Talisman Energy Inc. Q3 2007 Earnings Call Transcript

Nov. 4.07 | About: Talisman Energy (TLM)

Talisman Energy Inc. (NYSE:TLM)

Q3 2007 Earnings Call

November 2, 2007, 1:00 PM ET

Executives

John A. Manzoni - President and CEO

Phil Dolan - Vice-President, Finance and CFO

Ronald J. Eckhardt - EVP, North American Operations

T. Nigel D. Hares - EVP, International Operations

John 't Hart - Executive Vice-President, Exploration.

Paul Blakeley - Executive Vice-President, International Operations

Analysts

Brian Singer - Goldman Sachs

Robert Morris - Banc of America

Kam Sandhar - Peters & Co. Limited

Steve Calderwood - Raymond James

Chris Theal - Tristone Capital

Brian Dutton - Credit Suisse

Benjamin Dell - Berstein (Sanford C.) & Co

Andrew Potter - UBS Securities

Gil Yang - Citigroup Smith Barney

Robert Plexman - CIBC World Markets

Operator

Good morning ladies and gentlemen and thank you for standing by. Welcome to the Talisman Energy Inc., Third Quarter Results Conference Call. At this time, all participants are in a listen-only mode. Following the presentation we will conduct a question-and-answer session, instructions will be provided at that time for you to queue up for questions. [Operator Instructions]. This call contains forward-looking information. Certain material factors and assumptions were applied in making the forecast and projections to be discussed in this call and actual results could differ materially from those anticipated by Talisman and described in the forward-looking information.

Please refer to the cautionary advisories in November 1, 2007 new release and Talisman's most recent annual information form which contains additional information of the applicable risk factors and assumptions.

I would like to remind everyone that this conference call is being recorded on Friday November 2, 2007 at 11 a.m. Mountain Time.

I would now like to turn the conference over to Mr. John Manzoni, President and Chief Executive Officer. Please go ahead.

John A. Manzoni - President and Chief Executive Officer

Thank you very much. Ladies and gentlemen good morning, and welcome and thank you for joining our third quarter conference call. This is my first conference call for Talisman and I want to start by saying how excited I am to be part of this team and I am looking forward very much to getting to know all of you better over the course of the next few months.

I am joined here today in Calgary by the management team Nigel Hares, Ron Eckhardt, Paul Blakeley, John 't Hart, Phil Dolan, Jackie Sheppard, Robert Redgate and Layal Mcloud [ph].

As you've seen already we've changed the format of our press release slightly this quarter. Our intent here is to allow you to see more quickly and distinctly what the company is doing. And we've posted the full discussion, analysis and financials on our website.

Now I think you'd be little disappointed if I didn't share some reflections from my first 8 weeks in this role. So today before discussing the quarter I would like to do that and give you a sense of the priorities for myself and the management team going forward.

My first observation is that Talisman has great people and very strong assets. The assets will provide the great platform to build the next phase of the company's growth. And I found the people in the company focused and hardworking and I am delighted to say have welcomed me warmly into my new role.

My second point is that although the company has a good safety record, I am determined that we will have no room for complacency. And I plan to focus on the systems and processes which will drive continuous improvement in this area. I want there to be no question internally or externally that continued safety of our operations is my highest priority.

My third observation is that by not delivering our guidance numbers in the last few quarters we are losing credibility. Although this isn't necessarily unique to Talisman in my meetings with many of you over the last few weeks, you've pointed this out to me and of course I can say it myself internally. I am quite determined that going forward we will improve our track record in this area, we must achieve the targets we set.

The good news from what I can see is that this is not significantly related to underlying reservoir performance. The challenges arise from general pressures on the supply chain and limited project and engineering capabilities particularly in house. Here in Canada, the supply chain is under pressure because of the activity levels driven by oil sands and in the North Sea and Southeast Asia, similar pressures are being felt across the industry.

In basic terms, we feel we've relied too much on outside contractors. It used to work very well on a reward for performance basis but not in today's overheated market. In response, we've taken steps to strengthen our internal project capability, and we're embedding our own people into critical areas like design and procurement.

In the North Sea alone, we've hired over 50 project specialists in the last 12 months. The Duart project in the North Sea was a test case and I am happy to say came in two months ahead of schedule. We're also changing our internal processes so that we more carefully assess the risks to project delivery and put in place actions to address those risks before moving new projects through the approvals process. This should provide more certainty in terms of timing.

We've also undertaken a fairly comprehensive review of our forecast production for the remainder of this year, and we're in the process of doing the same for the future. Since we still have a number of projects in the pipeline, my second priority after safety is to fully underpin that delivery and meet the targets we communicated.

This brings me to my fourth observation which relates to the portfolio and it's potential. We have a portfolio which has high returns and has embedded growth for the next few years from our underlying operations. Over the last two years, we've been trimming the portfolio and divesting non-core assets which has resulted in the falling headline production rate. By the end of this year, we will have received about $1.6 billion of proceeds and used those funds to buy back over 80 million shares.

