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Apache Corporation (NYSE:APA)

Q2 2008 Earnings Call

July 31, 2008 2:00 pm ET

Executives

Bob Dye - Vice President of Investor Relations

Steve Farris - Chief Executive Officer

Roger Plank - Chief Financial Officer

Analysts

Tom Gardner - Simmons & Company

Brian Singer - Goldman Sachs

Gil Yang - Citi Investment

David Tameron - Wachovia

David Heikkinen - Tudor Pickering Holt

Joe Allman - JP Morgan

Leo Mariani - RBC

Jeb Armstrong - Calyon Securities

Operator

Good day everyone and welcome to the Apache Corporation's Second Quarter Earnings 2008 Conference Call. This call is being recorded. Today's presentation will be hosted by Mr. Bob Dye, Vice President of Investor Relations. Mr Dye, please go ahead sir.

Bob Dye - Vice President of Investor Relations

Thank you for joining us today. This morning Apache Corporation released second quarter 2008 results, which totaled net income of $1.4 billion or $4.28 per diluted share and cash flow of $2.3 billion, which were both all-time records.

Today’s discussion may contain forward-looking estimates and assumptions and no assurance can be given that those expectations will be realized. A full disclaimer is located on our website. In addition, any non-GAAP numbers that we discuss such as adjusted earnings, cash flow from operations, or cost incurred will be identified as such with the reconciliation again located on our website at www.apachecorp.com.

Steve Farris, our CEO, and Roger Plank, our CFO, will now make prepared remarks prior to taking questions. And, with that, I will turn the call over to Steve.

Steve Farris - Chief Executive Officer

Thank you, Bob. Good afternoon everyone. Thank you for joining us for Apache’s second quarter earnings conference call. Our second quarter was marked by record financial results, continued explorations success, and sustained progress in delivering on our pipeline of development projects.

As Bob pointed out, we achieved record financial results for the quarter with $4.28 per diluted share of earnings and cash from operations of $2.3 billion for the quarter. Not only did we exceed $4 per share of earnings for the first time, but we exceeded our highest previous total by over $1 per share. Cash flow of $2.3 billion exceeded the previous record set in the fourth quarter of 2007 by over $400 million.

Our exploration achievements during the quarter again reflected our ability to identify and control profitable opportunities and build value for our shareholders. And I would like to just give you a few highlights.

In the Gulf of Mexico, the US made major discovery at the Gulf of 1X, which holds an estimate recoverable reserves of 100 BCF, we don’t operate -- we have a 40% non-operated interest.

In Egypt, the Heqet-2, which is located in the western part of the Greater Khalda tested 2,100 barrels a day from a deep horizon and that opens up a new play potential, which potentially could extend hundreds of square miles primarily on our acreage.

Also in Egypt, we achieved 4,300 barrels a day of production from a new well in the Umbarka field in the Greater Khalda area and have identified a new water flood project in East Bahariya concessions in (inaudible) Basin. In Canada, new drilling results by our partner and our Ootla shale play further supports our estimated 9 to 16 TCF of net recoverable reserves to Apache.

In the North Sea, we have five new wells in the Forties Field that have aggregated 8,900 barrels a day during the quarter and I will point out that all of those wells that I just mentioned will contribute to the second half production.

On the development side, we made progress on our pipeline of several new projects, which continue on track to add 135,000 barrels a day over the next four years and I would like to just mention too our Egyptian water flood project is already ramping up, we have increased production output and shipped two days production output increase over the next several years.

Second, our new natural gas processes plants in the Khalda area of Egypt are on track to begin commissioning in October and should contribute an additional net production of 100 million a day and about 5,000 barrels of liquids a day by the end of the year. I might point out that by the end of the year we should nearly double our gas production in Egypt to over 750 million a day. So far, we have not added our Ootla play to our pipeline potential because we are still scoping the capacity and the timing of getting that on.

Our daily production for the quarter was down 1% from the first quarter of 2008 and primarily due to two non-recurrent events. First in the North Sea, we were impacted by the maintenance turnaround and refinery strike that we have no commercial interest in I might say that reduced oil production by 5,150 barrels a day for the quarter.

Secondly, we had a pipeline explosion in Australia on the June 3rd and caused us to shut in all of our production at Varanus Island and this incident alone reduced natural gas volumes by 60 million a day and oil volumes by 1,900 barrels a day during the quarter and that will impact us during the second half of 2008.

And once again, I would like to say we would like to assure the citizens of Western Australia that we fully understand the hardship that they have experienced. It will continue to commend our highest priority until production is fully restored. We will bring every consumable resource there to restore production as quickly and as safely as possible, and I am pleased to announce that we are ahead of schedule on expect to commence production over the next few days at an initial rate of 110 million cubic feet of gas a day and by the latter part of August we expect to increase production we should double that to about 220 million a day. The remaining gross production volumes of about 95 million a day should be restored by year end and this volume is associated with Harriet joint venture facility that was directly adjacent to the explosion and will require more significant repairs. We expect net production to average roughly 65 million a day and 7,000 barrels a day of oil in Australia in the third quarter of 2008 before returning to full volumes by the end of the year.

I might point out that the Van Gogh, Pyrenees, Reindeer and Julimar development projects also in Australia are not associated with Varanus Island and the incident will not delay our timetable of full production on any of those projects.

