Apache (APA) John J. Christmann on Q2 2016 Results - Earnings Call Transcript

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Apache Corp. (NYSE:APA)

Q2 2016 Earnings Call

August 04, 2016 2:00 pm ET

Executives

Gary T. Clark - Vice President-Investor Relations

John J. Christmann - President, Chief Executive Officer & Director

Stephen J. Riney - Chief Financial Officer & Executive Vice President

Timothy J. Sullivan - Executive Vice President – Operations Support

Analysts

Pearce Hammond - Simmons Piper Jaffray

David R. Tameron - Wells Fargo Securities LLC

John P. Herrlin - SG Americas Securities LLC

Brian Singer - Goldman Sachs & Co.

John A. Freeman - Raymond James & Associates, Inc.

Evan Calio - Morgan Stanley & Co. LLC

Edward G. Westlake - Credit Suisse Securities (NYSE:USA) LLC (Broker)

Doug Leggate - Bank of America Merrill Lynch

Charles A. Meade - Johnson Rice & Co. LLC

Operator

Good afternoon. My name is Brandi, and I will be your conference operator today. At this time, I would like to welcome everyone to the second quarter 2016 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session.

Thank you. I would now like to turn the conference over to Mr. Gary Clark, Vice President of Investor Relations. Please go ahead, sir.

Gary T. Clark - Vice President-Investor Relations

Good afternoon and thank you for joining us on Apache Corporation's second quarter of 2016 financial and operational results conference call. Speakers making prepared remarks on today's call will be Apache CEO and President John Christmann and Executive Vice President CFO Steve Riney. Also joining us in the room is Tim Sullivan, Executive Vice President of Operations.

In conjunction with this morning's press release, I hope you have had the opportunity to review our second quarter financial and operational supplement.

As discussed in our press release yesterday, Apache announced that during the second quarter of 2016, the company voluntarily changed its method of accounting for oil and gas exploration and development activities from the full cost to the successful efforts method. All numbers discussed today will be stated under successful efforts unless otherwise noted.

Please note the following documents will be available after the close of business today: our second quarter 10-Q filing; Form 8-K filings that include certain financial information from Apache's 2015 Form 10-K and first quarter 2016 Form 10-Q recast to reflect the retrospective application of the successful efforts method; and a successful efforts conversion PDF presentation which contains additional detailed information regarding the impact of this accounting change. Please reference our Investor Relations website at investor.apachecorp.com to access these documents.

I'd like to remind everyone that today's discussions will contain forward-looking estimates and assumptions based on our current views and reasonable expectations. However, a number of factors could cause actual results to differ materially from what we discuss today. A full disclaimer is located with the supplemental data on our website.

I will now turn the call over to John.

John J. Christmann - President, Chief Executive Officer & Director

Good afternoon and thank you for joining us.

Apache continues to make great progress in all aspects of our business, as demonstrated by the strength of our second quarter results. Before we get into the details, I would like to start off by highlighting a few important takeaways from today's call.

First, we delivered another solid quarter of adjusted earnings and operating cash flow. This underscores the significant progress we have made on costs and the resilience of our portfolio in a low price and low reinvestment environment.

Second, we have been working all aspects of our cost structure for more than 18 months. Last year, the majority of our cost savings came from G&A reductions and capital efficiencies. While these costs continue to improve, we are now seeing most of our significant savings coming from LOE [Lease Operating Expenses].

Third, production volumes continue to hold up well and track in line with the increased guidance range we provided last quarter. Our production expectations for the full year remain unchanged.

Finally, with our cost structure better synchronized with the lower oil price environment and with the potential for prices to exceed our $35 budget for the year, we can see a path to more normalized investment levels. Our conservative budgeting approach coupled with incremental cash flow in the second quarter now gives us the optionality to increase investment activity. Any incremental investment will continue to be made within the construct of our rigorous capital allocation process and within operating cash flow.

Now I will turn to our second quarter results, focusing first on the positive results we are realizing from our cost-cutting initiatives. Apache continues to drive significant reductions to its cost structure. After an impressive first quarter, our lease operating expenses were down even further in the second quarter. Our operational teams have done an exceptional job attacking every aspect of LOE. For example, we have renegotiated power, chemical, and water handling contracts, in some cases locking in very attractive pricing for the long term. We have also significantly lowered our third-party contractor costs in the field as we further leverage the capabilities of our field personnel.

On the G&A front, while most of the heavy lifting was done last year, we continue to identify additional opportunities to align overhead costs with projected activity levels. Importantly, we have retained the capacity to support much higher investment, so we do not anticipate these costs to revert.

On the capital side, last quarter I noted an impressive decrease in our average well costs, which were down cumulatively about 45% compared to 2014. While we are seeing the rate of service price reductions begin to flatten out, we continue to find opportunities for overall well cost improvements.

As we transition from strategic testing to development drilling operations, we will realize additional efficiencies and cost savings. For example, we will increase pad drilling operations, thereby enabling more efficient batch drilling and completions. We will drill longer laterals and reduce the number of future wellbores and associated costs. We will increase our utilization of rotary steerables, enabling better landing zone targeting and faster penetration rates. In addition, most of our rigs currently working in North America and the North Sea were contracted prior to 2015 at very high day rates. Consequently, we anticipate our average rig rates will decline in the future.