We will continue to trim and focus our activities so that we can concentrate our resources on higher return assets which have growth potential, but in our core operations we've been spending heavily on new projects and we're just starting to see the benefits. In the UK North Sea we've bought Blane and Duart fields on stream, Wood should come on stream over the next few days and we're a few weeks away from ramping up production to about 40,000 barrels a day at Tweedsmuir. And going into 2008, field developments underway at Galley, Affleck, Enoch in the UK as well as Rev and Yme in Norway.

In Southeast Asia, we're expecting to bring the Song Doc field on stream in about mid 2008 and as well as the first phase of the Northern Fields in the Malaysia-Vietnam joint area.

In Indonesia, the pipeline to West Java began taking gas in October this year with a projected ramp-up through 2008. In our North American operations, as you know we've built an extensive land position, particularly in the Alberta Foothills, which we're in the early stages of drilling.

We are, of course, now carefully reviewing the impact of the proposed changes to Alberta royalties before finalizing our drilling program, both through the remainder of this year and into next year. It's taking quite a lot of time to run the numbers, because the new royalty rates are as you know sensitive to price, debt and volumes and thereby become well specific. In general terms, I think we can say we're concerned of the impact of the royalty rates in particularly on deep, high productivity wells in the Alberta Foothills.

Also prompted by the royalty regime changes, I put on hold the proposed monetization of our midstream assets. The market is just too uncertain for the moment in the light of those royalty changes. We plan to reassess the potential of this business as part of our longer term review of growth options.

I've outlined some of the projects we have underway to remind you of the growth potential within this portfolio over the course of the next two to three years. Our capital program has reflected this and we're just now starting to see the first project come on-stream from that spending. We must deliver the remainder of the program effectively and hence my second priority to ensure that we underpin that delivery.

Looking further ahead, our portfolio also contains a rich set of longer term growth opportunities. Some growth will come from our exploration activities and some I expect will continue to come from us being opportunistic in the marketplace.

My third priority is to provide you over time with a clear vision of just how we expect to deliver growth in cash flow over the longer term while maintaining our attention to the returns of the portfolio. We've just begun an internal review to help us make choices and focus our efforts, and over the course of the next few months, we will begin to articulate these longer term opportunities and choices for you. I currently see no reason to change our longer term goal to 5% to 10% production per share growth as long as it adds shareholder value.

So in summary, my priorities are first to ensure that we continue to have safe operations; second, to deliver on our promises and set and achieve realistic growth targets for the next year and beyond; and third, over time to clarify the opportunities and choices which will secure longer term growth in cash flow.

Now I'd like to turn to the third quarter and perhaps highlight some of the results for you before asking Phil Dolan to fill in some details. Cash flow for the quarter has remained robust at around $1.13 billion in spite of lower production and lower gas netbacks. Earnings were down hit by lower production, higher DD&A and higher dry hole costs. However, our returns in the portfolio remain very competitive at around 19%.

Headline production averaged 441,000 barrels a day which is down 4% from a year ago, but this is largely due to non-core asset sales which in total will add up to 55,000 barrels a day by the end of the year. Production from our underlying operations grew 1% and production per share increased by 3% reflecting our share repurchase program.

Looking ahead to the fourth quarter, we expect production to average between 460,000 and 470,000 barrels a day benefiting from the new projects which are coming online now. I aware that this may be lower than the estimate that some of you are carrying. We suffered a number of delays through this year in bringing our capital projects on stream. These delays have also had some impact on the fourth quarter production rates and relate mainly to the projects moving forward in the North Sea.

In addition, we've seen some extended maintenance turnaround which are currently reducing our 4Q projections. We have also seen a series of integrity issues with right... with risers which have been shut-in until we can ensure safe production. In Australia for instance, there was a riser failure in the Corallina field in early October and this is likely to impact production for several months.

Finally, it is possible we may conclude the sale of our Brae assets in the U.K. earlier than planned at the end of November and Brae is currently producing around 16,000 barrels a day. Despite the delays and some operational issues which we will fix, the long awaited projects are now starting to come online giving us confidence that we will begin to see the benefits in production and unit costs as we move forward.

Our exploration program continues of course with a number of wells currently drilling including a sidetrack appraisal to test the commerciality for Cayley discovery in the Montrose area of the North Sea. In North America, we drilled several successful wells during the quarter in the Alberta Foothills.

You will also note that the pace of buybacks has slowed in the third quarter and that we've begun to pay down debt. Our buyback program over the last two years has bought about $1.6 billion worth of shares broadly matching the sales proceeds which we expect to have gained from our disposition program by the end of this year. This was our stated objective and therefore this phase of the buyback program is now complete.

Now I'd like to hand to Phil who will take you through the main points of the release. So, Phil over to you.

Phil Dolan - Vice-President, Finance and Chief Financial Officer

Thanks John. Overall production was down 4% to 441,000 boe per day, the result of non-core asset sale. Production from continuing operations increased by 1%.

In North America, excluding asset sales, gas volumes were down 1% compared to a year ago largely due to turnarounds in the Greater Arch and Southern Alberta Foothills and core development results in the Eastern U.S.. However, we set a new production record in the Foothills and grew production at Monkman and the Bigstone/Wild River areas.

In the UK volumes were up 70% excluding asset sales due to new field start-ups and successful development drilling. The rig development is about to start and we expect additional volumes from Tweedsmuir in a few weeks.

