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Hess Corporation (NYSE:HES)

Q1 2008 Earnings Call

April 30, 2008 10:00 am ET

Executives

Jay R. Wilson - Vice President Investor Relations

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

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

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

Analysts

Doug Leggate - Citigroup

Arjun Murti - Goldman Sachs

Erik Mielke - Merrill Lynch

Paul Sankey - Deutsche Bank

Mark Gilman - Benchmark

Paul Cheng - Lehman Brothers

Robert Kessler - Simmons & Company International

Mark Flannery - Credit Suisse

Operator

Welcome to the first quarter Hess Corporation earnings conference call. (Operator Instructions) I would now like to turn the call over to Jay Wilson, Vice President of Investor Relations.

Jay R. Wilson

Our earnings release was issued this morning and appears on our website, www.Hess.com. Today's conference call contains projections and other forward-looking statements within the meaning of the federal securities laws. These statements are subject to known and unknown risks and uncertainties that may cause actual results to differ 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'Conner, President, Worldwide Exploration and Production, and John Rielly, Senior Vice President and Chief Financial Officer.

I'll now turn the call over to John Hess.

John B. Hess

I will make a few brief comments, after which John Rielly will review our financial results.

Net income for the first quarter of 2008 was $759 million. Our results benefited from higher crude oil and natural gas prices and production volumes which more than offset higher costs and weaker refining margins compared to those in the year ago quarter.

For the first quarter of 2008, Exploration and Production generated net income of $824 million. Crude oil and natural gas production averaged 391,000 barrels of oil equivalent per day, which was 2% above the same period last year. Contributing to this growth were higher crude oil production from the Okume Complex in Equatorial Guinea and natural gas production from the Ujung Pangkah Field in Indonesia. Our full year 2008 production forecast remains 380,000 to 390,000 barrels of oil equivalent per day.

With regard to our field developments, the JDA Phase 2 project in the Gulf of Thailand, in which Hess has a 50% working interest, is on track to start up this summer, and we expect net production from the JDA to increase from approximately 120 million cubic feet per day to nearly 250 million cubic feet per day.

At the Shenzi development in the deepwater Gulf of Mexico, in which Hess has a 28% working interest, the tension leg platform, TLP. hull arrived at Kiewit Yard in Ingleside, Texas in February. Installation of the TLP and topsides is planned for this summer. Installation of sub sea facilities is scheduled for the second half of 2008, followed by commission and first production in the first half of 2009.

In Indonesia, commencement of oil production from our Ujung Pangkah Field, in which Hess has a [25%] working interest, is on schedule for the first half of 2009.

With regard to exploration, in March we announced the results of the Pony No. 2 well in the deepwater Gulf of Mexico in which has a 100% working interest. The well encountered the objective sands in a downdip position in the water leg. During the first week in April, we kicked off a sidetrack well which is designed to establish the location of the oilwater contact and should allow us to further refine the range of resource potential on the block. We have recently set casing and the well is currently drilling near the first objective section. Results for the well are expected to be announced during the second quarter.

Following completion of the Pony No. 2 sidetrack, we will release the Ocean Baroness rig for one well slot to another operator. At the end of the second quarter we expect to spud the first of four wells that will be drilled back-to-back on our 100% owned Block WA-390-P in the Northwest Shelf of Australia.

In the third quarter, we plan to drill a well on Block 54 offshore Libya in which we have a 100% working interest, and we also plan to participate in an exploratory well on Block BMS-22 in the Santos Basin of Brazil in which we have a 40% working interest.

In the first quarter, we expect to spud our first well on our Cape Three Points Block in Ghana, in which we have a 100% working interest.

Turning to Refining and Marketing, net income was $16 million in the first quarter of 2008, which was below the year ago period due to sharply lower refining margins, particularly for gasoline and residual fuel oil.

Retail marketing operations continued to be negatively impacted by rising wholesale prices in the first quarter. Fuel volumes were up nearly 2% versus the year ago quarter, however convenience store sales were lower by about 2% due to weaker economic conditions.

Energy marketing was negatively impacted by milder weather in the first quarter of 2008 versus the same period last year. While fuel oil sales were down, natural gas and electricity sales continued to grow year-over-year.

I will now turn the call over to John Rielly.

John Rielly

In my remarks today I will compare first quarter 2008 results to the fourth quarter of 2007.