Moving on to production for the quarter, as noted in this morning's press release, Apache's global pro forma production was 461,000 barrels of oil equivalent per day, consisting of 282,000 BOEs per day in North America onshore and 179,000 BOE per day in international and offshore. North American onshore production declined roughly 16,000 BOEs per day from the first quarter. We only placed 20 new gross operated wells on production in North America during the second quarter, so these declines were expected. Notably, less than 5,600 BOEs per day of this decline was in the Permian, where Apache currently generates its highest North American margins.

As set forth in our quarterly supplement, Apache's cash margins in the Permian averaged approximately $17 per BOE in the second quarter, which is more than double those in the rest of North America. Consequently, most of the volume reduction in North America had relatively little impact on our earnings and cash flow.

Our Permian region produced 165,000 BOEs per day in the second quarter or nearly 60% of Apache's total North American onshore production. In the Delaware Basin, we placed only two gross operated wells on production, both of which targeted the Third Bone Spring formation in the Pecos Bend area. One very notable well which we mentioned in last quarter's call was the Blue Jay Unit 103H. This well was placed on production in April and achieved an exceptional 30-day average rate of nearly 3,200 barrels of oil equivalent per day from a lateral length of approximately 5,100 feet. In fact, in its first 90 days on production, the oil component alone of this well was 147,000 barrels, making it Apache's best well to date in the Delaware Basin.

In our Waha area of the Delaware Basin, through drilling longer laterals and taking advantage of natural fracture systems, we continued to enhance production rates. This has significantly improved the economics at Waha and reduced our breakeven oil price. An example of our recent successes is the 905H well, which we placed on production just after the end of the second quarter. This well achieved a peak 24-hour IP rate of approximately 1,750 barrels of oil equivalent. As a result of our technical progress, we now have an expanding inventory of attractive locations at Waha in both the Wolfcamp A and Third Bone Spring formations.

To sum up our opportunity in the Delaware Basin, in the Pecos Bend and Waha areas alone, we can support a multi-rig drilling program for several years.

In the Midland Basin, Central Basin Platform, and Northwest Shelf, we placed a combined 16 gross operated wells on production, which is down from 25 wells in the first quarter. During the second quarter, we brought online two Wolfcamp B wells, the Connell 38B 2HM and Connell 38C 2HM, each of which achieved a 30-day average rate of more than 1,300 barrels of oil equivalent per day from one-mile laterals. Subsequent to quarter end, we placed another strong Wolfcamp B well, the CC 4144 East 2HM, on production at a peak 24-hour IP rate of approximately 2,200 BOEs per day.

Much of our testing in the Wolfcamp involves completions and landing zone optimization. The improvements we are making, as demonstrated by these wells, will significantly enhance our Wolfcamp program going forward.

Also in the Midland Basin, we look toward bringing on three Lower Spraberry shale wells in the second half of this year, where we have significant running room and anticipate very compelling economics.

Finally, on the Northwest Shelf, we placed nine horizontal Yeso wells on production during the quarter and continued to generate very good production rates and economics from this play. One noteworthy well, the Hummingbird #7, produced a 30-day average rate of 734 BOEs per day. As a reminder, our well costs in the Yeso play are very low, typically around $2.5 million.

To sum up the Permian, Apache has made great strides during the downturn to improve every aspect of our business. Reduced drilling days, better landing zone targeting, optimized fracs, and many other efficiencies have all contributed to expanding our economic drilling opportunities. We look forward to continued improvements which will fully leverage the upside potential of our vast acreage position.

Outside of the Permian, Apache had no active drilling rigs in North America and placed on production only two other operated wells, both of which were in the Woodford-SCOOP. We have limited activity planned in the SCOOP for the remainder of the year. However, Apache's 50,000-plus net acres in the play will underpin a profitable two or three rig drilling program for many years to come.

Despite our low level of reinvestment, we are making great progress in North America. As I mentioned at the beginning of the call, our North American onshore production guidance is tracking in line with our previous 2016 guidance range of 268,000 to 278,000 BOEs per day.

On the international and offshore side, pro forma production for the quarter was 179,000 barrels of oil equivalent per day, consisting of approximately 101,000 BOEs from Egypt, 71,000 BOEs from the North Sea, and 7,000 BOEs from the Gulf of Mexico.

In Egypt, gross production of 350,000 BOEs per day was down modestly compared to the first quarter, due primarily to outages at a third-party gas plant. On a net basis, pro forma volumes declined sequentially by 2,800 BOEs per day, primarily due to the impact of improving Brent oil prices on the cost recovery mechanisms and our production sharing contracts. Apache placed 14 wells on production in Egypt during the second quarter and achieved a drilling success rate of 93%.

In the North Sea, production was approximately 71,000 BOEs per day during the second quarter, up slightly from the first quarter. This was primarily the result of a few strong development wells brought into production around the end of the first quarter and improved operational uptime which more than offset the underlying base decline.

Apache drilled two very notable development wells in the quarter. The BCR B81 in the Beryl field was placed on production in late June and achieved a peak 24-hour IP rate of 55 million cubic feet of gas equivalent per day. The LP7 well was also placed on production in June at a peak 24-hour IP rate of 46 million cubic feet of gas equivalent per day. Looking ahead to the third quarter, we anticipate North Sea production will be up modestly from the second quarter. The benefit of BCR and LP7 will be mostly offset by seasonal maintenance downtime.