Volumes in Southeast Asia were down slightly over last year primarily due to natural declines in the PM305 field. We have commissioned the new BRE gas facility at PM-3 which will add to gas volumes going forward.

Indonesia volumes were up 10% with higher nomination in Corridor and following completions of the South Sumatra to West Java pipeline. PGN has been taking $14 million a day of gross sales gas at $14 million a day net count.

Cash flow for the quarter was $1.1 billion, is relatively unchanged from a year ago. This was relatively robust performance given the drop in gas prices and lower production volumes. Cash flow per share was up 7% reflecting share buyback.

Net income was down 33% from a year ago, also reflecting the impact of volumes and netbacks. In addition, we also saw higher DD&A and dry hole costs. Dry hole costs were unusually high at a $149 million, largely due to some extent of foothills and Appalachian wells in North America and onshore wells in Trinidad and the Naga Dalam well in Malaysia.

Netbacks were down 4% from a year ago. But the increase in world oil prices was offset by the 8% gain in the Canadian dollar over the period. NYMEX gas prices were up 6% from a year earlier and AECO was down 14%, also impacted by exchange rates.

Royalty rates were relatively unchanged from a year earlier. Unit operating costs were up 26%, compared to the third quarter of 2006. Of the total increase of a $108 million in operating expenses, about a third is due to the acquisition of the Auk and Fulmar field in the North Sea at the end of last year.

But off redevelopment, these unit costs will come down. In the short term, as John mentioned, we expect unit operating costs to fall in the fourth quarter with the forecast volume increase.

My final point is that we paid down $385 million in long terms debt, during the quarter and also saw reduction in the debt levels due to foreign exchange movements.

At September 30th, long terms debt, net of cash was $4.2 billion. But the trailing debt to cash flow ratio of 1.05 to 1. Thank you, I'll now turn it back to John.

John A. Manzoni - President and Chief Executive Officer

Thank you Phil. I think you've already heard enough from us for now. So I think now what we should do is, turn it over to you for some questions and the management team and I would be now be very happy to answer your questions.

Question And Answer

Operator

[Operator Instructions]. Your first question comes from Brian Singer of Goldman Sachs. Please go ahead.

Brian Singer - Goldman Sachs

Thank you. Good morning. Given the lack of... I guess final decision of processing of exactly what the Canadian royalties will do for the deep gas drilling program, how do you think about the timing of your winter drilling program and when do you have to make a final decision on what you are going to do?

John A. Manzoni - President and Chief Executive Officer

Thank you, Brian. I am going to ask Ron to answer that question for you.

Ronald J. Eckhardt - Executive Vice President, North American Operations

The deep program well. Let's be clear on deep and really deep. What industry has been calling deep is what we would call... normally call deep basin and multi-zone well. And those are relatively unaffected by the royalty programs. Although payouts are stretched slightly NPVs are relatively unaffected. The deeper programs what we call deep in the foothills because they're higher rates built in... because they're high rates initial... initially in their life both NPV and payouts are affected. And because the royalty rates are very sensitive to rate we have to work through our program on a well-by-well basis. And that's exactly what we are doing in the course of a number of the months, we will have that effect... well in the course of the number of weeks we will have that effect.

John A. Manzoni - President and Chief Executive Officer

I think Brian directionally. For the deep foothill wells in the conventional gas, the royalties structured are going to have an impact. We've already signaled some reduction going forward into next year in terms of our programs, and Ron is busy working through detail for the results of the program that he can impact in the fourth quarter. Does that help?

Brian Singer - Goldman Sachs

It does, thank you. And then in your opening comments you mentioned the impact of that asset sales have had on headline production numbers being down year-on-year. Obviously that's going to change but the projects you referenced that are coming on, but where do acquisitions if at all fall into your priorities as a way of both sailing growth and using free cash flow?

John A. Manzoni - President and Chief Executive Officer

I think as we go forward... the answer... direct answer to your question is that, the history of this company has been based in acquisition. As we go forward we will be considering of course all sources of growth of cash flow going forward and acquisitions will feature as part of those considerations as well as exploration and exploitation of the core asset areas that we have today. So, I think all options open, Brian.

Brian Singer - Goldman Sachs

Great. Thank you.

Operator

Your next question comes from Robert Morris of Banc of America. Please go ahead.

Robert Morris - Banc of America

Good morning, John. Two quick questions. You mentioned that the phase of share repurchases being funded by asset sales is a pretty much wrapped up now. How do you think about share repurchases going forward, will that be solely funded by cash flow, excess cash flow, if you do have it which obviously is dependant on commodity prices? And if you don't have the excess cash, how are you going to approach that going forward for share repurchases?

John A. Manzoni - President and Chief Executive Officer

Robert, let me deal with that one first then. So, yes I have said that, we broadly matched up to this point disposition proceeds with the share buyback program, that was the undertaking and that therefore now brought us to a close. Now looking forward, my preference quite clearly is to use our cash flow to invest in profitable and high return oil and gas development activities. So that must be our number one aim, and that I think that I have indicated that we have initiated process which really looks at all of our options for that, so that we can identify, how much we want to spend and the priority with which we want to spend it.