Net income for the first quarter of 2008 was $759 million compared with $510 million in the fourth quarter.

Turning to Exploration and Production, income from Exploration and Production operations in the first quarter 2008 was $824 million compared with $583 million in fourth quarter. Excluding the fourth quarter impairment charge of $56 million, the after-tax components of the increase are as follows:

Higher selling prices increased earnings by $122 million. The impact of sales volumes improved earnings by $23 million. Lower costs, primarily exploration expenses, increased income by $42 million. All other items net to a decrease in earnings of $2 million, for an overall increase in first quarter income of $185 million.

In the first quarter of 2008, our E&P operations were overlifted compared with production, resulting in increased income in the quarter of approximately $15 million. The Exploration and Production effective income tax rate for the first quarter of 2008 was 48%, within the expected full year range of 47% to 51%.

Turning to Marketing and Refining, Marketing and Refining earnings were $16 million in the first quarter of 2008 compared with $31 million in the fourth quarter. Fourth quarter 2007 results included an after-tax gain of $24 million from liquidating LIFO inventories. Results of refining operations amounted to a loss of $3 million in the first quarter of 2008 compared with income of $27 million in the fourth quarter.

The corporation's share of HOVENSA's results after income taxes amounted to a loss of $6 million in the first quarter compared with income of $12 million in the fourth quarter, primarily reflecting lower margins.

During the first quarter, the corporation received a distribution from HOVENSA of $25 million. Port Reading earnings were $2 million in the first quarter of 2008 compared with $14 million in the fourth quarter. Marketing earnings were $32 million in the first quarter of 2008 compared with $19 million in the fourth quarter. First quarter 2008 Marketing results include seasonally higher margins and sales volumes of natural gas.

Trading activities generated after-tax losses of $13 million and $15 million in the first quarter of 2008 and fourth quarter of 2007, respectively. Turning to corporate, net corporate expenses amounted to $39 million in the first quarter of 2008 compared with $59 million in the fourth quarter. The fourth quarter 2007 results included an after-tax charge related to MTBE litigation of $25 million.

Our after-tax interest expense was $42 million in the first quarter compared with $45 million in the fourth quarter, principally reflecting lower average debt.

Turning to cash flow, net cash provided by operating activities in the first quarter, including a decrease of $92 million from changes in working capital, was $1.176 billion. The principal use of cash was capital expenditures of $849 million. All other items amounted to a decrease in cash flow of $32 million, resulting in a net increase in cash and cash equivalents in the first quarter of $295 million.

At March 31, 2008 we had $902 million of cash and cash equivalents. Our available revolving credit capacity was $2.693 billion at quarter end. Total debt was $3.960 billion at March 31, 2008, and $3.980 billion at December 31, 2007. The corporation's debt-to-capitalization ratio at March 31, 2008 was 26.9% compared with 28.9% at the end of 2007.

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

Questions-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Doug Leggate - Citigroup.

Doug Leggate - Citigroup

If you take the disclosure you gave on DD&A and cash operating costs, both are down quite a bit from the fourth quarter and I'm curious as to why that might be. And if you could update, John Rielly, please, the guidance for the balance of this year and perhaps similarly on the tax rate guidance for this year, which was also low end of your guidance range on the upstream.

John Rielly

There's no changes on our guidance, actually, for the unit costs or for the tax rate.

Typically in the first quarter when our production's running full out and we really haven't entered the maintenance season, our unit costs are lower in the first quarter, and it's not unusual. It happened actually the last two years that our unit costs come in under our guidance range for the year. And it will build just because production will be reduced as we move into the maintenance season in the second and third quarters, and then the fixed costs get spread over lower barrels.

So again, just to reiterate, our guidance for cash costs are $14 to $15 for the range, DD&A $12.50 to $13.50, for an overall range of $26.50 to $28.50, and we do see ourselves for the full year coming in that range.

Same thing on the tax side. There's nothing unusual from the tax rates. What we just have is a change in the mix of production, so if you're moving from the fourth to the first, you have a little more EG production at the 25% tax rate. And also if you remember in the fourth quarter, the JDA was shut down for Phase 2 construction so now we've got a full quarter running on JDA at the zero percent tax rate. We just happened to lower it.

But again, our guidance for the year, it was 47% to 51% and we don't see any change in that.

