Hess Corp. Q4 2007 Earnings Call Transcript.

Jan.30.08 | About: Hess Corporation (HES)

Hess Corp. (NYSE:HES)

Q407 Earnings Call

January 30, 2008 10:00 am ET

Executives

John B. Hess - Chairman of the Board and Chief Executive Officer

John P. Rielly - Senior Vice President and Chief Financial Officer

John J. O'Connor - President, Worldwide Exploration and Production

Jay R. Wilson - Vice President-Investor Relations

Analysts

Mark Flannery - Credit Suisse.

Doug Leggate - Citigroup.

Robert Kessler - Simmons & Company.

Nikki Decker - Bear Stearns.

Paul Cheng - Lehman Brothers.

Kate Lucas - JP Morgan.

Arjun Murthy - Goldman Sachs.

Paul Sankey - Deutsche Bank.

Mark Gilman - Benchmark Company.

Operator

Good day, ladies and gentlemen, and welcome to the Hess Corporation fourth quarter 2007 earnings conference call. My name is Katena and I will be your coordinator for today. (Operator Instructions). As a reminder, this conference is being recorded for replay purposes. I would now like to turn the presentation over to your host for today's call, Mr. Jay Wilson, Vice President of Investor Relations. Please proceed.

Jay Wilson - Vice President-Investor Relation

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

John Hess - Chairman of the Board and Chief Executive Officer

Thank you Jay. Welcome to our fourth quarter conference call. I would like to highlight key achievements of 2007 and provide some guidance for 2008. John O'Connor will then discuss our exploration production business and John Rielly will review our financial results.

Our company generated solid operating and financial performance in 2007. Results benefitted from higher volumes of crude oil and natural gas production and strong commodity prices, which were partially offset by higher industry costs and lower margins in marketing and refining.

Corporate net income was $1.8 billion. Exploration production earned $1.8 billion and marketing and refining earned $300 million. In 2008, our company's capital and exploratory expenditures are budgeted to be $4.4 billion versus $3.9 billion in 2007. The majority of our 2008 spending will be targeted to exploration and production. This year, our exploration expenditure expenditures are expected to increase to $1.2 billion compared to $740 million in 2007.

While we continue to reinvest a majority of our cash flow in exploration and production, we strengthened our financial position in 2007 with debt to capitalization improving to 28.9% compared to 31.6% at the end of 2006. With regard to operations, exploration and production achievements in 2007 included rolling crude reserves to 1.33 billion barrels of oil equivalent replacing 167% of production at an FD&A cost of about $6.20 per barrel. Lengthening our reserve life to 9.5 years marking the 5th consecutive year in which we lengthened our reserve life, increasing crude oil and natural gas production by 5% versus the prior year of 377,000 barrels of oil equivalent per day.

In 2008, we forecast a production average between 380,000 and 390,000 barrels of oil equivalent per day. In terms of our Hess operated field developments, 2007 marked the commencement of natural gas production from the Pungkah fields in Indonesia in which we have a 75% working interest as well as a significant increase in crude oil production at the Acume complex in Equatorial Guinea where our working interest is 85%. We also made significant progress in the development of the Shenzi field in the deep-water Gulf of Mexico where Hess has a 28% interest.

The tension-leg platform hull recently left the Samsung yard in Korea and, along with the top sides, is scheduled to be installed this summer. First oil is expected in the first half of 2009. During 2007, we also advanced several Hess operated field development projects including Bakken shell in North Dakota, Seminole Residual Oil Zone in West Texas, and Pangkah Oil in Indonesia.

In addition we sanctioned, during the past year, two field developments. The Hess operated (Jamie Morang) Natural Gas project in Indonesia and the Valhall field redevelopment in Norway. In exploration, we continue the appraisal of the Pony and Tubular Bells discoveries in the deep-water Gulf of Mexico. Results of both the Pony Number 2 and Tubular Bells Number 3 appraisal wells are expected by the end of the first quarter.