Despite the non-recurring events in Australia and the North Sea, we still expect production to increase in 2008 around 2% relative to 2007 that is provided we meet our timetable for restoring production of doing the filing. I might note that our income on our cash flow generation remains remarkably strong and although these events affected our current production profile, they have no impact on our ultimate reserve.

Our long-term outlook hasn't changed. Frankly it's never been better. Driven by successful drilling programs and a very strong development pipeline, we are confident that Apache is entering into a period of accelerating production growth 2009, 2012. We do intend to give an outline of our production growth at our Analyst Meeting that we are going to hold in Houston on October 23rd and I would invite all of you to join us.

I'd like to go over a few regional highlights now with you. In Australia, which I've covered most of the major projects I'd like to go over some of our major development projects. Van Gogh oil development remains on track for first production in mid 2009. That should bring on about 20,000 barrels a day net to Apache.

The Pyrenees development which is operated by BHP will most likely come on strain at the end of 2009 or the first part of 2010 and that will be an additional 20,000 barrels a day net to Apache.

Our Reindeer gas development is on track from mid 2010 with the start up of 60 million a day net and we are closing in on our refining our initial gas sales contract. In fact we have an all hands on deck meeting scheduled in Perth tomorrow to walk through the remaining issues.

We continue to study options for marketing and developing our Julimar gas area. First production is scheduled for 2011, 2012, delivering the gas (inaudible) into the domestic Western Australia market or into an international markets.

During the first quarter we made a nice discovery called Halyard that was tested at 68 million a day. We received governmental approval on the Halyard field in the second quarter this year. Actually that's only 90 days from the discovery date. We are working to establish first production by 2010.

In addition to our activities in the Carnarvon basin we have an expiration program that is said to begin around the end of the third quarter in the Gibson Basin. And all total Australia will be a large and important growth driver for the company for many years mainly driven by the materiality and debt of our exploration and project portfolio.

In Canada, we drilled 176 wells in the first half of 2008. We intend to accelerate activity in the second half of 2008. We plan to drill 415 wells in our shallow gas area of Alberta and drill 46 deeper wells for the Kaybob. We also planned 24 wells at House Mountain, but the big story in Canada continues to be our most Muskwa Shale play in a new area of Northeastern BC.

Apache has a 50% interest and operates approximately one half of the over 400,000 gross acres that we have in this play. In April we announced the results of three horizontal wells we had drilled during the first quarter. We have 24 hour test rates of 5.3, 6.1 and 8.8 million cubic feet of gas a day respectively.

EnCana our 50/50 partner has also drilled three wells this past winter. They have recently completed tested and hooked up two of those wells and which are now currently flowing to Apache's missile gas plant. The average production rate for the both those wells individually both those wells after the first 30 day was about 5 million a day and yesterday's rate were about 4.5 and 4.3 million cubic feet of gas a day.

We estimate our net reserve potential to Apache in this play to be 9 to 16 TCF of gas reserves and for reference a worldwide proven gas reserves at the end of 2007 totaled 7.8 TCF. We have yet to finalize our 2008, 2009 winter growing program and infrastructure at Ootla, but I anticipate a step change in the activity level this coming winter.

Ootla has the potential to not only be one of the key growth place in North America but also a major driver for growth for Apache over the next several years. We anticipate significant volumes coming from this area in 2011, 2012 timeframe. I should also note that we closed a minor asset sale in Canada at the end of the first quarter that was about 12 million a day affecting our production. In Egypt our diversified portfolio across several basins continued to yield drilling successes during the quarter and I would like to cover four highlights.

The first one is Bahariya concessions we operate and own a 100%. The C1X well tested 584 barrels a day before [refract] from 45 feet of pay in a 1400 acre closure. We will refract that well as soon as we get governmental approval for development lease and we would expect like all the other wells in that area that we make over 1000 barrels a day and we appear to have discovered another water flood opportunity similar to the five other fields we are currently developing in this concession. And for reference point, we are currently producing gross production from the concession primarily from water floods of over 27,000 barrels a day.

Second, also in the (inaudible) basin, but this is in the NEAG Concession that we have a 48% interest in and shale operates, we drilled two good development wells in the JG field and those are expected to come on momentarily at 1500 to 2000 barrels a day.

I would like to move over to the western edge of the greater Khalda area and that area is called a Faghur Basin. We drilled and fract the well called Heqet-2 which tested 2100 barrels a day from the Jurassic lower Safa at 14,700 feet. This is unexpected depth and horizon to find oil instead of natural gas and Faghur basin is cooler than the Shushan Basin where a cost of discovery is. We (inaudible) stimulated this Heqet-2 with excellent results and we potentially have several hundred square miles of fairway that may lend similar opportunities mostly already on our concession.

Finally we drilled an outstanding development well in the Umbarka field in North Central portion of the greater Khalda area that Umbarka-174, tested 4300 barrels a day and remained AEB field play and Umbarka is one of the eight different fields in Egypt presently underwater flood.

On the development side in Egypt as I mention earlier we are looking forward to increase our gas volumes from the Salam plant expansion project in the Khalda area during the fourth quarter of 2008. In addition, to this capacity we've also had capacity increase with the Salam plant. We have also been increasing volumes through that or buy its plant. We began the year averaging 160 million cubic feet of gas a day. We have gradually increased that over 180 million a day with additional processing available.