Operator

Your next question comes from Arjun Murti - Goldman Sachs.

Arjun Murti - Goldman Sachs

In light of the sharply higher oil prices and natural gas prices, just wondering if you had any update on how you're thinking about capital spending and incremental use of free cash flow this year?

John Rielly

I hate to sound like a broken record but there's really no change, also, on our view on what we're doing with cash flow and where we see our capital expenditures at this point.

We were successful at the Gulf of Mexico lease sale. Not all the licenses have been awarded at this point, but we were excited by that. We did have a placeholder in our capital expenditure budget for that. Where we see early in the year, we don't have any change in guidance. We'll certainly update you on the second quarter conference call on where we see capital expenditures going.

As far as use of our cash flow, it really is the same strategy. We're focused on our developments. We will be reinvesting in the E&P operations. That's where we look to fund it. If we have some excess cash flow during the year, what we'll do is - again, same strategy - we'll look potentially to reduce debt during the year, but I don't see it. [Inaudible] giving you guidance right now, I don't see our debt coming down and, again, the focus will be keeping the cash flow ready for our E&P operations and investing in the future.

Arjun Murti - Goldman Sachs

And given the plethora of your exploration activities and development programs, probably shouldn't be looking for a big new stock buyback program. It'll be maybe not paid on debt, but cash can build up a little bit in anticipation of future spending?

John B. Hess

That's a fair assumption, Arjun.

Arjun Murti - Goldman Sachs

Any change to your production guidance for the year?

John B. Hess

No, the production guidance is the same, as I mentioned in my comments.

Operator

Your next question comes from Erik Mielke - Merrill Lynch.

Erik Mielke - Merrill Lynch

On the European gas market we've seen from some of your peers that reported they had very strong results in Europe. I'm just wondering if you could comment on what you saw in the quarter and how it affects the outlook for the operations that you have in that part of the world?

John Rielly

You're correct. We saw the same obviously improvement specifically in the U.K. gas market, and obviously we received the benefit of that. What you would say from an operational standpoint, I would say normally we are producing, we'll have the maintain season and we'll get the benefit of higher prices.

The only thing that would be a little different that we're looking at right now is if you remember the Cromarty field was shut in for the summer last year and with these strong U.K. gas prices we will probably look to produce Cromarty through the summer.

Operator

Your next question comes from Paul Sankey - Deutsche Bank.

Paul Sankey - Deutsche Bank

A follow-up to Arjun's question which just for the sake of asking I'll ask, any potential for acquisitions from you over the next year or so?

John O'Connor

As is our company practice, we don't comment on acquisitions or divestments. Obviously, we're always looking to upgrade the portfolio, but right now we're focused on the organic opportunities we have before us.

Paul Sankey - Deutsche Bank

I don't think you mentioned Tubular Bells. Is there any update there?

John O'Connor

No particular update, Paul. I think that probably BP will be probably the best source of commentary both on Tubular Bells and on another discovery they recently announced in an offsetting block. So I can see some potential for joint development in that area but, as I said, better off leaving the commentary to BP, the operator.

Paul Sankey - Deutsche Bank

And can you just finally, from you, just on the rig situation at Pony. Could you just update us on where that is right now? Thanks.

John O'Connor

Yes, sure. In terms of rig usage, I think as John said in his opening remarks, on completion of the current sidetrack - and the current sidetrack should certainly be finished in the next 45 days - the rig will be released for one rig slot to an operator in the Gulf of Mexico, which is a trade to provide us with a rig in West Africa to enable us to drill a well offshore Ghana.

And on completion of that particular trade, we get the Baroness back and we'll have the potential to drill either on Pony or on another location depending on the results of the sidetrack.

Paul Sankey - Deutsche Bank

It seems that the HOVENSA FDC is running at very low levels. Can you just comment, if that's the case, what the outlook for 2Q is and any other general observations you have on the gasoline market?

John B. Hess

With the weakness in the gasoline to optimize economics, it's better to run for yield than volume. And that's why you saw the lower rates in the first quarter. There were economic incentives to optimize the refinery that way. And in the second quarter, let's see how the second quarter turns our before we jump the gun in terms of what the predictions will be.

If the gasoline market comes up, the volumes may come up some. If the gasoline market stays where it is, it's likely to assume that we're going to run for yield as opposed to volume.