Hess has a 100% interest in Pony and a 20% interest in Tubular Bells. With regard to marketing and refining, our refineries operated reliably in 2007. However, full year financial results for the Hovensa Joint-Venture refinery were impacted by the turnaround of the Coker in the second quarter of last year and lower margin environment that existed in the second half of the year.

In retail marketing, fuel sales and convenience store sales continued to show annual increases, but the improvement in volumes was more than offset by lower fuel margins. Finally, our energy marketing business had a strong growth in sales and margin improvement, both in natural gas and electricity. We are pleased with the operating and financial performance that our company delivered in 2007. We are proud of our organization and excited about the investment opportunities we have to provide long-term profitable growth and create value for our shareholders. I will now turn the call over to John O'Connor.

John O'Connor - President, Worldwide Exploration and Production

Thank you John. Good morning everybody. The fourth quarter of 2007 production of 390,000 barrels of oil equivalent per day was up 7% versus the fourth quarter of 2006. This increase was underpinned by production from the recently commissioned Hess operated Okume Complex, Pangkah and Valhall Fields. 2007 was another year of strong execution and delivery for E&P. As John mentioned, in ‘07 our production increased by 5% and improved reserves increased by 7%.

This performance resulted in year end 2007 approved reserves of 1.33 billion barrels of oil equivalent and a reserve life of 9.5 year. Approved reserve additions totalled 280 million barrels of oil equivalent before PSC related revisions. Net of these revisions, which totaled 46 million barrels, we added 234 million barrels of oil equivalent. In addition to the impact on reserves of the fields operated under PSEs, the high crude prices that prevailed in 2007 will result in reduced 2008 production entitlements from Algeria and Azerbaijan due to the achievement of contractual rate of return thresholds.

In 2008, we expect production to be in the range of 380,000 to 390,000 barrels of oil equivalent per day. Obviously, depending on commodity prices, the workings of PSE contracts have the potential to impact our production volumes. As we see the year unfold, we will be better able to quantify this impact. Gross production from the Okume Complex in Ceiba fields in Equatorial Guinea recently reached 100,000 barrels per day with Okume at its design capacity of 60,000 barrels a day.

At the JDA, another important milestone will occur in the second quarter of 2008, when we start Phase II gas production following the commissioning of new facilities. Net gas production from the JDA will double from about 120 million cubic feet a day to about 250 million cubic feet per day.

Turning to exploration, let me first give you an update on our Pony Number 2 well. We are currently drilling below 28,000 feet with about another 500 feet to drill to the next casing point. Following the setting of the next casing string, the objective (inaudible) section will be drilled. While in 2007 our exploitation drilling efforts were directed to appraising discoveries, in 2008 we will see an active high-impact Wildcat program.

In the second quarter, we will drill the first of four back-to-back exploration wells on WA390-P in the northwest shelf of Australia. In the second quarter, we will spread a well and block 54 offshore Libya in the second half of the year we’ll spread our first well in the K3 points permit offshore Guinea and we expect that the operator fee MS22 in the San (inaudible) in offshore Brazil will spell the first of two exploratory wells. Our 2008 exploration program also includes wells in the west of Shetlands, offshore the west coast of Ireland, and in the deep-water Gulf of Mexico. We also plan to continue our appraisal drilling at Pony.

2007 was a year of significant progress for the company's E&P business. Objectives were met or exceeded, new resources were captured, and projects were delivered on schedule. Reserves and production grew in line with stated targets, cost effectively. We look forward with confidence to 2008. And, now I'll hand the call back to John Rielly.

John Rielly - Senior Vice President and Chief Financial Officer

Thank you John. Hello everyone. In my remarks today, I will compare fourth quarter 2007 results to the third quarter. Net income for the fourth quarter of 2007 was $510 million compared with $395 million in the third quarter.

Turning to exploration and production, income from exploration and production operations in the fourth quarter of 2007 was $583 million compared with $414 million in the third quarter. Excluding the items affecting comparability in earnings, the after tax components of the increase are as follows.

