I see a continued increase in trend that is the course.

Mark Flannery - Credit Suisse

Alright. Thank you very much.

Operator

Your next question comes from the line of John Herrlin of Merrill Lynch.

John Herrlin - Merrill Lynch

Yeah, hi. Three quick ones, with West Med, John, what did you book for that?

John O'Connor

John, good morning. We haven’t sanctioned West Med yet. So, there will be no bookings there.

John Herrlin - Merrill Lynch

Okay great, that’s what I thought. With Pony should we expect given the current drilling you are talking about kind of a third quarter type update or will you update us once you done with next well?

John O'Connor

I think as probably in (inaudible) so meaningful in terms of shareholder information that on completion of operations on assets as in tight hole, we would update you.

John Herrlin - Merrill Lynch

When do you think we will see that?

John O'Connor

Well it's going very well frankly, but I think we had planned about 120 days on the sales as part of the beginning of the year. So we are looking at four months, end of April possibly.

John Herrlin - Merrill Lynch

Okay.

John O'Connor

And we would like to try to beat that if we can.

John Herrlin - Merrill Lynch

Great, and how about the Jack Hays?

John O'Connor

Jack Hays also is very tight hole, confidential and very strategic in nature. John would probably tell you it's drilling below 25,000 feet currently.

John Herrlin - Merrill Lynch

Okay. Last one from me is with respect to hedging, any changes at all with that for WTI? I mean prices have been pretty volatile. You have a fairly large program, John.

John O'Connor

Yeah, no plans to add to the hedges we have. We are very comfortable taking the price risk with the balance sheet that we have and the cash flows we are getting from the new developments.

John Herrlin - Merrill Lynch

Okay, thank you.

Operator

Your next question comes from the line of Robert Kessler of Simmons & Company.

Robert Kessler - Simmons & Company

Good morning gentlemen. I had a question on your reserve bookings this year. Genghis Khan sounds like it was not booked in 2006, can you confirm that transaction had not closed by year-end and what you might book for 2007 as initial reserves there?

John O'Connor

Robert, you are right that it was not included in year-end 2006 reserves. Back to the transaction that was not yet closed, I believe. It's in the final stages. It's imminent, but it has not yet closed. And unfortunately, I don't recall off the top of my head what we're going to book, but I don't think it's going to be significantly material initially.

Robert Kessler - Simmons & Company

Okay, I think you had guided to a resource range of 65 million barrels to 170. Is it fair to say it starts at the low end of that range and then the optionality would be included in future?

John O'Connor

That sounds like that would be a gross number for the three partners of which we would have 28%. So if you took 28% of 60 or there about that might be appropriate still.

Robert Kessler - Simmons & Company

Fair enough. Thank you very much.

John O'Connor

That would be actually on the high side.

Robert Kessler - Simmons & Company

Thank you. And then on the exploration, obviously you have a lower year in terms of your net exposure for the exploration wells, particularly in the first quarter with Jack Hays being carried by Maersk and then obviously Pony still drilling on through the quarter. Can you give us a sense for baseline G&G kind of exploration expense on that basis on top of which we could layer in any dry hole exposure?

John O'Connor

Let me pass it to John Rielly.

John Rielly

That type of exploration expense numbers we don't give out because again it really is -- it depends on where the program ends up, where the seismic, what's the timing, getting all the boats and the work done. So, it's very difficult for us to forecast that and like you said what happens with dry holes and the success or lacks of success. So at this point, we can't really guide you on the exploration expense and all we will do is quarter-to-quarter is give you updates on the wells we are drilling.

Robert Kessler - Simmons & Company

Okay. Thank you.

Operator

Your next question comes from the line of Mark Gilman of the Benchmark Company.

Mark Gilman - Benchmark Company

Guys, good morning.

John Hess

Good morning.

Mark Gilman - Benchmark Company

I had just a couple of quick things. Can I assume -- can I be safe in assuming that Shenzi was the largest single element of the non-Libyan reserve bookings in '06?

John O'Connor

Yes.

Mark Gilman - Benchmark Company

Okay. US production, liquids and gas, fourth quarter really seemed to have slipped to a much greater extent. Was there a downtime John associated with that or is the decline rate accelerating, could you put some color on it?