At our Aviat project in the Forties field, we have now completed and tied in the first well. As you will recall, Aviat enables a switch from diesel to natural gas as our primary source of power for the Forties field. This is an environmentally friendly project that will extend the economic life of Forties and reduce certain safety, cost, and reliability risks associated with bunkering diesel to our platforms. As highlighted in our November 2015 North Sea webcast, we are drilling two exploration prospects in the second half of 2016, Storr and Kinord. Both prospects offer low-cost tieback opportunities to our existing Beryl infrastructure and have material reserve potential. We expect to have results for both before year end.

Since we have received many questions lately on Suriname, let me provide a brief update. On Block 53, we have completed an extensive geologic and 3-D geophysical review and prioritized a number of attractive prospects. We anticipate drilling our next exploratory well on the block in 2017. A drill ship has been contracted and preparations are underway. On Block 58, a 3D seismic shoot is in progress, and we will have an early look by the end of the year and have a fully processed data package in 2017.

To sum up international and offshore, while activity was limited, we had very good development results in both Egypt and the North Sea during the second quarter. We remain on track to produce between 170,000 and 180,000 BOEs per day on a pro forma basis for the full year 2016. Both Egypt and the North Sea generated positive free cash flow in the first half of 2016, and we anticipate that we'll continue to do so for the remainder of the year. We are excited about the future exploration potential in our international and offshore portfolio and look forward to providing more details in the future.

Now for a look into the second half of 2016 and our updated view on full-year capital guidance. As we mentioned in last quarter's call, our top priorities for incremental capital in 2016 are to increase investment activity in the Permian, keep two platform rigs operational in the North Sea, and to accelerate strategic testing initiatives across the portfolio. We have now initiated action of all of these priorities.

In the Midland Basin, we added a second rig in late July and will focus on Lower Spraberry and Wolfcamp B targets through the remainder of the year. In the North Sea, our two platform rigs will remain manned and focused on workovers and development drilling. Additionally, a considerable portion of our incremental capital will be directed toward accelerating strategic testing initiatives that will have minimal impact on 2016 production. As a result of the increased activity I just described, we now expect our 2016 North American capital spend to be at the high end of our $1.4 billion to $1.8 billion guidance.

Importantly, we will not lose our capital discipline as activity increases, and we will continue to target unchanged or lower net debt at year end irrespective of changes in commodity price. Our incremental 2016 spending will have minimal impact on average 2016 production. However, this increased investment will help to stem our production decline and build momentum as we enter 2017.

In closing, Apache has benefited from deliberate decisions to budget conservatively and to position the company for stability and success in a lower price environment. We have streamlined our asset base, significantly reduced our cost structure, and allocated a considerable percentage of our resources to strategic testing initiatives. Despite more than an 85% reduction in capital investment since 2014, we have high-graded our drilling inventory and substantially increased our opportunity set.

I can say with confidence that despite the industry downturn, Apache has far more potential than we did just 18 months ago. We have protected our balance sheet and chosen to invest within our cash flows while maintaining our dividend and avoiding equity issuances. This approach has paid off, as we have maintained our investment-grade credit rating and reduced our net debt level by 38% since early 2015.

Going forward, our budgeting approach will remain conservative and methodical. We will continue to manage oil and gas price volatility by setting a reasonable expected price band and gearing our capital spending, returns targets, and capital structure to the lower end of that band. Should realized prices come in higher, we will maintain the planning capability and operational flexibility to respond accordingly. This will help to ensure we generate the best possible returns on our drilling programs and maintain our strong financial position through the cycle.

In the second half of 2016, our primary goals remain unchanged. We will live within our means, maintain our strong financial position, continue to build high-quality development inventory for the future, and invest to improve long-term returns and create shareholder value.

I will now turn the call over to Steve Riney.

Stephen J. Riney - Chief Financial Officer & Executive Vice President

Thank you, John, and good afternoon, everyone.

On today's call, I will cover several key topics. I will begin with Apache's switch from the full cost accounting method to successful efforts. I will lay out the rationale for the change and outline the primary differences between the two methodologies. Next, I will review our second quarter 2016 financial results as reported under successful efforts. I will contrast these with results that would have been reported under full cost.

Please note that our quarterly financial and operational supplement contains a slide that compares key second quarter line items under successful efforts to the same items under full cost. I encourage you to review these comparisons to better understand the impact of the accounting change on our second quarter results. The full cost results outlined in the supplement are probably more comparable with analyst estimates for the quarter and should compare favorably to most expectations.

Following that, I will review Apache's primary financial objectives for the remainder of 2016. And finally, I will update and expand our 2016 guidance. Our guidance will now be based on 2016 anticipated results under successful efforts.

So let's begin with a discussion of our switch to the successful efforts accounting methodology. As many of you are aware, Apache has been evaluating a switch to successful efforts for several quarters. We have now effected that transition with our second quarter 2016 results.

We decided to proceed with the change for two primary reasons. First, successful efforts provides for a better matching of costs incurred with the period in which they impact financial results. This is primarily accomplished through the recognition of exploration expense. Under full cost accounting, more costs tend to be capitalized onto the balance sheet and then depreciated over time. During periods of sustained low oil and gas prices, this typically results in significant ceiling test write-downs, as Apache experienced over the last 18 months. Successful efforts generally results in lower reported earnings and operating cash flows in the near term. But in the long run, the balance sheet and earnings are less impacted by commodity price volatility.

Second, successful efforts is generally preferred by the investment community and is more commonly used by the vast majority of E&P companies. Nine out of the 11 companies in what we often refer to as our peer group currently utilize successful efforts. So this transition allows for more easily understood and more comparable financial results for Apache.