Higher selling prices increased earnings by $163 million. Increased sales volumes improved earnings by $139 million. Higher costs including exploration expenses decreased income by $129 million. All other items net to an increase in earnings of $19 million for an overall increase in fourth quarter adjusted income of $192 million.

In the fourth quarter of 2007, our E&P operations were over-listed compared with production resulting in increased income in the quarter of approximately $15 million. As indicated in the press release, the fourth quarter results include asset impairments on two United Kingdom oil fields, which are nearing the completion of their productive lives. The impairment charge resulted from reductions in reserves and from increases in estimated operating and dismantlement costs.

The pre-tax amount of the impairment charge was $112 million and is included in the line item depreciation, depletion, and amortization. The exploration and production effective income tax rate for the full year of 2007 was 50%. The E&P effective income tax rate in 2008 is expected to be in the range of 47 to 51%.

Turning to marketing and refining; marketing and refining earnings were $31 million in the fourth quarter of 2007 compared with $46 million in the third quarter. Refining earnings were $27 million in the fourth quarter of 2007 compared with $25 million in the third quarter. The corporation's share of (Avenza) income after income taxes was $12 million in both the fourth and third quarters.

During the fourth quarter, the corporation received a distribution from Avenza of $100 million. Poor rating earnings were $14 million in the fourth quarter of 2007, compared with $10 million in the third quarter. Marketing results were $19 million in the fourth quarter of 2007, compared with $21 million in the third quarter. Fourth quarter 2007 downstream results included an after-tax gain of $24 million from liquidating LIFO inventories. After-tax trading activities resulted in a loss of $15 million in the fourth quarter of 2007 compared with break-even results in the third quarter.

Turning to corporate, net corporate expenses amounted to $59 million in the fourth quarter of 2007 compared with $28 million in the third quarter. The fourth quarter 2007 results include an after-tax charged related to MTBE litigation of $25 million. Excluding this item, net corporate expenses for the fourth quarter and year were $34 million and $125 million respectively. Net corporate expenses in 2008 are estimated to be in the range of $130 to $140 million.

The pre-tax amount of the fourth quarter charge was $40 million and is included in general and administrative expenses in the income statement. After-tax interest expense was $45 million in the fourth quarter compared with $37 million in the third quarter, principally reflecting lower capitalized interests. For the full year of 2007, after-tax interest expense was $160 million. After-tax interest in 2008 is expected to be in the range of $165 million to $175 million.

Turning to cash flow, net cash provided by operating activities in the fourth quarter including a decrease of $307 million from changes in working capital was $806 million. The principal use of cash was capital expenditures of $805 million. All other items amounted to an increase in cash flow of $41 million resulting in a net increase in cash and cash equivalents in the fourth quarter of $42 million.

At December 31st, 2007, we had $607 million of cash and cash equivalents. Our available revolving credit capacity was $2.780 billion at year end. Total debt was $3.980 billion at December 31st, 2007, and $3.772 billion at December 31st, 2006.

The corporation’s debt-to-capitalization ratio at December 31st, 2007, was 28.9% compared with 31.6% at the end of 2006. This concludes my remarks. We will be happy to answer any questions. I will now turn the call over to the operator.

Question-and-Answer Session

Operator

Thank you. (Operators Instructions). Our first question comes from the line of Mark Flannery representing Credit Suisse. Please proceed.

Mark Flannery

Thank you. Good morning. I'd like to get a little bit deeper into the PSC impact expected for 2008. It feels like we've pulled the guidance down a little or at least below where consensus might otherwise be, but can you quantify how much you're expecting roughly, the PSC impact to be versus let’s say what you would have expected six months ago. In others words, you must have an oil price forecast in that number I guess?

John Hess

Sure, and there are two components to that Mark. Let me go back to what John O'Connor talked about. In two of our PSC contracts, and it's only in those two countries and its in Algeria and Azerbaijan, there were rate of return thresholds in those PSC contracts. That’s what John O'Connor alluded to. If we were just going to do like for like compared to 2007 to 2008, those rate of return thresholds by themselves reduced our production entitlements by 12,000 barrels a day. So, again if you were using our 380/390 probably to your question, it would have been more in the 390 to 400 range related to that.