In the fourth quarter we expect our throughput to increase to 210 million a day as shale increases their compression capacity at the plant. On the water flood activity side, continues to post gratifying results, in aggregate during the quarter we drilled 43 wells water flood wells and eight separate projects. Quarter-to-quarter gross oil production increased 5% to 44,700 barrels a day and we are now injecting 61,000 barrels a day. With the combination of our large and diverse exploration portfolio and our low risk development there is no doubt that Egypt's growth will continue for many years.

I'd like to turn now to the North Sea. Production average for the quarter of 56,570 barrels a day, in this slide that we pointed out earlier, maintenance turnaround on a strike at Grangemouth, Scotland refinery that negatively impact our production by over 5,000 barrels a day for the quarter. At the refinery strike caused the Forties pipeline system to shut in, which in turn caused Apache to shut in its Forties field. I might point out we do not own an interest in the Forties pipeline system or the Grangemouth refinery.

Drilling results have been excellent this year in North Sea, five successful wells have been drilled and that aggregate produced 8900 barrels a day for the second quarter. Since the strike, fuel production has averaged over 63,000 barrels a day, which makes us optimistic that volumes in the second half of 2008 should be relatively strong to the 56,000 barrels a day we averaged in the second quarter.

Turning to Argentina, in the first half of 2008 we drilled 33 new wells. We had an 88% success rate and we have six drilling rigs working in [American] and 2 working in Tierra del Fuego. During the quarter we finished acquiring a 522 square kilometer 3D survey at Lago Fuego in the Southern part of Tierra del Fuego. That shoot as well as our earlier 2000 square kilometer survey completed during the first quarter has truly provided us a very large inventory of drilling opportunities. In fact we intend to pick up a third rig in Tierra del Fuego in the third quarter.

In the [Nakkin] basin we are developing shallow oil play which is present many of our producing and shut in wells in the heart of the basin. Shallow zone we have tested up to 150 barrel a day and appeared be present over a fairly large area. We are actively evaluating recompilation in drilling locations in that play.

Finally in Argentina you may have seen as now received our first coal load, ship load of LNG which is being a land at a price of 16 to $20 an Mcf which really underscores the fundamentals we are providing upside to our realization in our returns.

In the central region of the US we have 25 drilling rigs working during the quarter. We spotted 148 operated wells. We had a 99% success rate on 124 that we actually got down and I'd like to mention two of our highlights in the central region. In the Permian basin on the properties we acquired for last year, we drilled 13 successful well during the quarter which triple the pre drill expectations really due to the completion techniques developed through Apache expertise elsewhere in the Permian. The acquired properties are currently producing at a gross rate of about 11,300 barrels a day which is a 10% increase since the acquisition last year.

Secondly our positive momentum at Stiles Ranch (inaudible) natural gas play in the Texas Panhandle continued during the quarter with production now over 70 million a day. We control 38,000 gross acres in this play which is up from 10,000 gross acres we had at the beginning of the year. And we have recently doubled the number of rigs we are drilling at Stiles Ranch say.

Turning to US Gulf Coast, we average 18 operated rigs during the quarter which included nine jack-up and one semi. We also have two platforms rigs and a couple of barge rigs as well as four land rigs running. The big news in this region during the quarter is obviously our goal for 1X discovery in 2700 feet of water at [Garden Banks] 462. We obtained that lease in 2004 and our technical team developed the go for prospect late last year.

Regrettably we were faced with a lease deadline late in 2007 so we found a partner Mariner Energy who had the floater rig and the equipment window required for exploration and a quick development. We estimate the discovery contains about 100 Bcf of gross recoverable reserves and we are hopeful to initiate production of over 100 million a day by year-end using a subsea tie-back development. As I pointed out earlier we have 40% interest. We also have a second well currently drilling on that block.

One more highlight in the region I'd like to point out which is that our Union Bank 26 that we own 100% on we completed our fourth well sense fourth quarter of 2007 which is increased field production from only 700 barrels a day at the beginning of the year to over 4800 barrels a day. We have one well that is currently drilling and we have eight wells in eight locations remaining in our inventory. And I hope you can see we've had excellent results from our drilling in the Gulf region.

And summing up, I would like to make a few comments. We take stock of the second quarter as being yet another period of outstanding growth rate success for Apache. With 14 million acres across our diverse areas of operations around the world we continue to identify high profitable exploration, exploitation opportunities from the US, Gulf to Egypt from British Columbia to Australia.

Our drilling achievements during the second quarter across all of these regions have moved this strategy another step forward. In addition we have net production of 135,000 barrels equivalent coming on from our seven major development projects and we are working to add the Ootla Shale Gas Play in Canada as the eight and potentially largest major project in this pipeline, which extends our visible growth far out in the future. We obviously contend to be optimistic about the fort momentum of Apache. Roger?

Roger B. Plank - Chief Financial Officer

Thank you, Steve. Good afternoon, everyone. What a quarter. Apache turned in outstanding financial results that eclipsed all prior record as well as consensus of expectations despite our production challenges during the quarter. This obviously, speaks to the impact of substantially higher prices, but it also speaks to the effectiveness of Apache's balance portfolio approach that we could absorb both the pipeline explosion in Australia and a strike shutting down at Forties filed, our largest field and still have the rest of our portfolios production carry the day and enable our best quarter ever.

Oil and gas revenues climb $1.5 billion to a record $3.9 billion from second quarter of '07. $1.1 billion of the increase came from oil alone, another pleasant reminder of the benefit of Apache's balance production mix, which remains around half oil and half gas. Over one third of these revenues made it to the bottom line as earnings more than doubled to $1.4 billion from the same period last year and humbly are paced our previous best quarter by 370 million. As Bob and Steve mentioned, earnings per share of $4.28 were also a record beating our previous record by over a third.