Now let me touch briefly on the changes you will see under successful efforts. As I just indicated, one of the primary differences is that under successful efforts, we will report exploration expense. Exploration expense includes four significant categories of costs. First, it includes exploration-related seismic costs, which are differentiated from capitalized development-related seismic costs. Note, both exploration and development seismic activity are common at Apache. Second, it includes exploration-related G&A costs. Third, exploration expense includes lease rentals and the cost of any expired or surrendered leases associated with unproved acreage; and finally, dry hole costs, which will be expensed in the quarter in which an exploratory well is deemed to be uneconomic. Note, successful exploratory wells will be capitalized.

Changes resulting from the recognition of exploration expense will have the following impacts on our reported financial results. On the income statement, results in the near term will appear lower under successful efforts due to the immediate recognition of exploration expense. For the second quarter of 2016, we recognized $91 million in exploration expense under successful efforts. These costs would have been capitalized under full cost.

On the cash flow statement, net cash from operating activities results will be lower under successful efforts due to the exploration expense impact on net income. While the non-cash portion of exploration expense is added back to arrive at operating cash flow, the cash portion will remain as a reduction. There will be an equal and offsetting reduction in cash used in investing activities since these costs will no longer be capitalized. For the second quarter of 2016, the result was a $37 million reduction in reported operating cash flow and in cash used in investment activities. Net cash flow, of course, was the same under both methodologies.

On the balance sheet, exploration expense results in less capitalized costs and therefore a lower carrying value for unproved property. The impact of the second quarter exploration expense resulted in a lower carrying value for unproved properties of $22 million. In the long run, exploration successes will transition to proved property with a lower carrying value, resulting in lower DD&A. At the end of my discussion, I will offer guidance on expected exploration expense for 2016.

There are other differences between successful efforts and full cost accounting, such as capitalization of interest costs, impairment calculations, reporting of gain or loss on sales, and the treatment of assets held for sale. We don't have enough time to review all of those on this call. Accordingly, we will post a slide deck on our website at the end of the day that contains a more extensive comparison of full cost and successful efforts accounting methodologies as they relate to our financial reporting. Please feel free to reach out to Gary and his team with any questions as you work through the impacts of this change.

You will see that we have included in the supplement a summary of the impacts of the switch to successful efforts on our second quarter reported results. It details what I have outlined today as well as a few other items, the most significant of which is the cumulative historical impact on Apache's balance sheet. The balance sheet now reflects the aggregate effect of successful efforts accounting from an historical perspective.

You will note in particular that retained earnings has increased by $5.3 billion as of the end of the first quarter. This is the cumulative effect of many items, the most significant of which are: the recognition of past exploration expense, which reduces retained earnings by $8 billion; changes in past DD&A, ceiling test write-downs, and asset impairment charges, which increases retained earnings by $14.9 billion; changes to past reported gains or losses on asset sales that decreased retained earnings by $1 billion; and various other items, including adjustments to capitalized interest and changes in tax valuation allowances, which decreased retained earnings by $640 million.

So let's now switch our successful efforts based financial results for the second quarter as announced in this morning's press release. Apache reported a second quarter GAAP loss of $244 million or $0.65 per common share. These results include a number of items outside of core earnings that are typically excluded by the investment community in their published earnings estimates. In the second quarter, items generally not considered part of core earnings totaled $145 million after tax. Apache's loss for the quarter when adjusted for these items was $99 million or $0.26 per share. Under full cost accounting, our adjusted earnings would have been a profit of $0.05 per share. Since market expectations for the quarter assumed full cost accounting, we believe this is a more comparable basis for assessing our results.

During the second quarter, we generated cash from operating activities of $744 million, a substantial increase from our first quarter result. Improved commodity prices, disciplined cost control, and a release of cash from working capital drove this improvement. Under full cost accounting, cash from operating activities would have been $781 million.

Apache ended the quarter with $1.2 billion in cash on hand. This is an increase of approximately $200 million from the end of the first quarter. After consuming cash in the first quarter, we are now rebuilding our cash position back toward the $1.5 billion we had to start the year. This is consistent with our goal to end 2016 with the same or lower net debt than we began the year with.

Turning to costs, lease operating expenses in the second quarter were $7.38 per barrel of oil equivalent, down 4% from the first quarter, following a significant quarter-on-quarter reduction from the fourth quarter of 2015. We continue to focus aggressively on all forms of cost reduction, and LOE has shown a tremendous response to that focus so far in 2016. That said, our expectation is that LOE per barrel of oil equivalent will increase in the second half of 2016 due to the timing of workover activity and seasonal maintenance.

On the G&A side, costs continued to decline as we align our overhead cost structure with anticipated future capital spending levels. As you will recall, for the purposes of monitoring progress made on our G&A costs, we define G&A as our gross overhead cash costs. This excludes incentive compensation as well as G&A cost recoveries from our partners. These two items tend to offset one another but will vary from year to year. Our goal for 2016 was to reduce these costs to a range of $650 million to $700 million. We are currently tracking at the low end of this range.

G&A costs have historically been incurred such that 45% was capitalized, 20% went to LOE, and 35% was expensed. With significant changes to our G&A cost structure and elements of G&A now being reported as exploration expense, you should expect going forward that G&A costs will track more closely to 25% being capitalized, 15% to LOE, 10% to exploration expense, and 50% recorded as G&A on the income statement. Actual results will of course differ and will reflect quarterly fluctuations and the timing of costs. But this is a good general allocation to use on an annual basis.