Mark Flannery

Right.

John Hess

Then when we're laying out our production forecast in the 380 to 390 for 2008, what we've done is used $75 crude price to come up with that production forecast and then let me just give you some sensitivity to that. For every $5 change in the crude price there, so if the crude price is higher by $5, it should impact our full year of 2008 production by about 2,000 to 3,000 barrels per day.

Mark Flannery

Right. Very fine answer, thank you very much.

Operator

Our next question comes from the line of Doug Leggate representing Citigroup. Please proceed.

Doug Leggate

Thank you. Good morning everybody.

John Hess

Good morning.

John O’Connor

Good morning

John Rielly

Good morning.

Doug Leggate

A couple of quick ones from me. The reserve replacement number clearly is very strong. Did I hear that the planning and development cost number correct? Could you just repeat that for me, I think I missed it.

John Hess

Sure, it's about $16.20.

Doug Leggate

Okay, I thought you said $6.20. Okay, thank you. Okay, could we get a little more of a breakdown as to where the bulk of those bookings came from? And I'm curious in particular if Egypt did actually make it into the bookings at the end of the year?

John Hess

Yes Doug, Egypt did not and in terms of the source of the proved reserve adds, I think we're particularly pleased with the fact that they come from 19 or 20 fields. So, it really was an effort across the whole portfolio. So, there are new field sanctions such as Pangkah or Valhall redevelopment, but it is also subsequent subsurface work across the rest of the portfolio.

Doug Leggate

Okay, it is pretty widespread, thanks. Just two more real quick ones. I think in the last quarter call you have suggested Australia was going to spud in December and Tubular Bells was already on their way at number three. They look like they've may have been pushed back a little bit. Can you just us an update?

John Hess

I think Tubular Bells is somewhere below 24,000 feet at the last report and logging. Obviously, for any more details of that I would prefer you go to the operator, but they have a deep spud and they've come a long way.

In Australia we are working a rig slot for one of our Gulf of Mexico rigs for a rig of opportunity that’s currently working offshore Australia to save on transportation and mobilization, and unfortunately it has had a mechanical problem impacting its timings. So it will now come to us, we believe, end March or early April.

Doug Leggate

Great, thanks. And the second one from me is, John Rielly, you normally give us some idea of production costs and DD&A expectations for the coming year. Could we maybe get some guidance for 2008?

John Rielly

Sure, and I'll break it up between the cash costs and DD&A. Our guidance in for next year is on the cash side; our range is $14 to $15 per barrel, and on the DD&A side it is $12.50 to $13.50. So, overall unit cost per barrel is $26.50 to $28.50 for the year.

Doug Leggate

And that includes SG&A and the cash costs?

John Rielly

Correct, it does.

Doug Leggate

Great stuff. That’s it. Thanks very much indeed.

John Rielly

Thank you.

Operator

Our next question comes from the line of Arjun Murthy representing Goldman Sachs. Please proceed.

Arjun Murthy

Maybe to John O'Connor, I realize maybe it is a bit early, but the prospects for Tubular Bells sanctioned or not after the number three well?

John O'Connor

I would love to able tell you Arjun, but unfortunately I cannot. I think it's got to do really with the operator and their view of developments both in the Gulf of Mexico and elsewhere in their portfolios. So, as we are the 20% owner of Tubular Bells, we're much dependent on their assessment.

Arjun Murthy

That is great. Pony, with this appraisal, do you think you will be able to meaningfully narrow the reserve range that you've currently got out there?

John O'Connor

Yes, I think so. Just having moved aerially on the feature results are definitely going to give us some potential for narrowing the range. I would think though more drilling will be required to really refine the range of resources.

Arjun Murthy

Got you. And then just in Brasil, it sounded like versus maybe the year end spud date that had been talked about that there maybe some ability to accelerate that a bit. I don't know what your sense is of that actually happening closer to mid year versus year end.