Operator

Your next question comes from Mark Gilman - Benchmark.

Mark Gilman - Benchmark

John Hess, did you say 25% interest in the Pangkah oil rim?

John B. Hess

Seventy-five percent.

Mark Gilman - Benchmark

John Rielly, did you say zero tax on the JDA? Is that a function of equity accounting?

John Rielly

No, it's not. It's just that there was a tax holiday for the first eight years of production on the JDA, and then it goes up to 10% after a number of years, and then it ultimately ends up at a 20% rate. That's just the contract.

Mark Gilman - Benchmark

Zero percent for eight years, and then 10% up to how much?

John Rielly

And then it goes to 20%.

Mark Gilman - Benchmark

How long at 10%, John?

John Rielly

Seven years at 10%.

Mark Gilman - Benchmark

John O'Connor, do you have pre-stack depth migration on BMS-22?

Mark Gilman - Benchmark

On AIOC, there's a rate of return threshold. It looks like you hit in the first quarter. Is that true?

John Rielly

Correct, and it was part of our guidance, again. So our production is 380 to 390 for the year, so our rate of return thresholds and the triggers associated with it were part of our estimate for the year, and so that 380 to 390 encompasses that.

Mark Gilman - Benchmark

Is the decision, John Rielly, that you've talked about vis-à-vis Cromarty and producing this summer linked in any way to the decision to establish some forward sales hedges on U.K. gas?

John Rielly

You could look at it that way, Mark, but what we saw was some favorable pricing there in the U.K. so we just locked in. It was only a portion, actually, of the Cromarty field production that we locked in.

But again, where we see prices right now, we just see that it's a very favorable pricing regime so we will produce that through the summer.

Mark Gilman - Benchmark

And it's hedged against what, NBP?

John Rielly

Yes, it is. Correct.

Mark Gilman - Benchmark

And just one final one, if I could. The rationale on the lease acquisitions, John O'Connor, in the Gulf of Mexico sale recently, what were thinking, what were you shooting for?

John O'Connor

We have been doing an increasing amount of work, obviously, in the Gulf of Mexico. The result of that work is to identify a tract of exploration prospects. We had gone fairly extensively if not financially aggressively in the October lease sale, and this time we tried to combine both value and opportunity to capture at this lease sale, so it's just a combination of the consequences of a lot of work we've been doing, data we've been acquiring, increased knowledge base and looking to the future with 10-year leases to continue to maintain a solid inventory of good exploration prospectivity in the Gulf of Mexico.

Mark Gilman - Benchmark

Lower Miocene or lower tertiary focus, John?

John O'Connor

It turned out that in terms of acquisition, the acquisitions were probably more in the lower tertiary than the lower Miocene. That's probably appropriate giving the time [scale].

Operator

Your next question comes from Paul Cheng - Lehman Brothers.

Paul Cheng - Lehman Brothers

John, at the end of the first quarter from an inventory standpoint are you underlift, overlift or balanced?

John Rielly

We are balanced right now. We came into the year balanced, and we just had a slight overlift, as I mentioned in my script. But again from your modeling it out, I would just say that we're balanced and look to model in our expected production.

Paul Cheng - Lehman Brothers

John, any [peak] drill targets you can share that relate to the BMS-22, Australia and Ghana?

John O'Connor

Not in any meaningful way, Paul, certainly not for BMS-22 because it depends on what you ascribe to the individual well as distinct from the prospect. There's more to that than I care to go into right now nor that is helpful.

Ghana, I think, is a similar situation in that there are a number of prospects on the block and the block potential is the more material issue than the prospect to be drilled initially.

And Australia, actually coincidentally and perhaps strangely, is similarly a sequence of a number of prospects which in aggregate I think we've reported as lying in the range of 5 TCF to 20 TCF on block. A very large block, but the prospects will be significantly smaller than that, Paul.

Paul Cheng - Lehman Brothers

On the BMS-22, have you and your partner operator Exxon, have you decided which well to drill yet or are you still contemplating because I presume that has more than one prospect there.

John O'Connor

There is indeed more than one prospect there, and there's more than one partner there. We have partners in both Exxon and PetroBrass. And the group has at technical meetings decided indeed on the first two wells to be drilled on the block.