Cash flow of $2.3 billion exceeded second quarter a year ago by $853 million and bested a former high by $400 million. Apache's record profits yielded exceptional returns. Second quarter annualized return on capital employ average 29%. Return on equity was 35%.

Turning to detailed comparisons of second quarter versus the first quarter of '08, our oil realization rose 21.07 or 24% from the first quarter, while gas realizations rose $1.67 per Mcf or 26% driving up oil and gas revenues by 726 million or 23%.

I want to take a moment to remind everyone of the impact that higher prices have on production volumes in countries with PSCs and cost recovery mechanisms. Basically the higher the price the fewer the barrels needed to recover cost. So higher prices are a bit of a double edge sword benefiting revenues and profits, but hurting production volumes.

In Egypt we estimated a $10 per barrel increase in price reduces our volumes by approximately 2200 barrels of oil equivalent per day. And with Egyptian oil price up $28 a barrel over the first quarter, oil production was reduced by an estimated 6100 barrels of equivalent oil per day or just over 1% of our worldwide volumes. So that's another factor we considered in looking at our year-over-year production growth.

Earnings increased 42% or $424 million and cash flow increased 26% or $475 million from the first quarter. While the (inaudible) incident reduced production by 2% in the quarter, the earnings impact was a negligible $0.03 per share primarily because at present anyway Australian gas is some of our lowest price gas.

The real story for the quarter is the increase in our margins. While oil and gas prices increased 24% on average, our cash cost increase just 6% while our non-cash cost rose only 2%. This means the substantial portion of the increased revenue from the strong commodity prices was captured in our profitability.

Cash margins increased 30% sequentially to $59.71 per barrel of oil equivalent. Including DD&A our total pre tax margin increased 41% to $46.69 per barrel equivalent produced. These margins are over 30% ahead of our best quarter ever. It's interesting to note, if you remove the effect of taxes other than income, which are essential price sensitive, production taxes from our cash cost, our remaining controllable cost actually decreased 2% from the first quarter.

Now turning to cost in a bit more detail, lifting cost per BOE decreased 1% to $8.90. Efforts to hold the line on absolute cost are bearing fruit and as production grows in the second half LOE per unit produced should drop somewhat. Full cost DD&A increased 2% sequentially to $11.77 per BOE consistent with recent drilling cost being higher than our historical average.

G&A cost decreased a nickel to a $1.57 per BOE. Absolute costs were down. The result of lower second quarter payroll burns such as FICA taxes which peak in the first quarter with incentive compensation payments. Rising production should enable our future rate to fall below $1.50 per BOE.

Taxes other than income in total increased $1.17 to $5.95 per BOE on higher commodity prices. The increase was primarily related to North Sea PRT with the substantial increase in oil price drove a 34% increase in tax. Finance expense decreased $0.09 to $0.78 per BOE on lower average debt balances.

Turning to income taxes; our second quarter '08 effective tax rate of 38% compare to 39% in the first quarter. Strong commodity prices significantly increased current taxable income again this quarter pushing the current portion of our tax to 78% from 75% in the first quarter. The problem with making the money is you have to pay more taxes and we are certainly doing our part on that regard.

Given current commodity prices, we presently expect the deferred tax percentage in the 25 to 30% range for the year and 38 to 40% effective tax rate, absent the unforeseen such as foreign exchange movement from here on out. For those that may think that our industry doesn't pay enough tax and that they seem to be growing their number on a daily basis, I will point out that Apache anticipates paying some $1.7 billion of cash tax on income and production-related revenues for the first half of the year. At current commodity prices, the total cash tax for the year could exceed $3.5 billion, of which over $1 billion is a special non-income production tax reserved exclusively for extractive industries of which oil and gas is the largest.

Summing things up, Apache's outstanding second quarter results were underpinned by our portfolio approach, which has served us well in periods of rising costs and unprecedented commodity prices is also proving to be just as valuable amidst today's highly turbulent markets.

Our balance of crude oil versus natural gas, geographical diversity, mix of long life matured developments versus high risk, higher reward projects, and strong financial position are all designed to comprise an all weather strategy.

Our founder occasionally notes that ancient mariners navigated off distant stars in order to avoid being blown off course by whatever ways immediately came front of them. Similarly, we charged to execute on our growing backlog of E&D projects around the world in order to continue delivering consistent profitable growth, despite short term challenges.

Before closing, I wanted to underscore key points of our growth. As was the case last year when most all our production growth occurred in the second half, we anticipate another very strong second half this year and you can do the math, but achieving growth in 2008 entails a substantial ramp up between now and year end. So when we talk about growing production up to 2% for the year, we are planning on significant growth by year-end that will carry into the future. Bob?

Bob Dye - Vice President of Investor Relations

We are ready to take questions at this time.

Question-and-Answer Session

Operator

(Operator Instructions). And we will take our first question from Tom Gardner at Simmons & Company.

Tom Gardner

Good afternoon, gentlemen.

Steven Farris

Hey Tom.

Tom Gardner

A couple of questions on your emerging developments, first in Egypt. With reference to your high grade oil wells, how should we think about this opportunity, how would you characterize it as -- would it be an unconventional?

Steven Farris

Do you mean in our Heqet area, Tom?