John O'Connor

Yes. I think actually recent advice that we've got would indicate that there is a higher chance I suppose of it being early in the third quarter assessing from fourth quarter. It’s a new-built rig and I think its going to undergo sea trails in the second quarter or so. Following mobilization into Brazil, we're ready to go.

Arjun Murthy

That is fantastic. Thank you.

John O'Connor

Welcome.

Operator

Our next question comes from the line of Paul Sankey representing Deutsche Bank. Please proceed.

Paul Sankey

Hi, good morning everyone. John O'Connor, you spoke early last year about the importance of getting a good estimate of future crude prices for targeting your developments. You just said that you're using $75 for your PSC and volume assumptions. It is safe to say that you're now using $75 as your planing assumption as well.

John O’Connor

No, not at all, a good question Paul. We obviously have to pick a number to project volumes to give us a range of outcomes for the year and happened to pick $75. So, it’s not unreasonable, but for economic evaluation and for project determination, we still run a full range of outcomes median premise of $60 TI. It locates at (inaudible) 40 in the script. So, we look at all three prices and then we decide based on the nature of the project, where the returns should be at any given price.

Paul Sankey

I guess just on the volume targets despite the kind of slow patch that you've got coming up over the next year, you're still sticking with the 3% to 5% volume target going forward?

John O'Connor

Yes, yes we are.

Paul Sankey

Final one from me John on Ghana, I don't think we mentioned that. Could you just update us on your best guess what happens there? Thanks.

John O'Connor

Yes. I think that again we have arranged to exchange some slot time on one of our rigs in the Gulf of Mexico for a rig in West Africa and we think that will come to us for one well in about September/October time. It difficult to pin a time accurately because it is going to come from another operator, but that’s the time line we are working on Paul.

Paul Sankey

Great. Thanks.

Operator

Our next question comes from the line of Robert Kessler representing Simmons & Company. Please proceed.

Robert Kessler

Thank you. Good morning. I’ve got somewhat of an accounting question, but looking at your marketing results, you seem to have done a little bit better than I would have thought otherwise, and that seems to have been offset by weak trading results. I know that trading is nearly volatile and tough to predict, but I'm wondering if you could provide some comments about any transfer pricing between say the refinery gate on through to retail and whether or not some sort of mark-to-market there might have affected trading and marketing in a similar fashion.

John Rielly

No, I mean, again we do all, if you want to say, intercompany movements of products that they are all done at market prices. Now, you did hear that in my comments that I mentioned we did have a LIFO gain in the quarter. So, we have liquidated some of our prior year LIFO inventories so there is a $24 million gain that predominantly is in the marketing results.

Robert Kessler

Okay. That helps. Thank you.

John Rielly

Sure.

Operator

Our next question comes from the line of Nikki Decker representing Bear Stearns. Please proceed.

Nikki Decker

Good morning. Thank you. On Egypt, I did not see anything on West Med in you CapEx plans. Has there been any change in your plans at West Med?

John Hess

No. I don't think so. I think that we've made a lot of progress frankly. We have completed the multi-azimuth seismic survey and starting to load and process that. We're about 60% through front-end engineering at this time from KBR, who are the engineering consultancy working that up in the UK. We have completed a pipeline survey to go from the production facility onshore and we have a secured a location onshore for the gas processing plant. So, we've come a long way and we are far advanced also in terms of commercial discussions for the pricing of gas development.

Nikki Decker

Okay. Thank you. And then just switching to the Gulf of Mexico, first of all do you have an update at Bob North?

John Rielly

Bob North is in our results in the fourth quarter. It was a dry hole. There was an expense of $70 million approximately for Bob North in the fourth quarter.

Nikki Decker

Okay. And has (inaudible) spud?

John Rielly

No. It has not been supplied yet.

Nikki Decker

Okay.

John Hess

It is supposed to be imminent though.

Nikki Decker

Okay, and just on Pony. We are hearing that appraisal on Knotty Head is proceeding fully and it sounds like there are some rig constraints, difficulty in getting a rig that is suitable for the environment there. Have any of the partners sort of approached you. You obviously have a rig working. Has there been any more dialogue between you and the Knotty Head partners?

