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Anadarko Petroleum Corporation (NYSE:APC)

Q2 FY08 Earnings Call

August 5, 2008, 10:00 AM ET

Executives

John Colglazier - IR

James T. Hackett - Chairman, President and CEO

Karl F. Kurz - COO

Robert P. Daniels - Sr. VP, Worldwide Exploration

Charles A. Meloy - Sr. VP, Worldwide Operations

R. A. Walker - Sr. VP, Finance and CFO

Analysts

Thomas Gardner - Simmons & Company

David Heikkinen - Tudor Pickering & Co.

Brian Singer - Goldman Sachs

David Tameron - Wachovia Capital Markets

Joseph Allman - JPMorgan

Gil Yang - Citigroup

Philip Dodge - Stanford Group Company

Dennis Coleman - Bank of America Securities

Operator

Good day, ladies and gentlemen, and welcome to the Second Quarter 2008 Anadarko Petroleum Corporation Earnings Conference Call. My name is Annie, and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will be conducting a question-and-answer session towards the end of this conference. [Operator Instructions].

I would now like to turn the presentation over to your host for today's call, Mr. John Colglazier. Please proceed sir

John Colglazier - Investor Relations

Well, thanks Annie, and good morning, and thanks to everyone for joining us today for Anadarko's second quarter 2008 conference call. Joining me on the call today are; Jim Hackett, our Chairman and CEO and other executives who will be available to answer questions later in the call.

Also I would like to take this time to introduce Danny Hart, an engineer who is joining us in our Investor Relations group. Danny has been with the company for more than 10 years and will be available along with Chris Campbell and myself to continue to work with you and meet all your needs. As a reminder, we have posted additional information in our second quarter operations report that is posted on our website.

And before I turn the call over to Jim, I need to remind you. This presentation contains our best and most reasonable estimates and information. There are number of factors that could cause actual results to differ materially from what we discuss. And you should read our full disclosure on forward-looking statements in our presentation slides, our latest 10-K, other filings and press releases for the risk factors associated with our business.

In addition we'll reference non-GAAP measures, so I'll be sure to see the reconciliations in our earnings release on page 5. We encourage you to read the cautionary note to U.S investors contained in the presentation slide for this call.

And with that let me turn the call over to Jim Hackett.

James T. Hackett - Chairman, President and Chief Executive Officer

Thanks John. Good morning, everyone. During the second quarter, our portfolio demonstrated a capital efficiency we expected from the new asset footprint we built over the last two years. It also illustrated depth and flexibility as we overcame a major production shut in. We're delivering on a commitments we set forward in our Investor Conference in New York earlier this year.

During that meeting, if you recall we laid out our expectations for production, free cash flow, capital spending, reserve adds, and cost structure. And we are on target to meet or exceed each of these objectives by year end.

Starting with sales volumes for the quarter Independence Hub we shut in a month longer then we initially expected when we last updated you. And we were still able to meet our overall volume guidance for the second quarter. If the issues with the export pipeline at Independence Hub has been resolved in May as assumed in the guidance we provided at that time. We would've been at the high side of our guidance for the quarter.

Three areas in particular enabled us to overcome the challenges associated with the Independence Hub; the Rockies in the southern divisions and our oil producing properties in the Gulf of Mexico. These areas generated 1 million barrels equivalent above their forecasted volumes.

Our commitment to realize double-digit annual production growth in the Rockies remains on track. Our tight gas play in the Greater Natural Buttes Area, the Uinta Basin and our coalbed Methane operations in the Powder River Basin each generated more than 10% sequential growth over the prior quarter.

We continue to set daily production records in both areas. Greater Natural Buttes achieved 300 million cubic feet per day, and the Power River Basin surpassed 400 million cubic feet per day of gross operated production.

Our midstream build-out in the Powder River Basin continues with the startup of the big George Line, which freed up 75 million cubic feet per day. The final phase of the Fort Union Gas gathering system also was completed.

The system now has total capacity of 1.3 billion cubic feet per day. Additionally, we enhanced our capital efficiencies through improvements in our cycle times. During the quarter we reduced the number of days it takes to drill well and mobilize the rig to another location in nearly all of our onshore areas. For example, in the Carthage area our vertical rig problem realized an average decrease of two drilling days per well.

In one, but we improve cycle times by one full day and expect further improvements this year. The momentum achieve with onshore production in the first half of 2008, allows us to reaffirm our full year production guidance of 207 million to 212 million barrels of oil equivalent.