John Crum

The deep oil completion we made.

Tom Gardner

Yeah.

Steven Farris

Yeah, the Heqet area is kind of in the South Western quarter of -- obviously a huge acreage in our Khalda concession. Many years ago the Heqet -- the first well was actually drilled in 1991, the Heqet-1 and at that time we didn’t really bring frac equipment into Egypt until about 1997. So this was the first time we had fraced one of those deep Lower Safa zones in that well. We have a number (inaudible) of months through there and I can't tell you all of those are going to be good, but we are going to drill four wildcats in that area here in the coming months. We think because it is a cruder basin that we have potential to add significant low reserves down there.

Tom Gardner

Okay. Any characterization of how big the opportunity set could be beyond this field? I mean it just, I guess it's…?

Steven Farris

I think it's probably a little premature. We are going to get -- we are actually going to recomplete two of our earlier wells drilled. We drilled some wells down there from 1991 through about 1996, and it probably be just speculation at the present time.

Tom Gardner

Okay. Well, moving on to Canada and it looks like the major pipeline infrastructure appears to be targeted for 2011 or 2012. Can you talk about what's the plan capacity? There's been -- these discussions would be for that optic capacity?

Steven Farris

Well, that is a moving kind of unfolding event. One major pipelines up there is talking to us about not only for us but for other players out there. Actually (inaudible) that area, which create significant takeaway capacity. I think in the end, our largest investment will be in plants because I think over time there will be major pipelines that come up there and take that gas. Right now we probably have -- if we have the plant capacity, we probably could take over 400 million a day out of there, gross out of that Ootla area. Ourselves and our partners in Canada plus the other players up there, you can see a time when 400 million a day is not going to be enough.

Tom Gardner

That's significantly liquids production with the gas?

Steven Farris

No, it's pretty dry.

Tom Gardner

Pretty dry, okay. Thank you gentlemen.

Steven Farris

Thank you.

Operator

And we will go next to Brian Singer with Goldman Sachs.

Brian Singer

Thank you. Good afternoon.

Steven Farris

Good afternoon Brian.

Brian Singer

Picking up on the end of some of the comments made on the second half production, I think depending on how you are calculating the 2%, it look like you have to get to about 590,000 BOE a day in the second half to get to that 2%. And I was wondering what you are assuming in terms of contribution from additional gas in Egypt from the Salam plant in your numbers?

Steven Farris

Well, we should -- actually we should be commissioning that in about the middle of September. And I think right now we are going to be ramping up I think the first -- October will be the first of any meaningful probably gross about 15 million a day. That's gross. And then we would ramp up another actually by the end of the year, we would be up almost to the 200 million a day and about 5,000 barrels of liquid.

Brian Singer

Thank you.

Steven Farris

And we take about half of that, I guess.

Brian Singer

Okay. You mentioned that you are looking at international markets for Australian gas. I know this has come up before and you discussed that upfront. Are there any new thoughts on how actively you consider participating in LNG development and the timeline for that?

Steven Farris

Well, I think if you look at the infrastructure going in an immediate area to where our discoveries are, you can understand why that may be an alternative. Certainly we've had discussions -- ongoing discussions along those lines, but we don't have anything to report at the present time.

Brian Singer

Okay. Also on the international gas front, any changes on the Egypt side? I think at the time of your last call, you were about ready to potentially bring the topic up and I was wondering what the latest on the consideration for higher gas prices if you build additional process and capacity?

Steven Farris

We have made a proposal to EGPC and also to the Petroleum Minister on our concession called the up to the North, [Heqet] concession, the Heqet discovery that we made. We made a presentation to them on a higher gas price. It's interesting. I just read a thing out of the Egyptian paper that the Egyptians are working to incentivize foreign contractors to increase activity, which is going to require cost prices in Egypt to go up. So I think we are beginning to see some traction in that area.

Brian Singer

Where do you think they could go?

Steven Farris

I don't have a timeline in that area. We made a proposal that was pretty aggressive. If we get half of what our proposal is we are probably going to be lucky. Now the one thing I would say in Egypt because I think some -- we don’t do a very good at explaining it. We have one portion of our gas that have 100 million a day gross is 50 million a day net that actually sells for about $15 an M because it wasn't capped back in 2001. So our average gas plays in the second quarter was much higher than the July gas plays of 2.65 plus BTUs. We actually average $6.25 per quarter.

Analyst

Great. And if I can just one more. When you look at where oil prices are and also where some of the international gas prices are and free cash flow that you are and are likely to continue to generate, any thoughts on the acquisition market, other international gas markets potentially or bulking upon North American oil?

Steve Farris

The one thing, I mean, Apache's 52 year history, we are an inquisitive company and we haven't stopped being an inquisitive. But right now it's very difficult to make things, make sense economically. We continue to look, but we continue to drill wells, which we have a tremendous opportunity to grow this company with the drill bit right now.

Analyst

Thank you.

Bob Dye

Thanks Brian.

Operator

And we will go next to Gil Yang with Citi Investment.

Gil Yang

Good afternoon. Could you make a comment on why there was a sequential drop, maybe you mentioned this earlier, but why was there a sequential drop in the Argentine gas price versus the first quarter?