John Hess

I wouldn't say there has been no dialogue. I think I have mentioned before Nikki that we have exchanged data and we do have dialogue with them, but I think in terms of securing drilling equipment suitable for working in that environment, that is pretty challenging. I mean it is fair to say that drilling on the Pony prospect is sort of world class. I will give you some sense of this. The casing load we ran on Pony Number 1 was £1.85 million and that was a world record hook load. Deepest core ever been recovered in the Gulf of Mexico was recovered from Pony Number 1. Only two Gulf of Mexico wells have ever drilled below 33,000 feet and the current projected TD for our Pony Number 2 well is 32.5. So, I just mentioned that to give you a sense that this is not bread and butter drilling.

Nikki Decker

Sure.

John Hess

It is challenging and I think the industry is up to it obviously. The Knotty Head well went ultimately successfully. We've drilled one and getting ready to get into the objective section with number 2, but the equipment required to do this is typically tied up well in advance and securing a rig capable of operating with that sort of load to that depth is difficult.

Nikki Decker

Okay. And just one final one, at Okume Complex, are you still on target for a plateau in the third quarter of '08?

John Hess

We are, in a word, actually on plateau at Okume Complex. In other words, we have gone past the 60,000 barrels a day gross volume design capacity, but we still have some additional well capacity to tie in. So, yes, the answer is we are at plateau, but in addition we have the potential to may be produce somewhat above design dependent on de-bottlenecking some of the production facilities.

Nikki Decker

And that upside would occur in the near term?

John Hess

Yes. It would happen during 2008. I wouldn't make a big deal about it, but I just want to give you the impression that may be there's another 5,000 barrels a day on top of the 60 that we designed for in terms of well capacity and if we de-bottleneck the production facilities then we will be able to, but we are currently above 60,000 barrels a day gross design capacity.

Nikki Decker

Thank you very much.

John Hess

Sure.

Operator

Our next question comes from the line of Mark Gilman representing Benchmark Company. Please proceed.

Mark Gilman

Hi guys. Good morning. I had a couple of things. John O' Connor could you possibly give us a more specific idea of the Shenzi and JDA contribution to the reserve bookings for year-end '07?

John O'Connor

Ask me that again Mark.

Mark Gilman

Well, I was looking for a more specific number regarding the impact of additions at Shenzi and JDA to the reserve adds in ‘07?

John O'Connor

Okay. Through Shenzi itself on the Genghis Khan Purchase, rough order of magnitude plus or minus 20 million barrels. JDA, about the same order of magnitude and this is out of the total of 234.

Mark Gilman

Okay. Back to the production sharing and the entitlement threshold issue. John Rielly, the 12 that you mentioned, is that a full year number? In other words were these thresholds hit in '07 or is it something you anticipate and the $75 environment will be hit in '08?

John Rielly

No. The thresholds were hit in 2007. And so that 12,000 barrels a day is the full-year effect in 2008.

Mark Gilman

Okay. John O'Connor, can you possibly give us an idea whether in your mind based on the company's technical work, whether your prospect on BMS-22 is or is not an extension of the Carioca feature?

John O'Connor

I honestly don't have any insight into that Mark and I think it's best to leave it there.

Mark Gilman

Okay. And finally just an update on the Balkan program, on production and what's anticipated from the activity standpoint in '08?

John O'Connor

Okay. Continuing active program in the Balkan, I think we will see additional acreage being acquired. We will be adding two rigs next year and moving up to 10 the following year. Currently, production is around 5,000 barrels a day, but this is not something where you take the average well rate times the number of wells, multiply one by the other to come up with the rate. It's got to do with tying back production facilities, and it's got to with gas handling at the target gas plant. So, in a word, we’re very pleased with the position, like where we are and like where we are going.

Mark Gilman

Reserves per well running 0.75 million barrels?

John O'Connor

Yes. That's the sort of a number we are using Mark.