Paul Cheng - Lehman Brothers

So you've already decided? And then are the two wells going to be drilled one right after the other or they're just going to have some, I think now you're saying that in the third quarter you're going to drill on the BMS22, and I think currently you assume probably within six months [inaudible]. Should we assume that the rig is going to right then move to the next prospect or that it's going to take some time?

John O'Connor

At this stage I would assume that they're pretty much back to back.

Paul Cheng - Lehman Brothers

Final question, John, on Pony No. 2 sidetrack, what are you expecting to find or hoping to find from that well?

John O'Connor

I would definitely hope to find enough data to establish the oil-water contact in the three target sample.

Paul Cheng - Lehman Brothers

Is it checking on the up-dip or down-dip?

John O'Connor

The sidetrack is up-dip. It's being drilled at about an angle of somewhere between 30 and 36 degrees from the vertical. The previous well is a straight hole vertical, and this one is being drilled up-dip.

Paul Cheng - Lehman Brothers

And how long is the TD that you're going to drill? How far you'd extend it out on the sidetrack [inaudible]?

John O'Connor

I think it's something like 1,500 feet. I don't have that number to hand actually.

Operator

Your next question comes from Robert Kessler - Simmons & Company International.

Robert Kessler - Simmons & Company International

Just looking at trading, second quarter in a row of a fairly sizeable net loss. Any thoughts given there with respect to derisking the book or any attribution for the net loss?

John Rielly

Basically, as you've seen, our trading activity represents a small part of our business. It's been consistently profitable on an annual basis. We basically remain comfortable with the strategy, the place it has in our portfolio. And again, from a guidance standpoint, I typically just give out about $20 million per year and that's what we'll look to try to attain from our trading activities.

Robert Kessler - Simmons & Company International

Any particular reason for the loss this quarter?

John Rielly

No. It's a diverse portfolio. It's spread across the energy commodity so there's nothing in particular there.

Operator

Your last question comes from Mark Flannery - Credit Suisse.

Mark Flannery - Credit Suisse

Could you update us on what's going on in the Bakken and what your plans are there, any changes given recent views and noise and whatever in that area?

And the second question's on Pony. Let's just for the moment assume that you get everything you want out of the sidetrack. You release the Ocean Baroness for another well slot. Can you then run us through in an ideal world what the next three or four steps would be at Pony?

John O'Connor

So if the results of the sidetrack are as we hope and expect, we would probably have, depending on precisely the results, so attrition to information to firm up a development scheme, whether that development scheme would be standalone or would be in conjunction with partners to the south depends on the result of the sidetrack. But in any event, by the end of the year I think we would come close to being in a position to have a [inaudible] development scenario.

So that's pretty much the way we see things going forward. We've done quite a lot of work in the subsurface in rock mechanics and fluids and process concept, selection of design, over the past year or so, so it's not as though we're starting now to move forward. A lot of that work has been done, and we're awaiting, if you will, calibration from the sidetrack well and, indeed, the data from the previously drilled straight hole Pony No. 2, Sidetrack No. 2.

On the Bakken, we currently have net 410,000 acres or so. We're still in the business of acquiring more acreage provided it makes economic sense. We have 50 operated wells in the Bakken. We expect production in 2008 to be around 8,000 barrels a day. We're running six rigs. By the end of the year we'll go up to eight, and by 2009 we'll go up to 10.

Individual well rates with rates being the average of the first 30 days of production range from about 100 barrels a day to 400 barrels a day. We see some variation in the reservoir quality in an aerial sense. We're doing a lot of work to model the subsurface, to understand the geology better, and we're also continuing to do work to optimize completion practices, particularly fracing technology.

Mark Flannery - Credit Suisse

Is there any event or anything you might learn this year that could lead you to add another couple of rigs in '09 or is it just steady as she goes?

John O'Connor

Well, that's a very good question. To be honest with you, the limitation is more around having skilled people to operate and to act in support of the operation in North Dakota than it is anything else. Investments in North Dakota will be up significantly this year versus last year. So we are ramping up the pace, but we're trying to do it in a prudent manner.

If we are fortunate and if we found the people I think there would definitely be a push to add more drilling capacity.

Operator

Operator

I show no further questions in the queue.

Jay R. Wilson

We appreciate everybody's attendance on the call, and we look forward to your attendance on the next call. Thank you very much.

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