As I stated in the earnings release, I am very pleased with the amount of free cash flow our operations generate in the second quarter. For this first six months of 2008 our free cash flow generation has been nearly $2 billion. We further improved our financial flexibility as we continue to strengthen our balance sheet. With a quarterly reduced total debt by approximately $700 million from cash on hand, proceeds from property divestitures, and the IPO over midstream MLP Western Gas Partners.

Our capital expenditures for the second were within guidance at approximately $1.2 billion and our reserve adds were on target for the year. We expect our total capital spending including the expensed exploration to be in the range of $4.9 billion to $5.1 billion, which is anticipated to add more than 250 million barrels of crude reserves.

Our full year guidance on an improving cost pressure also remains on course. LOE was below the low-end of our guidance and G&A was inline with our expectations for the quarter. We are maintaining our guidance going forward for these areas, in spite of mounting inflationary pressures.

Now I am going to highlight some of our operations beginning with our international activities. Offshore Ghana we anticipate sanctioning the Jubilee field later this year. During the second quarter we increased the field's estimated recoverable resources to range of 500 million to 1.8 billion barrels of high quality crude oil. This estimate is more than double the prior low side and almost double the high side projection as well.

We've increased the resource estimates following drill stem test in the upper and lower zones on the successful Mahogany-2 appraisal well. Each zone poured at a rate of about 5,000 barrels per day despite equipment and facility constrains. The partnership also is preparing to avoid countries [ph] for some of the long lead items such as the FPSO and subsea equipment as we work toward initial production in 2010.

We expect to have two rigs active in the area later this year with another two rigs contracted in 2009 and beyond to continue with our exploration, appraisal, and development programs. We have now expanded our opportunity set along this emerging Ghana like deepwater Cretaceous trend offshore West Africa, by recently acquiring positions in five new blocks offshore Liberia and Sierra Leone.

Moving across the Atlantic we relocated the Deepwater Millennium drillship from the Gulf of Mexico to Brazil during the quarter; and are currently drilling our first operated pre-salt prospects called Wahoo and black-30 in the Campos Basin. Once we complete drilling operations at the Wahoo prospect we plan to move the Millennium drillship to the Espírito Santo basin and renter the Serpa prospect.

As we previously reported the initial Serpa test was suspend before reaching its primary objective due to insufficient rig capacity. The encountered hydrocarbon bearing sands prior to suspension and are encouraged by the potential of our targeted deeper primary objective. Once we complete the Serpa well we plan to continue our pre-salt program offshore Brazil by drilling two additional exploration commitment wells.

In moving our Millennium to Brazil we built enough flexibility in the rig schedule to position us to potentially farm into other Brazilian opportunities as we have done previously in the Gulf of Mexico and Ghana. First cross the Atlantic again and coming around South Africa in Mozambique we completed the largest 3-D seismic acquisition in the company's history. It covered more than 3,000 square kilometers in the offshore of Rovuma Basin. We expect to drill our first offshore well in 2009 and are currently acquiring seismic for onshore Mozambique acreage as well.

Turning to our activities in the deepwater Gulf of Mexico, we continue to drill the Sturgis North prospect in the Atwater Valley Block 138. And the Anadarko operated Shenandoah lower tertiary prospect in the Walker Ridge area. Both the detail and our operations report.

In the third quarter we expect this about the Anadarko operated Heidelberg prospect in the Green Canyon area, which is on trend with the Tonga West discovery. We hold a 44% working interest in Heidelberg. We also anticipate join the Vito prospect in Mississippi Canyon during the third quarter. Vito will targeted Miocene objective. We also operate this well at the 20% working interest.

We are currently drilling three appraisal wells in the Green Canyon area the Gulf of Mexico. The first is in our K2 field. The GC 562 number force in updip sidetrack to the successful GC 561, which was discussed in the first quarter conference call.

We've made significant progress in this well in the last few days and are encouraged by the results today. The side tracked well has enhanced our understanding of the area and has extended the pay sections of four new sands. We anticipate booking reserves this year from this activity. Additional well operations are being finished along with plans to complete this well for initial production in mid 2009. We also anticipate making recommendations to the partners for the optimal enhanced oil recovery program in this large field by year-end.