Apache's DD&A in the second quarter under successful efforts was $13.75 per barrel of oil equivalent. This is a modest increase relative to the first quarter as reported under full cost. This increase in DD&A is primarily attributable to an increase in the carrying value of our oil and gas properties resulting from the switch to successful efforts.

Next, I would like to turn to our key financial objectives for the remainder of 2016. Apache has worked hard to build a strong financial position, and we like where we stand. We have a strong liquidity position with $1.2 billion of cash and $3.5 billion of available credit facility. We have a very reasonable level of debt, and we have maintained our investment-grade rating through the downturn.

Equally important, we are running the business to be cash flow neutral at $35 oil. That being the case, we now have the possibility of higher cash flow in 2016 to the extent oil price averages above $35. We are in a unique position where we could fund an increase in capital investment with cash from operations. As always, incremental capital spending will be subject to a rigorous focus on long-term full-cycle rates of return.

With this context, our key financial objectives for the second half of 2016 are to: continue to focus on cost management in all aspects of the business. We have accomplished a lot, but there is always more to do; allocate capital resources to the very best projects to enhance the quality of our drillable inventory and to deliver attractive fully burdened returns; balance capital spending with available cash flows to end the year with the same or lower net debt; and maintain our current investment-grade rating.

I would like to conclude by updating our guidance for the remainder of 2016 and offering a few additional items that may be helpful in light of our switch to successful efforts. As John already noted, after raising production guidance with our first quarter results, our full-year production guidance ranges for both North America onshore and international and offshore remain unchanged. He also reviewed our increased activity levels and noted that we now expect full-year capital spending to be at the high end of our $1.4 billion to $1.8 million range.

With regard to LOE, following our first quarter results, we reduced our 2016 LOE guidance from $9.50 to $9.25 per BOE. Given the continued excellent progress we have made during the second quarter but taking into account an expected increase in workover and seasonal maintenance expense, we now expect full-year LOE at $8.50 per BOE or lower.

On G&A costs, we will continue to speak about this in terms of gross spend, regardless of where it shows up in our financial statements. As indicated previously, we are approaching the lower end of our guidance range of $650 million to $700 million. While we continue to focus on our overhead cost structure, our guidance will remain unchanged.

With the change to successful efforts and recent write-downs of unproved properties, we anticipate expensing a higher percentage of our interest costs going forward. Accordingly, we forecast that approximately 90% of our total interest cost will be expensed in 2016.

As noted previously, successful efforts requires the recognition of exploration expense each quarter. Exploration expense includes some items that are planned and predictable and other items that tend to be volatile from quarter to quarter. Specifically, dry hole costs and unproved property impairments by their nature do not lend themselves to guidance. Consequently, for the full year 2016, we anticipate exploration expense in aggregate will be in the range of $250 million to $300 million. This includes actual dry hole costs and unproved property impairments through the second quarter but excludes them for the second half of the year.

Finally, with regard to taxes, as I noted on our call back in February, we anticipate minimal cash taxes will be paid in 2016.

In conclusion, we are proud of our financial accomplishments over the past 18 months. Our liquidity is strong. Our debt levels are under control, and we are living within our means. We have completed the transition to successful efforts, which will enhance comparability with our peers and better inform our already rigorous planning and capital allocation processes.

We look to the future with great optimism and have set our long-term sights on significantly improving returns on capital employed and generating competitive per share growth, which will be an outcome of disciplined returns-based investment decisions.

I would now like to turn the call over to the operator for Q&A.

Question-and-Answer Session

Operator

Our first question comes from the line of Pearce Hammond with Simmons Piper Jaffray.

Pearce Hammond - Simmons Piper Jaffray

Thank you for taking my questions. John, on hedging, what are your latest thoughts there?

John J. Christmann - President, Chief Executive Officer & Director

Pierce, we came into this downturn unhedged. And our best hedge was being able to reduce our activity levels, which we've done. We feel like we're living within cash flow. We're going to approach forward-looking prices in terms of budgeting around a band and then giving ourselves flexibility when prices range above that. So the plan at this point is we don't have a lot of plans for hedging. We want the exposure. And I think the big key has been we're making long-term decisions and long-term investments, and we need to be gearing our cost structure and overhead structure and investment criteria to where those prices are. We'll budget conservatively and then reap the benefits when things are above it.

Pearce Hammond - Simmons Piper Jaffray

Great. And then my follow-up is what are you doing differently with the Blue Jay well, the very strong well results there? Is there anything specific that you're doing differently now versus, say, a few months ago?

John J. Christmann - President, Chief Executive Officer & Director

I think it's just the culmination of the technical work that we've been doing in the area with specific targeting. We now have three zones in the Third Bone in that area. We've really gone in and I'll say specialized our completions. We're learning which zones, where we want to complete with all of the changes there. But it's just really the evolution of the process and the continuous improvement that we seek in every well we drill.

Operator

Our next question comes from the line of David Tameron with Wells Fargo.

David R. Tameron - Wells Fargo Securities LLC

Good morning – or I guess it's afternoon. John, when you start thinking about 2017 and assume a higher price deck, I'll just call it whatever, call it $50 – $55, how should we think about the Permian as far as allocation? I know that number bumped up a little bit this quarter, thinking about 2016. So how do you think about Permian allocations, and where would those rigs be focused within the Permian?