John O'Connor

Yeah, sure Mark, I'll be happy to do that. In point of fact, it was facility issues both on Llano and on Conger and the irony is that they are both are not operated by us. Llano goes to the Auger platform and Conger goes to Enchilada. In one case, actually Enchilada I believe suffered from storm impact, whereas Auger was plant maintenance. So, both of those had a significant impact on the production delta between the fourth quarter and the third quarter. Now, it's also fair to say, I will be we just ingenuous not to that both Conger and Llano are of course continuing to slide.

Mark Gilman - Benchmark Company

Can you quantify at all what the impact of the downtime might have been John on those two?

John O'Connor

Yeah, my estimation of the downtime is around 5,500 barrels a day for the quarter-versus-quarter, Mark.

Mark Gilman - Benchmark Company

Okay. One final one if I could. On Phu Horm, can you give us an idea what the tax and royalty provisions look like and what kind of base gas price we are looking at there?

John Rielly

Sure Mark. From a based gas price right now, let's just say what we had in the fourth quarter from initial production is approximately $5 Mcf for the gas price. We the -- in Thailand, it's the normal tax and royalty type process there, and the tax rate in Thailand is approximately at the 50% range.

Mark Gilman - Benchmark Company

And the royalty about 10% or 12%, if I remember, John?

John Rielly

I can't remember that off top of my head, Mark. I'll have to get back to you on that.

Mark Gilman - Benchmark Company

Okay. Thank you.

Operator

Your next question comes from the line of Paul Cheng of Lehman Brothers.

Paul Cheng - Lehman Brothers

Good morning gentlemen.

John Hess

Good morning.

Paul Cheng - Lehman Brothers

Actually only several quick questions. John, do you have a number, what is the Libya production for the year? And if you [could touch on] if any inventory and overlifting or underlifiting?

John Rielly

As far as the overlift, underlift, there wasn't the overlift that I spoke about in the fourth quarter, the biggest piece of it came from Libya. But from an overall standpoint in 2006, now our sales volumes are equal to our production volumes.

Paul Cheng - Lehman Brothers

Right, John, what's the fourth quarter Libya production?

John Rielly

It was 23,000 barrels a day.

Paul Cheng - Lehman Brothers

23. And on a going forward basis now that -- what's the sales has been?

John Rielly

The sales -- we are expecting it again within an overall year period to equal the 23,000 barrels a day.

Paul Cheng - Lehman Brothers

Right. And what is in the fourth quarter, you said that is a big thing.

John Rielly

Oh, I am sorry, in the fourth quarter, we had an additional just under 1.2 million barrels overlifted in Libya.

John O'Connor

We have got up on the underlift.

Paul Cheng - Lehman Brothers

You caught up on the underlift?

John O'Connor

Yes.

John Rielly

Yes. But in the fourth quarter, we were overlifted about 1.2 million barrels.

John O'Connor

So going forward, we shouldn’t be imbalanced on year-on-year basis.

Paul Cheng - Lehman Brothers

Perfect. John, you gave a full-year production guidance, do you have a number for the first quarter?

John Rielly

No Paul, we are not really providing the guidance specifically on the first quarter. There are, as John O'Connor has mentioned, various moving parts that happened within the portfolio including even things with JDA and getting phase II gas online. So there will be something downtime and we are not exactly sure where that will link in with the Thailand operation. So at this point, I think you follow the basic guidance that John O'Connor spoke about earlier that we will be having a ramp up. Okume will be ramping up. Genghis Khan doesn’t come on to the third quarter. Pangkah doesn’t come on to the second quarter. So, we have a normal ramp up there. So you can see kind of towards the fourth quarter where that production will be higher than --

Paul Cheng - Lehman Brothers

Can you tell me what is the current production rate for the Okume?

John O'Connor

Sure, it's running about 11,500 barrels a day right now.

Paul Cheng - Lehman Brothers

Net to you or that’s gross?

John O'Connor

That’s gross.

Paul Cheng - Lehman Brothers

11,500, gross ?

John O'Connor

That’s from three wells that are on stream. And as I said in my remarks, Paul, we expect to bring five wells per quarter on. So to underline what John Rielly has just been saying, you can see that the production profile for the year is heavily back-end loaded towards the fourth quarter. They remind also that we expect a normal third quarter seasonal outages for a heavy maintenance activity in the north sea and also at the turn of the first quarter, it’s the second quarter we expect the JDA to be down for roughly 40 days for Brownfield tie-in for connection of the 42-inch line to Thailand.