Mark Gilman

Okay. Thanks very much.

John O'Connor

Sure.

Operator

(Operator instructions). Our next question comes from the line of Paul Cheng representing Lehman Brothers. Please proceed.

Paul Cheng

Hi. Good morning gentlemen.

John Hess

Good morning.

John O’Connor

Good morning.

John Rielly

Good morning.

Paul Cheng

I think this is for John O'Connor?

John O'Connor

John, I think last October that you mentioned Pony, you were hoping to be finished by year end and of course that probably has some delay there. Is there anything changed that you have known or that has come as a surprise?

John O'Connor

Absolutely not Paul, but I'm glad to address the issue. In October, we expected the rig having come out of the shipyard after its five-year annual inspection to go back to work and make some progress, and point of fact, after 3 months in the yard, it came back on location and then had to take a further 2 months to resolve some mechanical issues which in many ways had been caused by the contractor during its work in the shipyard. So, we lost another couple of months there and that's really what has sort of held us back. Partially, as a consequence of some earlier problems, we also ran into lost circulation fairly severely coming up to the end of December. That put us back about 20 days probably, but we have sidetracked around that, we’ve overcome it, and as I said in my comments earlier, we should today or tomorrow probably, be in a position to run casing immediately above the objective section.

Paul Cheng

And you still feel confident. I think the last time you said that it's a great learning experience and you believed you have found a solution to get around the drilling difficulty and so that is still the case?

John O'Connor

Yes. That really has not changed since we talked about that in October. What you are referring Paul was we encountered in the first half of 2007, bitumen had a shallower level than has previously being encountered by other operators in the area and we did have learning's about how to overcome that, but it took some time to do that. Yes, very important, new tools have been developed by service companies in the industry to help us and other operators drill through this bitumen.

Paul Cheng

And John, I think for the last several quarters that you guys have not talked much about your Russian operation after you purchased it. Any update there where we are in terms of production and any plan on that whether that should be considered as part of your core operation going forward, and if it is, any plan on that?

John O'Connor

I think probably we were not asked any questions and there was nothing abnormal to report. It's performing as planned as projected, Paul. We are perfectly pleased with having it in the portfolio. We have talked in the past about it providing us with an opportunity to understand the nature of the industry in an area with significant hydrocarbon resources and of course that’s the business we are in, so it is serving that purpose.

Paul Cheng

What’s the current production there?

John O'Connor

Varies between 21,000 to 22,000 barrels a day pretty much.

Paul Cheng

Are they increasing or that is pretty much flat for you guys?

John O'Connor

It has the potential to go somewhat higher, but I wouldn't see it going much beyond 25,000, plus minus 25,000 barrels a day, Paul.

Paul Cheng

Okay. I have number of short questions for John Rielly. John on the year end, in the fourth quarter, you have an over lifting. At year end, is the inventory now under lifted or balanced?

John Rielly

It's balanced right now. So, with guidance, I would say for the first quarter is just a factor in production and assume that our sales volumes would equal production. Our inventory levels are at the appropriate amount. Obviously, there can always be timing on lifts, but right now we are in a balanced position.

Paul Cheng

On the Bob North, you said that the net charge to you guys is 17 or 70?

John Rielly

Sorry, it's is 70, seven zero.

Paul Cheng

Did you carry it or this is your share, the 30%?

John Rielly

If you remember what we have is combined between Bob North and Will K. We were exposed, the guidance we give to approximately $100 million, which does include well costs and (promote). So as related to Bob North, $70 million was expense.

Paul Cheng

So it is not like the well you said is $230 million?

John Rielly

Correct.

Paul Cheng

Okay, a final one on the DD&A for the full year. You said 2008 is going to be about $12.5 to $13.5, 2007 is around $10 and we are looking in the fourth quarter about $11. What is the new project coming on stream that is going to be much higher in terms of the DD&A?

John Rielly

There are many variables obviously in there and the production mix is one of it and as you know there is really not too many projects per se coming. Okume is going to be there for the full year. Obviously, that had some acquisition costs associated with it, so that has some higher DD&A, but I point you back to what John O'Connor talked about on the reserves that $45 million to $46 million of PSC related price revisions were part of our reserve adds.