So first call on free cash flow going forward is investments into oil and gas development activities. Now until we are clear on what the opportunity in those core areas are/is and how much and where we want to spend it, it's a little difficult therefore to articulate that we are going to continue to put buy backs. I think buybacks is a good interim strategy, I don't think it's a long-term strategy. I'd far rather identify new development projects around the world in which to invest our cash. So that's my stance on this.

As you say, excess cash if it's available then we'll have to make decisions at that time. But for now I want to identify, have a really good review of all of our areas and their future potential. They all have potential by the way. The issue is what priority we accord to which and how we allocate the capital.

Robert Morris - Banc of America

Okay. In that regard as you look at your projects, and had been mentioned before by the company that had built a substantial inventory of unconventional targets, Alberta and in Appalachia that you would resume activity on if natural gas prices rebounded. Are we at that point now or, where would you then look to step up activity, natural gas price wise on those?

John A. Manzoni - President and Chief Executive Officer

So, let me... I am going to turn this to Ron in one second. I mean I think unconventional is clearly one of the options available to us in North America. So Ron, any comments on unconventionals for Robert?

Ronald J. Eckhardt - Executive Vice President, North American Operations

Specifically in Eastern North America as you know we have lots of shale opportunities there. We are engaged with other shale players and talking about possible joint ventures and looking at it, and over the course of 2008 we plan on drilling one or two horizontal wells and complete them with modern kind of up-to-date completion technology and are planning on making material decision in 2008. And I think the point is doubling isn't the answer, we're going to either commit or not.

John A. Manzoni - President and Chief Executive Officer

I think that's a great answer Ron. I mean I think the issue here is that if we are going to step into it, we need to step into it and that's a strategic decision, Robert which you may end up of course gets mixed up in the mix of our review over the course of the next few months. And as Ron says we're taking some steps in the course of 2008 which will help us make that decision.

Robert Morris - Banc of America

Okay. So initially it's more like testing than anything else. Okay. Good. Thank you.

Ronald J. Eckhardt - Executive Vice President, North American Operations

Okay.

Operator

Your next question comes from Kam Sandhar of Peters & Company. Please go ahead.

Kam Sandhar - Peters & Co. Limited

Hi John. Quick question, I know earlier when you were talking in your earlier calls, you mentioned that you're looking... you've done fair a bit of asset rationalization already, but you are looking to do further non-core assets divestments. So could you just comment on what areas you're looking at doing that or is there a specific regions you are looking at exiting?

John A. Manzoni - President and Chief Executive Officer

Kam I think, I have to be general in my response to you because it's just too early at the moment to make... to be too specific. But I think what I... we have not been afraid of trimming the tail of the portfolio of course of the last 18 months. And I think what I am signaling is that we shall not be afraid to do so going forward. The important thing here is for me, the areas in which we invest must have a good return and they must have potential to grow into the future and preferably potential if they are new areas to grow in to new core areas for the company. So we are looking for that. And the issue of course then we must examine our portfolio through a number of different lenses to identify how we can release cash in order to invest into areas with those qualities.

I think that, it's going to be a little while before I'm going to be more specific than that, frankly two weeks in, I'll have... we'll have more conversations and we'll have better ideas if we wait a little bit longer. If you don't mind.

Kam Sandhar - Peters & Co. Limited

Okay, thanks.

Operator

Your next question comes from Harry Meteria [ph] of Lehman Brothers. Please go ahead.

Unidentified Analyst

Hi guys. Just first, can you clarify that so when you receive the proceeds on Brae those proceeds will be applied towards I assume debt reduction rather than buying back shares in the quarter because you've already used the bank revolver to buy back shares previously?

John A. Manzoni - President and Chief Executive Officer

That's correct. We are not identifying specifically ahead. The Brae sale proceeds to buy back future shares because it's already matched up.

Unidentified Analyst

Okay. So you had about $1.4 billion drawn on the bank line at the end of the quarter. Assuming Brae has applied towards reducing the revolver. That gets you to a little over $800 million. I guess my question is two-fold. One, if I am looking at this right you projections imply capital spending of roughly $1.5 billion to $1.6 billion in the fourth quarter and cash flow of roughly $1.1 billion to $1.2 billion. So, given then it looks like you will be out spending cash flow by at least few hundred million in the quarter. What's the plug there? Do you intend to draw down on the bank line to bridge the gap between free cash flow or what's finding that difference? And then secondly, given that in any case you are still going to have a fairly significant amount drawn on the revolver what are your plans for any term debt issuance over the next six months?

John A. Manzoni - President and Chief Executive Officer

Harrylet me just say. I mean I think... I am not... I don't think we are projecting hugely cash negativity in the fourth quarter as we go forward. I don't think there is a big gap here. I am going to turn to Phil in a minute to ask him what we are going to do in particular or if we can say anything about return debt situation in fourth quarter. Phil?

Phil Dolan - Vice-President, Finance and Chief Financial Officer

I would say no for us to term our debt to likely time would be sometime in 2008 we might consider it much later.