Paul Cheng - Lehman Brothers

I am sorry, John, the JDA will be down in the second or third quarter?

John O'Connor

It will be down -- it's going down in the middle of March as currently planned, Paul, for 40 days. So, its major impact will actually be in the second quarter.

Paul Cheng - Lehman Brothers

And the assets sales in UK, when that’s going to be finalized, is it first quarter event or second quarter?

John O'Connor

That is projected to close in the first quarter -- by the end of the first quarter, Paul.

Paul Cheng - Lehman Brothers

By the end of the first quarter?

John O'Connor

Yes.

Paul Cheng - Lehman Brothers

And the 9000 BOE per day is the weighted average for the year, I presume?

John O'Connor

It’s the current production rate.

Paul Cheng - Lehman Brothers

That’s the current production?

John O'Connor

Right.

Paul Cheng - Lehman Brothers

Okay. And also I think, John, you have touched base on that, I am wondering some people have said that they start to see a relief in the rig availability and also cost pressure in the upstream side of the business, have you guys noticed that, that’s really true, any comment that you can add?

John O'Connor

We haven't actually been in the market to secure new equipment Paul, but I see the same information I guess as you and others do. It looks like at least there is a flattening off in the escalating rates that we have seen over the prior three years. And if nothing else that’s encouraging.

Paul Cheng - Lehman Brothers

Okay, how about on the development side, has the cost pressure started to tail off or that is still rising pretty rapidly?

John O'Connor

I, we don’t -- we are not out in the market for any new developments currently and it's very difficult for me to comment on what’s happening. The concept of a plateau in cost is appropriate given that the cost of sale is still pretty high.

Paul Cheng - Lehman Brothers

I see, very good. Thank you very much.

Operator

Your next question comes from the line of [Kate Lucas] of JP Morgan.

Kate Lucas - JP Morgan

Hi, good morning.

John O'Connor

Good morning.

Kate Lucas - JP Morgan

I have a question about the Genghis Khan development and the Shenzi development, are you -- given that you've sanctioned the Shenzi project before you announced the acquisition of Genghis Khan and that they are part of the same structure, are you looking at changing any of the development plans for Shenzi as a result of Genghis Khan acquisition?

John O'Connor

We are indeed, Kate. One of the attractions, and if you like the synergies through the existing partnership in Shenzi acquiring the western portion of the prospect, which is called Genghis Khan, is that it allows us to optimize well locations which is significance in this development.

Kate Lucas - JP Morgan

Okay and then just one quick question on your international E&P tax rate, it was about 58% over the course of the quarter. Is this a good representative internationally E&P tax rate going forward or was it favorably or unfavorably impacted by your self volume mix?

John Rielly

It was a volume mix that I spoke about just a little bit earlier we were overlifted in Libya with obviously were we have enough, greater than 90% tax rate. So that drove up the international tax rate in the fourth quarter.

Kate Lucas - JP Morgan

Okay, thanks very much.

John Rielly

You're welcome.

John O'Connor

Thank you.

Operator

Your next question comes from the line of Bernard Picchi of Wall Street Access.

Bernard Picchi - Wall Street Access

Good morning, a question John O’Connor about Okume, you said that production will plateau in the first quarter early in '08 and you laid out the development program quarter-by-quarter, could give us an idea what the plateau term will be? How long production will remain at that plateau and then how quickly decline rate will set in, question one. And then also in Equatorial Guinea, in a general sense, could you talk about additional development opportunities you may have within the lease in terms of additional satellites or exploration or development opportunities elsewhere within Equatorial Guinea?

John O'Connor

Let me start with the last one. I don’t anticipate any Greenfield exploration opportunities to emerge from our remaining concession area in Equatorial Guinea. We are pretty much drilled what we thought was viable and we have relinquished the non-prospective acreage. So we are pretty much done in the areas surrounding the production assets. There is certainly one, if not two possibilities, to tie into the production facilities and there maybe more as our experience in the currently producing areas grows with time, but I would not look to see substantial change. I think that the issue with respect to Equatorial Guinea will be the expectation that recovery factors will turnout to be better than currently perceived as we continue with pressure maintenance and effective recovery in both side of the field and in Okume Complex.