John J. Christmann - President, Chief Executive Officer & Director

At this point, we geared 2016 at $35. And at that level, we were not making very many development drilling choices in North America. You see with the little shift in capital, North America is getting the lion's share of that. The lion's share of that is going into our Permian operations. Clearly, at those types of price levels, Dave, we'd be looking at significant higher levels of investment. We're running a bunch of scenarios as we start to think about 2017. We'll come out with more color and more guidance like we typically do when we look at the fourth quarter call of this year as we start to think about 2017.

David R. Tameron - Wells Fargo Securities LLC

Okay, and then let me follow up with the North Sea. You're talking about keeping two operated rigs – or platform rigs out there. Can you talk about what that looks like over the next six months?

John J. Christmann - President, Chief Executive Officer & Director

It shows you that first and foremost, we're able to add a couple of platform rigs back into our plan in the North Sea. And truthfully, if you look at our international CapEx, it's going to be down from where we started initially the year, which is due to the efficiencies. So it shows you the progress we've been making on the international front as well. We felt like maintaining those two rigs is critical. We've got a lot of workovers and a lot of high-return projects that we can pursue, and it's not a lot of capital added back in for the back half of the year. So they compete very, very well, and a lot of low-hanging fruit that we'll go after.

Operator

Our next question comes from the line of John Herrlin with Société Générale.

John P. Herrlin - SG Americas Securities LLC

Yes, hi. Thank you. John, in your prepared comments, you mentioned that your employees can support a much higher level of activity. Could you give us a sense of how high is high?

John J. Christmann - President, Chief Executive Officer & Director

John, the one thing we didn't want to do, we reduced our staff about 30% in 2015. And quite frankly, I think when we look at us today, we've got the ability to ramp up internally significantly from where we sit today. I think we could probably handle a $60 – $65 deck pretty easily. So we tried really hard. We've got a lot of employees we've made significant investments in, and we were very methodical and forward-thinking in terms of our staffing levels. So I feel really good about our internal head count. That's the one area we didn't want to get too aggressive and try to gear it to this lower side of the – the lower end of the price environment.

John P. Herrlin - SG Americas Securities LLC

Okay. Thanks. My next one for me is on Suriname. I couldn't quite hear you. You shot seismic on Block 53 or Block 58?

John J. Christmann - President, Chief Executive Officer & Director

We've got two blocks there. Block 53 we own 45% of. That seismic was shot prior. We have gone and we drilled a well last year and have gone in and fully evaluated that. We have a handful of prospects we're looking at. We have contracted a rig and anticipate drilling a well on Block 53 in very early 2017. Block 58, we are currently shooting seismic there now, and we own that block 100%.

Operator

Our next question comes from the line of Brian Singer with Goldman Sachs.

Brian Singer - Goldman Sachs & Co.

Thank you, good afternoon. As you begin to ramp up CapEx a bit, you talked about the incremental going a little bit more for strategic testing versus development. Can you talk about how long the period would be where you'd be more focused on strategic testing versus development based on the inventory or opportunity to do those strategic tests? Or what oil price would you need to see where you would allocate meaningfully more capital towards the development side of the equation?

John J. Christmann - President, Chief Executive Officer & Director

I think the important thing, Brian, is we've got a lot of opportunity in our acreage position that we're excited about, and we have a lot of key wells that we want to drill. We want to get some of those wells drilled because knowing those results and those things will impact how you grade out your capital in the future, which projects you pursue, and also it comes into how you address the portfolio. So there's a lot of things out there. And quite frankly, we took a very balanced approach this year. We took a conservative approach. We budgeted $35. We scaled back significantly. That just slows down the rate at which we're moving through some things that are pretty important to us.

Clearly, with prices averaging in the second quarter above $35, it's given us some cash flow. You see we put a rig out last month in the Midland Basin, which will be drilling some Midland Basin, Wolfcamp, and Lower Spraberry shale wells. So we're excited about that, and clearly we've got some areas where we're doing some additional testing. And I think we'll keep testing until we feel like we're in a position that we're ready to stop testing.

Brian Singer - Goldman Sachs & Co.

Got it, thanks. I guess it goes to the question of is $45 a good price for Apache or just a better price than $35 to accomplish both your delineation, development, and potentially in places like Suriname, exploration objectives? Or do you feel like you need the $50, $55, $60 to accomplish those objectives based on today's cost structure and how you see the balance sheet?

John J. Christmann - President, Chief Executive Officer & Director

I think the point there is, with the progress we've made on cost structure, we feel pretty good about even a $45 deck. If you go back to this year, and keep in mind our North American capital has not gone to development type projects to try to bring on volumes, at $45, if we budgeted $45 and added an additional $900 million of CapEx to North America this year, we would have kept North America flat, lived within our means, and we're already keeping our international flat.

So I think the thing as we think into 2017, that number is going to be lower. Number one, our capital efficiencies are much, much better. They continue to get better. You see the progress we're making on the cost structure, the overhead structure, the LOE, the well costs. So our capital efficiency is actually – we continue to surprise ourselves with the progress we're making on the capital efficiency side. And then the other piece is, our base has come down a little bit as we've been less focused on growth and more focused on adjusting cost structure to where we can generate returns. So quite frankly, $45 would have been a pretty comfortable price for us this year, and I think that number would be lower in 2017.

Operator

Our next question comes from the line of John Freeman with Raymond James.

John A. Freeman - Raymond James & Associates, Inc.