John A. Manzoni - President and Chief Executive Officer

I think Harry it'll all to do with how you consider the cash balances going forward. I don't think we have got very strong ratios. I am not frankly least speaking in any way about the balance sheet but I don't actually see an issue in the fourth quarter, as particularly our cash flows look relatively robust from here we paid down something in the third quarter. As we go forward the cash balances look pretty healthy. We've got strong prices as we are going into the fourth quarter as we... as I sit and talk today. So I am not sure, I don't know whether I have pin pointed your concern but I may be not seeing the same issue as you are.

Unidentified Analyst

No, it's less of a concern a more just a question regarding whether or not you guys want to turn that out sooner rather than later rather than increasing debt just whether you want to term it out?

John A. Manzoni - President and Chief Executive Officer

Yes, I mean in due course, we are obviously are going to keep reviewing the term structure of the debt and the bank lines versus the long term debt structures. This is a sort of fluid situation but I doubt we will make any comment at the moment.

Unidentified Analyst

Okay, that's helpful. Thank you.

John A. Manzoni - President and Chief Executive Officer

Thanks Harry.

Operator

Your next question comes from Steven Calderwood of Raymond James. Please go ahead.

Steve Calderwood - Raymond James

Yes good morning thanks for taking my question. John on the guidance especially for 4Q '07 the mid-point of which implies a 5% growth over 3Q. You are fairly certain on the band on one hand I suppose this is due to the fact we are close to the end of the year but on the other hand Tweedsmuir alone is 14,000 barrels a day. So you must be pretty certain about the timing and the start of... I think I have got November 14 in my note somewhere. Is that what you are shooting for, is that... in that project?

John A. Manzoni - President and Chief Executive Officer

Steve,I hope we put... you are absolutely right I mean Tweedsmuir is a big deal at the end of this year and it's 40,000 barrels a day, the projection is that it'll be 40,000 barrels a day at the end of the year and provided that's the case, then we're going to be in the zone of the guidance that we provided to you. Now, you think you mapped November the 14th. I mean I think I am going to ask Nigel how confident he is feeling about Tweedsmuir. I hope we've put just before Nigel, because that I hope, we've put sufficient boundaries on this. I'm very clear, if for any reasons, Tweedsmuir is not clearing at the end of the year, we will not be within that guidance, because it's a big deal for us at the end of this year. How confident you are feeling Nigel.

T. Nigel D. Hares - Executive Vice President, International Operations

Well, I think the first thing I'd say Steve is that in our... we do not project Tweedsmuir in our 4Q guidance here, that come off one day and be at 40,000 for the rest of the year. We're taking a cautious approach and we have between a 50% on the 60%, 70% uptime assumed in our guidance. That's the first point I would say. Secondly, I would say, within our projections, we have a band of when they'd startup, two to three weeks from now.

Steve Calderwood - Raymond James

Excellent. So, getting back to the, how fine should the range be if you're sort of giving guidance for 2008 in the near future? What would be a reasonable boundary for guidance on... I mean obviously, you want to be growing production and maximizing production growth in an E&P business. So, I'm not sure what the point have been upper end of the band is, but is that what you're implying that you need to hit a target which is fairly narrow?

John A. Manzoni - President and Chief Executive Officer

No, I mean, Steve, you know me well enough and I know you that I'm going to give you as little guidance as latest possible; I've told you that. But I have to say that I think, range is a better and I'm not going to be drawn on 2008, yet. Frankly, because other than to say what I have said, which is that I see no current reason to change the 5% to 10% production per share growth over the longer term for this company and I... we need to properly assimilate before we start talking about 2008 guidance I would expect that you will see a range when we do it.

Steve Calderwood - Raymond James

Okay. If I could ask a second question on exploration. The vast number of areas that you're currently exploring the world, can you say that there is certain number which is some optimum to pursue? And if it is through to be able to rank the exploration prospects unless let's just say for example in Alaska it was number one prospect, I'm not sure if you have been to Alaska, you said you've been to some of the operations. But and you may not have had time to formulate any opinion on Alaska at all. But if you rank things isn't it better just to pour majority of the money into the best exploration prospect?

John A. Manzoni - President and Chief Executive Officer

John, let me ask you to make a comment on this one.

John 't Hart - Executive Vice-President, Exploration.

Yes Steve, I 100% agree with you, we are in a number of areas, some of them came in through acquisition, some of them were at bottom up via exploration [ph]. And we are in the process of our strategic review prioritizing these opportunities and it is very clear that some of them rank quite a bit higher than others, and from our past discussions we have indicated that areas like... like of Vietnam, like Norway and our key areas where we see significant exploration upside. Now in some of the other areas we see significant upside as well. And there are a few which will have to prove over the next year whether they go make it. So the bottom line is, a year from now we likely will be in a few less exploration areas than we are at the moment, and then we have the mix of lower risk, lower rewards and higher risk, high rewards. And you are in Vietnam and we looked at Indonesia. And of course this is high potential but also high risk and at the moment we see this as a risky thing. But if it works, it will be great for this company. So at bottom-line, I think we will at less exploration areas in a year's time.

Steve Calderwood - Raymond James

So I heard you say that the number of areas is going to go down, right?

John 't Hart - Executive Vice-President, Exploration.

I think so, yes.

Steve Calderwood - Raymond James

Okay. Thank you.

Operator

Your next question comes from Chris Theal of Tristone Capital. Please go ahead.