As to the plateau, the facilities in Okume Complex have been designed for 60,000 barrels a day, plateau gross. Generally speaking, these facilities can be de-bottlenecks and nudged and certainly the well capacity will exist to meet if not exceed that plateau rate. The issue will be one more of subsurface. How connected are the various geo-bodies, how effective is water injection and thus far, I would say is that we have been presently pleased with the drilling results, but there is a long way to go. As I said, we will be completing five wells per quarter. So we have a lot of learning to do on Okume through the year. As far -- and that of course is going to impact how long the plateau will last, but currently I think our projection will be that we will see the plateau last for four to five year's. It's very uncertain at this stage and thereafter, it would probably decline somewhere between 5% to 7% a year. So this is long duration activity.

Bernard Picchi - Wall Street Access

Excellent. Thank you, John.

John O'Connor

Okay, Bernard.

Operator

Your next question comes from the line of Daniel Volpe of Barclays Capital.

Daniel Volpe - Barclays Capital

Good morning gentlemen. Have you had a chance to share your reserve results with the rating agencies prior to the release and do you have an update on your discussions with Moody’s, specifically with regards to investment-grade ratings?

John Rielly

Typically, right before our earnings release calls, we will update the rating agencies on results and we did discuss the reserve replacement with all the rating agencies. Our discussions with Moody’s have been positive and have been positive for the last several quarters; they see the improvement in the business. As far as any timing for them to do something without rating, it is up to Moody’s and we will -- we just will be answering the question as they sent it to us.

Daniel Volpe - Barclays Capital

Great, thank you very much.

John Rielly

Sure.

John O'Connor

Thank you.

Operator

Your next question comes from the line of Doug Leggate of Citigroup.

Doug Leggate - Citigroup

Hi, guys, apologies for the follow-up. I wanted to come back on one of John O'Connor's comments. You said the reserves bookings, John, were in the JDA, are you now in a position to put the third phase of the JDA?

John O'Connor

Sorry, Doug. I missed the last phase, are you asking about the third phase?

Doug Leggate - Citigroup

Yeah. I think you have a put option essential.

John O'Connor

Oh, the put, sorry. We've retained that option. I think that it’s certainly premature to exercise it. There are a number of moving parts. Very clearly, we have the gas resources that we have contracted for in both phases I and II. We also have a lot of drilling underway. Wells watch out for this year will be a deep well in [Bhumi] that is basically be a very high temperature well, not a quite high pressures, so not quite HP/HT, but certainly HT. And the success for all of us at that well will give us indication of how much on books and on contracted resource, we have in the central reversion zone in the block. So I think the best answer to give you is we have retained to put options. The market is very, very strong and is looking for additional gas volumes. We just have to be sure that we have got incremental gas and sufficient of it, and that the economic terms would be right to exercise put option.

Doug Leggate - Citigroup

Great, thank you sir. And there's just one final one for John Rielly. John, you have about -- I think at the end of 2005 something like $5 per share of net operating losses and net asset value. Can you tell us what that number was at the end of '06? And just walk us through the mechanics of how you realized that value?

John Rielly

Sure. I mean for the net operating loss what we'll do is obviously as the US has taxable income, we'll be able to utilize that NOL to offset current taxes. As of the end of 2006, we have approximately 3.3 billion of NOLs remaining to be utilized. So, we see that asset being utilized over the next several years.

Doug Leggate - Citigroup

What was the NPV, John, of that number?

John Rielly

Again it all depends on -- I would have to make a guess on commodity prices of what the taxable income would be in each year here going forward. So, it would be difficult to do that.

Doug Leggate - Citigroup

Not as similar to the '05 number? I think that was about 1.6 billion or something like that.

John Rielly

Well, again are you talking -- are you just talking about the deferred tax asset associated with it? That's just that --

Doug Leggate - Citigroup

Yes.

John Rielly

Okay. That's just that the tax rate in the US. So again you're using an effective 35% to 37% effective rate on those NOLs.

Doug Leggate - Citigroup

Great. Thanks a lot.

John Rielly

Sure.

Operator

Ladies and gentlemen, that concludes our question-and-answer session for today. We thank you for your participation in today's conference. This also concludes the presentation and you may now disconnect. Have a good day.

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