Good afternoon. When I'm thinking about the CapEx budget and through the new conversation on the higher end, can I still think about that when I'm looking at the implied oil price? Is it still okay to just say roughly, on an annualized basis, $400 million of incremental cash flow for every $5 improvement in the oil price?

John J. Christmann - President, Chief Executive Officer & Director

I think that's a pretty good number annualized.

John A. Freeman - Raymond James & Associates, Inc.

Okay, and then just one quick one. On the North Sea, last quarter you all had a good bit of the third-party plant and some pipeline outages, and I'm just curious. Did all of that get resolved, or did any of that spill into this quarter?

John J. Christmann - President, Chief Executive Officer & Director

I think we had a little bit. It was better this quarter. But I think we planned for a little bit more than in years past, but it's much better today.

Operator

Our next question comes from the line of Evan Calio with Morgan Stanley.

Evan Calio - Morgan Stanley & Co. LLC

Good afternoon, guys. My first question is a follow-up to Brian's macro question. John, you've been constructive on the oil outlook since February, and now you've begun a modest acceleration. So as it relates to Apache, what are your early thoughts on 2017 volumes on a low $50 oil price? And are you ready to join the emerging, growing low $50s club that seems to be emerging from earnings?

And I guess secondly, given the tremendous costs and sequential improvements, any thoughts on what that means for your commodity outlook that have been pretty constructive since they've been pretty accurate as well?

John J. Christmann - President, Chief Executive Officer & Director

The first thing I would say is we're going to be a member of the returns club, is the club we want to be focused in and focused on full cycle, full cost, fully burdened returns. And that's the club we're focused in. I think above $45 this year, you would have seen our volumes grow and been able to do that. So as I think about joining a $50 club, we probably already were in the $50 club. So we just haven't planned accordingly. We budgeted $35 this year, and you've seen us let a little bit of capital out.

So I think the market today is more constructive than it's been, both on oil and natural gas. I think it got a little bit ahead of itself here in the last few months, and we've seen it come back as we went back and touched $40. I think we'll see what kind of price band we look at as we get into 2017. I don't see us departing from a conservative budgeting approach, gearing things to the low end of the band. And then we can always let a little bit out where we don't get ourselves in trouble in terms of spending out way beyond our means.

Evan Calio - Morgan Stanley & Co. LLC

Great. My second question, your Bone Springs results have been very good. It's a smaller position there, Midland very attractive. We get the question on the depth of Apache's Tier 1 unconventional inventory. So any update or comments on the number of locations, percentage, or how you think about the amount that's economically attractive at a four-year or how you would classify as a Tier 1?

John J. Christmann - President, Chief Executive Officer & Director

We haven't come out and really updated anything since the fall of 2014. And the approach has been we've been doing primarily strategic testing. We're not running a ton of rigs in North America. We were running 93 rigs in the fall of 2014, and we had four rigs for most of last quarter. I think at some point in the future as we start to turn more capital loose, we'll come out and talk more about some of those things. We feel good about our acreage. We feel good about our inventory. We've been building inventory. And the big deal is working the cost structure. And you see with the few number of rigs we're running, you see results getting significantly better. And that's a credit to all of our teams, the science they're applying, and the progress we're making. So we feel quite good about our inventory, our running room in a number of plays.

Operator

Our next question comes from the line of Edward Westlake with Credit Suisse.

Edward G. Westlake - Credit Suisse Securities (USA) LLC (Broker)

Good afternoon. I guess you've allocated more capital to the Permian, and obviously that brings into question I guess non-core assets. You've got $7 billion of net debt, which could still be viewed as a bit high in a volatile oil price environment. So maybe talk through about disposals or the plans for Canada, the Mid-Continent, and the Gulf, an area which has not gotten as much capital together.

John J. Christmann - President, Chief Executive Officer & Director

I think right now we've been working on North American cost structure. And I'm thankful that we're not in the position that we're wholesale selling assets and that over the last 12 months in this low price environment. We moved some conventional assets in late 2014 when prices were high. We moved some South Louisiana assets in late 2014 when prices were high. We moved our LNG on a high price deck. So I feel real good about what we were able to sell.

I think as we look at the portfolio, and it will continue to evolve. And as we continue to assess our inventory and look at that, we'll address some of those decisions over the next 24 months in the future. But I don't see right now is a time that you want to be trying to just sell assets and bring forward cash when we're not in a period where we're outspending or wanting to spend more and drive a lot of development in this low price environment either. But clearly, over the next 24 months, we'll continue to assess what the portfolio looks like and where we will be making those types of investments.

Edward G. Westlake - Credit Suisse Securities (USA) LLC (Broker)

And a lot of your debt has got great duration. There is some in the 2018 to 2024 timeframe. Any plans on aiming free cash flow to reduce that debt or asset disposals?

Stephen J. Riney - Chief Financial Officer & Executive Vice President

Thanks for throwing the finance guy a bone. So no, we are looking at possibly using some of the cash on hand to pay down some of the debt. I don't think we'll be going to any extreme amount. But if we could maybe pay down a little bit of debt as we end this year, maybe into next year, that wouldn't be a bad thing.

I think you indicated we had a relatively high level of debt. I think our debt level is actually pretty comfortable right now. It could certainly be a little bit lower, yes. But with $1.2 billion of cash today and $3.5 billion of credit facility, I feel pretty comfortable with our debt level now. I might use some of the cash to pay down debt, especially in the short term. And in the meantime, I don't find that our debt level is what I would call burdensome, especially given the capital spending program that we have going on right now.