Chris Theal - Tristone Capital

Hi John, two questions. The first is on the letter regarding the original panel recommendations on royalties. Talisman had indicated at least a drop of $500 million in spending in Canada. Just reflecting the cost structure here, is that a baseline minimum in terms of what we can expect on lower spending next year and how would you gauge any increment above that with respect to the royalty decision?

John A. Manzoni - President and Chief Executive Officer

Yes Chris, let me answer the question. I mean we have already signaled from I think from prior years of the guidance or whatever was in the marketplace that we had already trimmed our North American capital budget going into 2008. And that was signaled, that was the one of the signals that Jim put in the marketplace a month or two ago, and I think that stands frankly because, and it's to do with the cost structure, it's to do with choices of where we decide to put our capital and all of that. So consider that as a... we've already set that. Now we need to think now about, partly how the royalty impact is overlapping with that or to what extent it extends that. Ron do you want make any other comment on this?

Ronald J. Eckhardt - Executive Vice President, North American Operations

No I think that's right your points have another $0.5 billion set in the minimum bar I think is very accurate, and we are expected to be less than that. But the impact will be less than that.

Chris Theal - Tristone Capital

Okay. And just secondly switch to Southeast Asia, Hai Su Den had spudded on a numerous well [ph] in Vietnam. Any update in terms of the progress of that well and when you would to see any results from it?

John 't Hart - Executive Vice-President, Exploration.

Yes we are... currently just at the top of the basement, we have an casing and the good news is we found oil on the way down, we found oil just above the basement, and we should be drilling out into the basement in the next... well I hope to in next 24 hours or so. It will take a while before evaluated this well, we plan to drill along horizontal, semi-horizontal wells and we almost think those well, that they will be probably close to year end before we have evaluated this well.

Chris Theal - Tristone Capital

Thanks John.

John 't Hart - Executive Vice-President, Exploration.

Yes, but keep in mind that there are vertical wells drilled into this structure before and both of these found oil. So we feel pretty good about it.

John A. Manzoni - President and Chief Executive Officer

I am trying to persuade these guys to hold that power, but it's not working very well here.

Chris Theal - Tristone Capital

That's very funny.

John A. Manzoni - President and Chief Executive Officer

Does that help.

Chris Theal - Tristone Capital

Yes thanks very much.

John A. Manzoni - President and Chief Executive Officer

Great.

Operator

Your next question comes from Brian Dutton of Credit Suisse. Please go ahead.

Brian Dutton - Credit Suisse

Yes good afternoon, while on the topic of Vietnam, I was wondering if you maybe give us little bit an update or the discussions are progressing in terms of the Hai Su Trang and perhaps developing now along with the TGT discovery?

John A. Manzoni - President and Chief Executive Officer

I am going to ask Paul to answer, see if he could answer that. Paul.

Paul Blakeley - Executive Vice-President, International Operations

Sure. Good morning Brian. The process into Vietnam for development approval is, first of all, to have agreement with the government on the reserves, associated with the development and so that's essential first step; the submission of reserve assessment report, as it's called have been made by the partners on the HST license. We understand that the reserve assessment for the license of the south TGT... where TGT discovery life that reserve assessment has not yet been submitted. So, we're really closed to a point where we'll be reviewing that with the TGT profits and deciding on development schemes going forward. But we're well on the way and I would expect that sometime in the third part of next year we'll be moving towards development planning.

Brian Dutton - Credit Suisse

Thank you and second question is just on the other two wells; you do plan to drill this year on 1502 in Vietnam. Could you give us little bit of an idea as to the size of the prospects that you're drilling, and are they also basement reservoir?

Paul Blakeley - Executive Vice-President, International Operations

No, they are not basement reservoirs. They are tertiary sands. The objectives are I would say in the range of HST or perhaps a little bit bigger. But, honestly, time will tell what we're going to find there and we see this as having some significant amount of risk. So, these are not in the backyard.

Brian Dutton - Credit Suisse

Thank you very much.

Operator

[Operator Instructions] Your next question comes from Ben Dell of Berstein. Please go ahead.

Benjamin Dell - Berstein (Sanford C.) & Co

Thanks. I just have a quick question in terms of your investment opportunities in the current portfolio. When you look at the North Sea versus North America versus Asia where do you believe the best opportunities stand today in terms of putting the incremental dollar to work?

John A. Manzoni - President and Chief Executive Officer

I think it Ben it sort of... it depends which lens you look through. Clearly returns go in the order Asia, North Sea, North America, but all of these areas have I think have opportunities that are different in nature in each area. So in Asia this looks like opportunities to build from existing core activities, some acquisitions may be possible but certainly some exploration excitement and some exploration opportunity and we've got as John has outlined. So quite a program actually is there to as we go forward that's the nature of those opportunities. The nature in the North Sea if you go to Norway looks very similar, quite exciting exploration upside in Norway in the North Sea and North Sea on the UK side the real question for us is what's the prospectivity that we can tie in, high return tie-ins going on there? And then what's the opportunity for us to if you like create new hubs around which we can tie in the future? These are all questions that we got to explore deeply and come to the answers on. So acquire and exploit stuff going on in the North Sea and then North America our upside opportunities we talked about tight gas some people are making that work really well. We have Monkman opportunities where we are going to back and have a look. Deep basin multi-zone stuff that we can go and find. So there are lots and lots of opportunities in North America as well.