Steve Farris

It's we are going through the winter. In Argentina, it's just the opposite of where we are here. I mean, in fact, it's cold there right now. I just got back from Argentina a week ago and it was about 37 degrees in the evening. So they use an awful lot of gas during the winter and what happens is the residential uses a lot of gas and because of the tiered approach that they have to gas down there, you get about $0.50 for your residential price and they redirect gas to the residential market in the winter. So you will see until they change their pricing, you will see that counter cyclic go through the United States and turn the prices in Argentina. The one thing I might point out is yesterday, Argentina just announced that they are going to increase electricity prices and that’s not natural gas prices yet, but there is a real anticipation that natural gas prices will be right behind them.

Roger Plank

To get an appreciation that Argentina is headed in the right direction with gas prices, even with this sort of winter effect, the price of $1.39 we averaged in the second quarter compared to $1.02 a year before. So we aren't making headway.

Gil Yang

Well, last year you didn’t seem to have as much of an effect maybe on region certainly, you didn’t seem to have a much winter effect on pricing, is that because of the industrial and the residential prices were more similar then?

Roger Plank

Probably and yeah, so you won't see -- okay, go ahead.

John Crum

We also lost a Methanex contract in TdF that we were abrogated, so that was a higher price contract than our average as well, Gil.

Gil Yang

When was that?

John Crum

Last year. That's on a suspended exports from TdF.

Steve Farris

John, I don’t know if maybe we didn’t explain ourselves. Roger pointed out that at end of June of 2007, our average price was $1.02 and the average price at the end -- for the second quarter of 2008 was $1.39. So we increased about $0.37.

Roger Plank

36%.

Steve Farris

Yeah, 36% from last year. And I am optimistic because one of the reasons I just got back from there and talked to a number of people. I think you are going to see -- we talked to the Finance Minister and my expectation obviously is not going to look like him, but we are going to start seeing gas prices start trend upwards there.

Gil Yang

Okay. And related to that, when you look at in a broader sense, when you look at capital allocation for all the different projects you have got and you look at Argentina versus Ootla versus Australia, are the investments in Argentina, are they economic at the current prices of oil and gas that you are selling or are you really the loss leader for the anticipation that prices will rise at some point in the future? And then with Ootla, how do the returns fit into the overall portfolio of return you have got on your different projects?

Steven Farris

Okay. With respect to Argentina, we don't drill wells at lost leaders. Every well that we drill makes economics at a price scenario that is under the current environment. It's interesting that we can find a lot of hydrocarbon. In fact, my message even to the government down there was that the Argentina has a lot of hydrocarbon. What they need is a little bit different pricing regime and they would have a lot more activity down there than they get today and that provides jobs and a lot of other things besides the product itself. So we don't - we make economics on the wells that we drill under our current price scenario.

With respect to Ootla, I think we had a presentation after we drilled our three wells and tested them and actually publicly showed the results of those, and it's 4 BCF. At $8 an acre we were making about 13% rate of return. If you get to 5 BCF it goes up and obviously it goes up exponentially at 6 BCF. So far we are -- and that was using $10 million per well to drill those wells. What we found and I think what we are going to continue to find is that we are not going to spend $10 million to drill and test those wells. And the other thing is I think over time you are going to see the reserves trend toward the upper number. If you look at the wells that EnCana drilled and they put 10 fracs on those wells, we put 6 to 8 fracs on our wells. They fracs them larger and if you just look at the early returns out of the EnCana wells, they are going to do better than our wells, which you would expect and you would also expect those two wells to be in the higher end of that reserve number that I gave you.

Roger Plank

One of the -- going back to the no lost leader in Argentina thing, one of the things that's also going on down there is the way that market is currently structured, we have to deliver basically a relatively fixed volume of gas into that residential market. So once you get above that allocation by the government that you deliver into it, then you can sell your incremental gas at what the market will bear and that's been 2.5 to $3.5 per MCF when you don't have winter iterations going on. But the point is the more incremental gas we bring on, the higher percentage of our gas will be sold at a more market sensitive price.

Analyst

Got you. Okay, thank you.

Operator

And we will go next to David Tameron with Wachovia.

David Tameron

Hi good afternoon. Question, going back to Argentina one more time, and I apologize if you mentioned this. You were talking about at some point doing a 3D seismic shoot, I think it was going to be done this summer. Did that get done and if so any color from that?

Steven Farris

We were -- I think what you are referring to is our shoot down in Tierra del Fuego. We have now shot about 2,500 square kilometers of 3D seismic down there, the latest of which was the Lago Feugo shoot, which was 520 square kilometers. In fact, spot price is in charge of Argentina and Australia. We both went down. I am very, very optimistic about the ability to find things from that 3D shoot and on some exploration stuff number of prospects and we are also adding a rig in the third quarter to take advantage of that.

David Tameron

Okay. So that rig is going to drill some of the -- is it going to drill these prospects that were just identified?

Steven Farris

You bet.

David Tameron

Okay. And you kind of talked about it, but pipeline issues coming out of Tierra del Fuego, where those currently stand or you had some pipeline takeaway capacity issues?

Steven Farris

We have two problems with pipelines, one is there is not enough capacity. The other one is that we are at the tail end of that pipe and what happens is a couple of Petrobas and Totale inject into that pipe on the mainland and changed the pressure regime down to our end. There is more than just a passing fancy to build a loop line. In fact we talked about it when we were down there. They've ordered the steel. The government sanction pipe that will take another 250 million a day by the middle of 2009 of what they are advertising. Take another 250 million a day out of Tierra del Fuego. So hopefully in the next year or year-and-a-half we'll have excess capacity coming out of Tierra del Fuego and then they have a longer term plan to move that up to about 550 million a day by 2011.