Operator

Our next question comes from the line of Doug Leggate with Bank of America Merrill Lynch.

Doug Leggate - Bank of America Merrill Lynch

Thanks, good afternoon. Stephen, I wonder if I could throw you another bone. The LOE guidance, clearly tremendous cost progress you guys have made. How much of that would you say is going to be kept by Apache, assuming oil prices do go back up? I guess we're hearing the service companies are starting to chat a little bit about them needing some relief to some extent.

Stephen J. Riney - Chief Financial Officer & Executive Vice President

Thanks, Doug. We feel like the vast majority of our cost reductions, not just in LOE, but on the capital side and on the expense side, we feel like the vast majority of those are going to be cost reductions that we can retain. Sure, if oil prices go back up, when they go back up, there will be some pressures in some places. I'm sure John will want to weigh in on this question as well.

But we feel like a lot of the actions that we've taken are really what we would call self-help type of things, changing the way we work, changing the way we do things, and both on the capital side and on the expense side. These are things that are not dependent upon the pricing from third parties. They're things that we do and the way that we work, and we feel like the vast majority of those are permanent. And a significant amount of these cost reductions have come in the onshore North America and in particular in the Permian Basin.

John J. Christmann - President, Chief Executive Officer & Director

And the only thing I would add, Doug, is just a lot to our field folks. What we've got is workforce out there that's taken on the burden of doing things themselves, things that they might have contracted in the past, and it's that old Apache hard-core, low-cost mentality, where everybody realizes they can pitch in and save a few dollars here, and it adds up. And it's that mindset that I think that you've seen really come through in 2016.

Doug Leggate - Bank of America Merrill Lynch

John, my follow up, if I may, is it seems from your prepared remarks that you're making some pretty good progress in your strategic review in terms of the initiatives and so on. Can you give us some idea where you stand then in terms of what you think is the identified inventory? Because clearly, you have a very large footprint, and I'm guessing that there's room for another portfolio high-grading exercise in North America somewhere down the line. If you could just give us some color on that, that would be great.

John J. Christmann - President, Chief Executive Officer & Director

I think the color we'll give you is we've been busy, and we're going to continue to be busy. We've had to go through a total reset in the business over the last 18 months. And the good news is we've made progress in all aspects of our portfolio. From Canada to our Mid-Continent to our Eagle Ford to our Permian, we've made progress in all of our projects, and we have a deep inventory. We also have a lot of key things that we're testing, which obviously could change the pecking order things. So we're working through all those things, Doug.

I think as we start to make some decisions and conclude some of the testing and things that we're doing and start to talk about some of that, I think then that leads to what some of the follow-ons might be after that. But I'm excited about the progress that we're making across the entire portfolio and that all of our areas are doing a fantastic job. And we've got a lot of things that look very attractive with where prices are today and where cost structure has moved today.

Operator

Our next question comes from the line of Charles Meade with Johnson Rice & Company.

Charles A. Meade - Johnson Rice & Co. LLC

Good afternoon, John, and to the rest of your team there. I'd like to drill in a little bit more on your Midland Basin program, where you're putting that rig back to work, or where you've recently put that rig back to work. Could you talk a little bit about, in your prepared comments, you mentioned the CC 4144 East 2HM well that came on at 2,200 BOE a day. Could you talk about, is that also in the Powell-Miller area, and was it also a 5,000-foot lateral, or was it a longer lateral?

Timothy J. Sullivan - Executive Vice President – Operations Support

Charles, this is Tim Sullivan. That well was in the Powell field. It is a little bit longer. It's about a mile and a half lateral, and it's currently flowing at a rate of about 2,000 barrels a day and about 1,800 MCF per day as well.

And in regard to the activity for that additional rig, second half activity in Midland will consist probably of about 17 wells, primarily focusing in the Wolfcamp and the Lower Spraberry shale. And where we will be drilling, again strategic testing in our three main fields at Wildfire, Azalea, and at Powell. And that should keep that rig busy for the remainder of 2016.

John J. Christmann - President, Chief Executive Officer & Director

The thing I'd add to that, Charles, is we've been busy doing some swaps and some things too that have really cored up that acreage neutral, but have cored up our position where we really can drill more longer laterals now and less the shorter laterals. That's another thing that some of the progress that we've made while we haven't had rigs in the field.

Charles A. Meade - Johnson Rice & Co. LLC

Got it. And, John, that actually gets to where I was going to go with my follow-up. Should we expect more longer laterals? It sounds like yes. And are you also still testing your individual landing zones within those formations, or do you think that you've pretty much figured out where you want to go there and you're more testing completion concepts at this point? Can you give us a sense?

John J. Christmann - President, Chief Executive Officer & Director

The answer to the first question is yes. You can anticipate longer laterals. That's one of the things we've been working on in our Midland basin portfolio. And then secondly, we're making progress, but there will still be some testing with this rig and some of these concepts. We've got a pretty good idea we'll be working some spacing tests as well as the zones and how you stack those zones across a section. And so we'll never stop testing.

Operator

Ladies and gentlemen, we have reached the end of our allotted time for today. Presenters, did you have any closing remarks?

Gary T. Clark - Vice President-Investor Relations

Yes, this is Gary Clark. For those of you that did not have an opportunity to ask a question, please feel free to follow up with myself or my team, and we'll be happy to get back and answer any remaining questions you have. Thank you all for joining us today and we'll talk to you next quarter.

Operator

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.

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