Strictly our returns lens would give you, as I said Asia, North Sea and North America. But in that course that you know we got to balance many things. It's about sustainability of the business. It's about long-term developmental core areas. There are some other things that I haven't mentioned outside of our core areas as well which we got to make some choices around. Building out from our base in Algeria might be possible. There are number of other choices that we've got to make. So I think it's who has got a difficult question to say what... strictly which choices will you make and which lenses will you look. Because I have to say... but it's also going to depend. What I will say to you is that the capital will be deployed into areas which hold future growth and which have good returns.

Benjamin Dell - Berstein (Sanford C.) & Co

Okay. Great and second question just on the cost structure. It seems in this quarter that your costs had a reasonable step-up probably slightly more than the rest of the industry. Do you feel on a per unit basis that was because your production came in line... because of operational issues and should reverse it going into the fourth or first quarter or do you think that's an area you need to address going forward from that?

John A. Manzoni - President and Chief Executive Officer

Okay. General issue... I mean the specifics of this quarter are actually in part line in North Sea actually. We've bought on I think Auk also high [ph]. And so I am going to turn to Nigel in a second to talk a bit about the North Sea. So I will give you two answers for the question. My sense of this company is that what we don't have is a sort of an overhang cost problem. I think we are very lean, I think the operations are lean we've clearly got to keep out eye on this and we will. I am not about a major cost cutting exercise in this company. I don't frankly think that it needs it. And as we go forward I fully anticipate that as the production ramps up, the costs will certainly be the... unit costs will certainly be nearer to the going forward. I should probably and in fact will reduce I'm sure going forward. Nigel, a comment on the North Sea.

T. Nigel D. Hares - Executive Vice President, International Operations

Yes, if you look 3Q '06 through 3Q '07 you're right, there was quite a significant increase in our operating costs of $70 million Canadian. About half of that came through our Auk, Fulmar acquisition which we made at the end of '06. And we have plans there obviously to increase production significantly there going forward. The remainder of the increase came... a large part actually came in the retirement area in the North Sea where we have shut in the Gallery field with the floating production facility. But as result of that we're having to buy more gas at market prices for the moment. So going forward, I think as John alluded to in his opening speech with we are at the high point of unit operating costs in the North Sea and as we bring on the remainder of our subsea tie-back [ph] projects we expect to go sub $20 more like $18, $19 Boe going forward.

John A. Manzoni - President and Chief Executive Officer

So If I may Ben just to... I think thank you for that a Nigel. I think... I think operating costs are not a big issue for us. We must keep keen of that of course and we do and we will. To some degree the third quarter was impacted by particular things, whether it's Auk, Fulmar whether it's some shut downs which impacted production levels. Going forward, I think today we're seeing in certain areas a leveling off of the rapid inflationary pressures that we've been seeing across our operations. At least a leveling off going forward and the second thing that's going to happen is the production is going to rise which will bring down the unit costs. So, does that draw a picture for you?

Benjamin Dell - Berstein (Sanford C.) & Co

Yes, that's great. Thank you very much.

Operator

Your next question comes from David Wynen [ph] of Prudential Investment Management. Please go ahead.

Unidentified Analyst

Hi gentlemen, I have two questions. First of all, what are your prospects for reserve replacement this year if you can say? And second of all, it maybe too early for this, but; what effect if any will the new royalty rates have on your existing reserve bookings?

John A. Manzoni - President and Chief Executive Officer

I think, David, it's certainly too early to answer the first part of your question. I'm looking at Ron for a signal. Do you want to say something Ron with the second part?

Ronald J. Eckhardt - Executive Vice President, North American Operations

As I said earlier, we are working through it in detail. A high level look says reserve booking shouldn't be impacted. As I said the deeper high rate wells, the effects, royalty effects will impact investments, but reserves should be intact.

Unidentified Analyst

Thanks guys.

John A. Manzoni - President and Chief Executive Officer

Thank you, David.

Operator

Your next question comes from Andrew Potter of UBS Securities. Please go ahead.

Andrew Potter - UBS Securities

Yes, hi guys, just wondering if you can update us on your exploration plans for Alaska this year.

John 't Hart - Executive Vice-President, Exploration.

Okay. Andrew we... as you know we found significant volumes of hydrocarbons but we have not found an anchor field as yet. And we are shooting seismic this winter and we hope that we can come up with a prospect of the required size. We found good reservoir and we hope to find this in the right positive precision. But it's hard to say what's going to happen until we have show the seismic in terms of the data, and so, hence no drilling this winter.

Andrew Potter - UBS Securities

SeismicJohn, what seismic program? Preceding this with.

John 't Hart - Executive Vice-President, Exploration.

Yes

John A. Manzoni - President and Chief Executive Officer

Yes. Andrew does that answer your question?

Andrew Potter - UBS Securities

It does. Thanks.

John A. Manzoni - President and Chief Executive Officer

Okay.

Operator

Your next comes from Gil Yang of Citi. Please go ahead.