David Tameron

Okay. But just going back 12 months, 250 shouldn't be - that should be more than enough for what you have in Totale and Petrobras, correct? You have excess capacity once that starts up?

Steve Farris

As long as we don't get the pressures regime problems that we get off of the mainland.

David Tameron

All right. And then another question and I don't know if this is for Bob or whom, but you mentioned the 2% growth target. You mentioned the assumptions for Salam to come back on line. Assuming if Australia come back online. Any other big project start ups that are needed in order to hit that target?

Steven Farris

No. The two big obviously are hitting our timelines on bringing to Salam and also hitting our timelines of bringing gas on in the Egypt.

David Tameron

Okay.

Roger Plank

You'll also get a pretty good uptick from the North Sea. We average about 55 to 56,000 barrels a day in the first half, and we've been averaging a fair amount higher than that since the strike ended. So I would anticipate that that will be a pretty good operation as well.

David Tameron

All right. Okay, thanks a lot.

Operator

And we will go next to David Heikkinen with Tudor Pickering Holt.

David Heikkinen

Okay. Just a couple of questions on Egypt, the Heqet discovery described as 835 acres on that structure, trying to get an idea of the scope and size of these, can you give us net feet of pay or resource potential for that?

Steven Farris

Well, it's a little early to give a resource potential. We had about 40 feet of pay in that zone, which we fracked and the most interesting thing about it frankly is that we drilled other wells in that area both sides of that big east west [pool]. And all of those wells have the potential to be fracked but have never been fracked, so it's somewhat a…

David Heikkinen

Okay. And then you had a well drilling Signus-3X, could you give a status on that well?

Steven Farris

Your memory is better than mine.

David Heikkinen

That was in Egypt, offset to…

Steven Farris

I thought Egypt 3X. That was [Hedrip 3X] We found some pay. It was thinner. Actually the well was updip and had a thinner pay, which was surprising because on our seismic picture we thought it would be downdip. So it's going to produce but it's not what we thought it was going to be.

David Heikkinen

So it's not the big discovery. It's 100 BCF, not the 3X.

Steven Farris

But we have a Hedrip 3 drilling as we speak, so we will hold that open. That well was eight kilometers away from the first well.

David Heikkinen

Okay. And then just one quick question. Thinking about Australia volumes, you talked about the gas volumes coming on August and late August and by year end. What's the appropriate ratio of oil ramp that comes with that? Is there any delay on the liquid facility or does it just match?

Steven Farris

Well, we should get a little liquids out of coming up in August, but we have a lot of black oil that goes through the Harriett facility and that Harriett facility -- the Harriett joint venture facility won't be on in December. So we are not going to see significant oil increases in Australia from where we are today until really the end of the year.

David Heikkinen

Okay. That was it. Thanks guys

Steven Farris

Thank you.

Operator

And we will go next to Joe Allman with JP Morgan.

Joe Allman

Thank you and hi everybody. I apologize if you covered this earlier but can you give us an update on that Reindeer gas contract?

Steven Farris

I would -- we talked about it so much, we ought to be able to give you an update, but I can. We do have a large contingent as I said on the call, a large contingent in Australia as we speak that will be meeting with various levels of the buyer in that and I anticipate that we get this thing done here pretty quickly.

Joe Allman

Okay. And what's been the delay to settling this?

Steven Farris

The honest delay is indemnity, which is interesting. We are down to lawyer negotiation about what happens if they don't take, what happens if we don't produce, and those events don't generally happen, but you got to ensure that you have mechanism on both sides in case that happens, but that is the hang up.

Joe Allman

Okay, thanks. And then a different issue. In terms of could you just comment on concerns you might have about the availability of steel to drill and develop your programs and also what you are seeing recently with drilling complete costs just across the various areas?

Steven Farris

Steel is a very interesting issue. Probably for the first time in my career because we do a stocking program, certainly for the first time in Apache, we are having to wait on steel. And if we don't take it immediately, sometimes even though we have a stocking program, that steel is not there. And I'm not the only ones that are suffering that, the reason you ask the question I assume. Steel is tight right now. Steel is tight more in this country or North America than it is in other parts of the world right now. We don't have that problem in Egypt. We don't have that problem in Australia. But in North America, that is an issue, and I think one of the reasons is that you got an awful lot more steel being put in the ground. In terms of cost, as you saw in our operating costs are down a little bit in real terms. North American drilling costs, completion costs are pretty level right now frankly.

Bob Dye

Joe, you cut out.

Operator

(Operator Instructions).

Joe Allman

Can you hear me?

Operator

Yeah.

Joe Allman

I appreciate that. Any areas around the world where you are seeing particular tightness in equipment and related cost increases?

Steven Farris

Well, we are not seeing significant increases. We are still -- obviously your waiting time on machines, whether it's turbines or the waiting time is longer. But in most places you can get around that. Like I mentioned earlier, the one place that we are beginning to see really you got to be on a tight leash in this country right now and in Canada is steel.

Joe Allman

Got you, okay. Very helpful, thank you.

Operator

(Operator Instructions). And we will go to Leo Mariani with RBC.

Leo Mariani

Hi, good afternoon folks. A question on your exploratory program in the second half of the year. You mentioned trying to ramp up activity in the Gippsland Basin, Australia in late 3Q. I was hoping you can give little more detail on what you guys plan to target out there?