Obviously that impacts the DD&A on our ongoing projects, and just on the same project, we will increase the DD&A rates as it related to those individual assets so that was also part of the drive.

Paul Cheng

John, any idea then how big is the increase related to the PSC?

John Rielly

We would say approximately a $1.

Paul Cheng

$1?. Okay. Thank you.

Operator

Our next question comes from the line of Kate Lucas representing JP Morgan, please proceed.

Kate Lucas

Hi. Good morning gentleman.

John Hess

Good morning.

John O’Connor

Good morning.

John Rielly

Good morning.

Kate Lucas

Just a quick question thinking about the slate of upcoming exploration opportunities you have, as you look at possible developments through the next decade or so, how do you go about prioritizing how you would allocate your upstream CapEx, either regionally or type of asset or keeping diversification within your upstream portfolio?

John Hess

Everybody is working around here Kate, trying to see who is going to answer that question. It's a most complex question. It drives a lot towards corporate strategy in addition to E&P strategy quite frankly. Often times, you don't have the luxury of picking which one you do one when, because the timing is driven by rig opportunities and expiry of areas. I think it is fair to say that we would be happy to see our OECD component of production and reserves increasing as a proportion of our total portfolio. At the same time, we have to be exposed to some of the more prolific oil and gas basins around the world, because that' where the resource is. So it’s partially driven, but strategically, it's partially driven by an opportunity set.

Kate Lucas

All right. In light of the fact that you have fairly large working interests in potentially large resources, have you been approached at all about potentially taking on partners or been approached about selling down maybe some of your interest where you hold a larger working interest?

John Hess

The properties we have very attractive. It is premature now to predispose ourselves to selling down or trading. We are happy to have the portfolio of opportunities. They need more delineation and definition and once we have them delineated and defined, then we will figure out how we prioritize them for development, and if during that time period, we can strategically reposition and strengthen the portfolio, that's something we consider, but it is not something that is imminent.

Kate Lucas

Okay. Great. Thanks very much.

Operator

Gentleman our final question comes as a follow-up from the line of Mark Gilman representing Benchmark Company. Please proceed.

Mark Gilman

Thanks. John O' Connor, the production forecast for 2008. What does that assume in terms of any summer gas shut-in at Atlantic-Cromarty.

John O Connor

Yes, well let me say this that when we put the portfolio together for the production projections for '08, one of the flexibilities we have got is the gas management strategy depending on the price for the UK gas in the summer, so at this stage, we are in more of a mind to have it shut-in than not and we will make a final decision as we see how the prices are between summer and winter in June.

Mark Gilman

Can you quantify the potential swing on that John.

John O Connor

Well it's probably less than 10,000 barrels a day average for the year of an impact. It’s probably closer to 5% frankly.

Mark Gilman

John Rielly, capitalized interest rocked to a negligible level in the quarter and yet, I guess, I am not aware of any particular project going into service that would be responsible for it. Could you explain what happened there and what is the assumption embedded in your 2008 interest returns forecast?

John Rielly

Sure, what it has to do and it's not intuitive as you look at it, but the Shenzi project actually went into production because of Genghis Khan. So, when we purchased Genghis Khan, it’s the western extension of the Shenzi field; we now just look at that project now as the Shenzi project with some additional area extent due to the acquisition of the Genghis Khan acreage. So, when the Genghis Khan wells started production, we ceased capitalizing interest on it.

Mark Gilman

Okay. So it's a fairly nominal amount in your 2008 interest forecast?

John Rielly

Oh yes. Sorry I know you did ask, but yes it is a nominal amount in the year 2008 forecast as well.

Mark Gilman

Thanks very much guys.

John Rielly

Sure. Thank you.

Operator

Ladies and gentleman we have no further questions. Thank you. I would like to thank you for your participation in today's conference. This concludes your presentation. You may now disconnect. Good Day.

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