Gil Yang - Citigroup Smith Barney

Hi John. Could you comment on in your efforts to deliver on your promises or the company promises in the future? How much of it is... obviously you've done some things just try to make it to bring it under your control a little bit better. How much of that help and how much of it may just come from your possibly more cautious guidance in the future? And have you given any thought to maybe changing the portfolio mix to towards one where results are more predictable and maybe less lumpy and more resource based type, more emphasis on the resource type of assets?

John A. Manzoni - President and Chief Executive Officer

Yes Gil, thank you. You put your finger on one part of this. Is that our portfolio does have some fairly lumpy things going on and therefore... and that lies particularly actually outside of North America. So here on this constant, in fact my observation is that our North American business is the most predictable of our businesses. We are world class of what we do here. We can keep doing fine things and in general we can predict, because we do a lot of little things well if not little, but we do a lot things and we do them repeatedly we know what we are doing. It's the other parts of the portfolio which become lumpy.

Now I think that's... we certainly have taken steps to underpin. Well to both be most certain internally before we sort of commit to a project and then talk about it. So that's something that we have done. We've... as you heard we have increased our resources internally because many of problems that are coming out now were born actually a couple of years ago at startup projects where we I think didn't have sufficient in-house engineering capability. We've rectified that over time. We've also taken steps to change nature of the contracting structures in many of our contracts. Because we hit a high development load just at the time that the external market became very, very tight and the quality in the external market went down.

So I think we can diagnose the issue and I think we've taken steps to, to rectify that going forward. That's not to say that there won't be future issues of course but I think we need to be very much focused on assessing the risks and putting in place, mitigating actions. To some degree, the extent to which we talk about before is ready to be talked about and promise it before it's ready to be promised. That will impact the nature of the targets that we communicate as well.

And you know now I don't know what balance of that but it's both the targets and hitting the targets and execution which we must attend to so that... I think the most important thing because... my judgment is that it's getting in the way for this company right now. People are tired of saying we are going to do this and then not doing it. So this is really behind my caution in setting targets too early for next year. So we've had a proper review of it. But I'm pretty determined that we are going to be... we are going to hit the targets that we meet when we communicate those.

In terms of whether or not we should adjust the portfolio in order to make it more predictable. I think that's to be determined, I don't think it's the primary reason for us for instance to make a decision to go into the resource place which are necessarily more predictable then that decision will be driven by our judgment of the fundamental underlying economics of those place. And the source of growth that it provides us and then stack up against our alternatives. That's what will drive the decision to unconventionals.

Gil Yang - Citigroup Smith Barney

Okay fine, it's a good answer. Second question I have got is do you have any sense yet for how much in Canada, how much service for Alberta rather. How much service costs would have to fall to offset to fully offset the impact of the higher royalties?

John A. Manzoni - President and Chief Executive Officer

Let me ask Ron if he's got a feel for that.

Ronald J. Eckhardt - Executive Vice President, North American Operations

Yes, what that's one of the issues we are working through. As I said all things outside of the really deep gas seem to be pretty benignly affected. But on the foothills it's very well-by-well sensitive and because of the complexities that how quickly the royalty moves given price and rate changes I can't give you a gist for that just yet and we are working through that.

Gil Yang - Citigroup Smith Barney

All right.Thank you.

Ronald J. Eckhardt - Executive Vice President, North American Operations

Okay.

Operator

Your next question comes from Robert Plexman of CIBC World Markets. Please go ahead.

Robert Plexman - CIBC World Markets

Hello John. I wanted to ask you if because of the continuous relation in capital cost if that's starting to have an impact on the expected economics for some of the new project. Now thinking about the redevelopments in the UK sector and revenue in the Norway besides as well as the Northern field?

John A. Manzoni - President and Chief Executive Officer

Robert,I think you know... we... you are seeing inside these numbers as an increase in DD&A and you can see that it's partly impacting the profit line. And I think we've got to understand that, it's primarily coming. The North Sea is a high DD&A area for us as you put your finger on that is... which is high capital cost. But it's also remember the highest netback area. And it's also particularly acute because we've been in this particularly high spend mode in the recent past in the North Sea as we are bringing on all of these developments. I'm actually optimistic that as you.... our model in the North Sea in particular is to acquire and exploit. So we've done that quite a bit here, we've put the capital on the books. Now we're into some of the exploit mode going forward which brings on new reserves which then in turn brings down the unit DD&A rates as we bring them on and tie them back at lower relative capital costs of the initial acquisition. I think if put my finger on what's your underlying concern does that answer your question?

Robert Plexman - CIBC World Markets

Yes it does John.

John A. Manzoni - President and Chief Executive Officer

Okay.

Robert Plexman - CIBC World Markets

Thank you very much.

Operator

Mr. Manzoni, there are no further questions at this time. Please continue.

John A. Manzoni - President and Chief Executive Officer

Ladies and gentlemen I'd like to say thank you very much for joining us. I hope we've been as articulate as we can and answered all your questions and I look forward talking about meeting with you over the course of the next few months and then revealing our year-end results next time. So thank you very much for joining us and I think with that we'll end the call. Thank you.

Operator

Ladies and gentlemen that concludes the conference call for today. Thank you for participating. Please disconnect your lines.

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