Steven Farris

Well, we have four wells on the schedule. Gippsland Basin is a very oily area, has produced over 4 billion barrels of oil. We are drilling a well kind of on the outer shale of two major fields in that areas we call it Block 59, but we are going to drill at least three structures there, closest of which is call Ne Mo. It's certainly not a step out, but it's very close to SOs and BHPs field that made over 900 million barrels. I mean, I am sorry. All right. So we are in a good area and obviously there are exploration place, but we have done an awful lot of seismic work and an awful lot of geology, so.

Analyst

Okay. Jumping over to Canada here, obviously you guys have some pretty significant research potential up in the Ootla area and obviously you have got a lot of land in Canada and in some other places. Just curious to know if you folks have looked at any other sort of emerging resource plays in Canada that may have acreage exposure, things like the [Modern Air] the Bakken oil play, extension up in Saskatchewan?

Steve Farris

One of the things I will say and -- in today's hectic world, it does not behoove you to advertise where you are putting acreage together because if you look at what happens to acreage cost just like they did (inaudible) for instance, when we bought most of our acreage in the Ootla area we probably have and probably we got less than $200 million on our acreage. If we sold our acreage in Ootla today for the latest land sale it would be worth $1 billion. So we are putting acreage together in plays and we get all of the acreage together that we want to get together then we will talk about where our acreage is. And again I am not trying to be evasive, it's just acreage is key today.

Analyst

Okay. Jumping over to Argentina, it looks like your oil price was up to about 50 bucks in the second quarter. My understanding is hearing some shed out there that the government is talking about partially eating some of the restrictions on the oil price selling. Do you guys have any kind of comments on that and how it impacts you all?

Steve Farris

We are allowed some oil price adjustments and some of that is catch-up on oil price adjustments that we haven't seen in the past.

John Crum

But they have allowed, you know, we were getting 42 and then 47. It's not just quality adjustment. What's happening is is the actual purchasers allowed to actually pay a premium for crude oil and without suffering the tax on it. And so what we have seen is a market for crude oil that increases our price without affecting the excise tax and I would expect that to continue. I mean they need oil and natural gas desperately.

Analyst

Okay.

John Crum

The one thing I would say, I apologize for interrupting but the other thing I would say is Roger's comments about the different tiers in Argentina, when we are not redirected we have contracts that go from 250 certainly but up to 390. So you are starting to see prices in Argentina on a market driven prices start to reflect what's happening with respect to limited supply.

Roger Plank

It's happening in the electricity. So they have been able to get away with fixed prices for a long time. I think there is a recognition that that just isn't going to work anymore.

Analyst

Okay. Last question the US operations, you are talking about oil 2008 growth of 2% for the company with upticks in Australia into the North Sea. Is there an expectation for an uptick in the US production in the second half of the year as well?

Steve Farris

Well, we certainly should see our central region buy-ins continue to go up modestly and I think from a quarter-over-quarter, you probably will see our Gulf region go up.

Analyst

Okay. Well, thanks a lot for your time.

Steve Farris

Thank you sir.

Operator

And we will go next to Jeb Armstrong with Calyon Securities.

Jeb Armstrong

Hi good afternoon. Turning back to acquisitions, given that you are one of the largest CBM producers in Canada, is that a reason where you think you would consider making an acquisition?

Steve Farris

Well, I think it was a right opportunity obviously from our perspective and I think most people's perspective is Alberta shot themselves in the foot, and you can gauge that a number of different ways. The lease sales that are going on in BC, the lease sales that are going in Saskatchewan, the activity level inn those two provinces versus Alberta. I think from our standpoint in Canada, we add more value to our company and to our shareholders from land acquisitions and drilling wells than we do from acquisitions and never say never, but that's probably not an area that we would actively pursue a significant producing property acquisition, not unless it brought a tremendous amount of acreage.

Analyst

Got you. And just turning back down to the Gulf of Mexico, following on go through, do you have any plans for any additional deep water wells?

Steven Farris

Well, we don't have any on our drilling schedule right now, but we have a team that is put together to look for those kinds of projects, which is where this project came from. So we continue to develop the geology to be able to find more of these.

Analyst

Good. Thank you very much.

Operator

And we will go back to David Heikkinen.

David Heikkinen

Just a follow up. What do you expect your total capital budget to be for 2008?

Roger Plank

It will be about $6 million, David.

David Heikkinen

Okay.

Roger Plank

We started lower than that but prices have held in and our regions have been able to find some new and interesting things to do, and so we are going to let them expand a little.

Steven Farris

And you have some things going on that affect that. And for instance, go forward work, that's a significant development as well as we'll probably drill three wells in there this year and those wells are not inexpensive.

David Heikkinen

And then what did you sell in Canada and the $142 million of property acquisition? Is that leasing or is there any production with that?

Steven Farris

A little bit of production but for the most part that was a land purchase and that's the one with the acreage buy. In Canada, we sold a number of scattered properties across Alberta.

David Heikkinen

Okay. Thank you.

Operator

And there are no more questions in the queue at this time.

Bob Dye

Well, thank you all for joining us. I know for most of you you've had a very busy day, but we appreciate your interest in the company and if any of you have any questions after the call, be sure to give me a call. Thanks.

Operator

And this does concludes today's conference. We appreciate your participation and you may now disconnect.

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Source: Apache Corporation Q2 2008 Earnings Call Transcript
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