The second appraisal well that currently is drilling is within the Caesar-Tonga complex and the third is an appraisal to our Mission Deep discovery. Onshore in the U.S Anadarko's exploration program is being executed within a 1 million acres in emerging shales and other exploration place. As an example, we reached total depth objectives in our first two wells in Marcellus shale, in Central Pennsylvania. The core data is being analyzed with encouraging results today.

We expect to track and complete these wells during the third quarter. We hold 50% interest in approximately 625,000 gross acres in this play, one of the largest acreage positions in the area. We also have approximately 70,000 net acres held by production in the Haynesville shale underlying our East Texas acreage. We expect to be dug up to four tests in the play this year. While testing other plays on our onshore exploration program including the Maverick, Haley, and Deep Maker shales and in the Wilcox type sand area.

Turning to our financial results for the quarter, the capital efficiency of our programs reflect in our substantial discretionary cash flow of approximately $2.3 billion compared to capital expenditures of approximately $1.2 billion. While we benefited from the rise in commodity prices, we also managed to hold the line in our controllable cash costs for the quarter. As a result of our free cash flow is sequentially higher than last period and once again provides us with the financial flexibility to comfortably execute upon our business model.

At the end of the second quarter our total net debt to capitalization was approximately 42%. As I mentioned, we reduced total debt by little more than $700 million during the quarter and we believe we would be below 35% net debt to capitalization by year end.

Our second quarter net income from continuing operations was $831 million or $1.76 per diluted share excluding items affecting comparability, which are also disclosed in detail on page five of our second quarter earnings release. We've already talked about volumes for the quarter and our focus on our controllable costs. However, we also want to address DD&A, which was above our guidance.

This was due to the primary well at Red Hawk watering out. As a result, our DD&A will be higher through the end of this year as remaining volumes are produced. We see significant potential at Red Hawk and planned further drilling in 2008. Success in this program should bring DD&A down in 2009. The supplemental information attached to the earnings release includes additional detail regarding our guidance for the third quarter and full year.

For the third quarter we expect production to be in the range of 51 million to 54 million barrels of oil equivalent. The midpoint of which represents a 13% increase from the third quarter of last year from retaining properties.

Our third quarter production guidance also includes an assumption for weather down time for potential hurricanes in the Gulf of Mexico, and warm weather affects on-production in the Rockies. We've also included our aggregate derivative positions in the supplemental materials and while we remind you that we've actively managed our risk in the Rockies, with both firm transportation commitments and attractive basis hedges covering approximately 95% of our production in both 2008 and 2009, and about two-thirds of our production in 2010.

This means that we've locked in differentials in the majority of our Rockies production with pricing of Henry Hub less $1.50 per million BTUs this year, Henry Hub less a $1.25 in 2009 and Henry Hub less a $1.13 in 2010.

Substantial additional takeaway capacity is expected to be online in the 2010 to 2011 time period. As announcement of second quarter we have signed a letter agreement with Northern Border Pipeline company outlining terms to establishing Anadarko as an anchor shipper and are proposed by some pipeline projects. Our commitment to the proposed project is 250 million cubic feet per day of natural gas.

We've also made a commitment for up to additional 200 million cubic feet per day and the proposed Ruby Pipeline. Together these lines will help to ensure our continued production growth from our Rocky Mountain assets. With some of the softening we're currently seeing a commodity prices especially in the natural gas side, this is a good opportunity to emphasize the robust economics of the Anadarko's major U.S onshore programs. Each of which generates at least 10% rate of return at $5 NYMEX flat price desk.

In summary, our portfolio is performing well. It's capital efficiency is demonstrated by our significant free cash flow generation and the step was illustrated as the number of areas exceeded expectations offsetting the independent sub challenges and enabling us to deliver production results within guidance.

To repeat we're... reaffirmed the full year production guidance range of 207 million to 212 million barrels of oil. Total capital expenditure guidance range of $4.9 billion to $5.1 billion including the expense exploration and anticipated reserve as of more than 250 million barrels of oil equivalent; all well continuing to improve our cost structure.

With that Annie we will open up lines to feel questions from the audience.

Question And Answer

Operator

[Operator Instructions]. And your first question comes from line of Tom Gardner with Simmons & Company. Please proceed.

Thomas Gardner - Simmons & Company

Good morning, Jim.

James T. Hackett - Chairman, President and Chief Executive Officer

Good morning, Tom.

Thomas Gardner - Simmons & Company

Given Anadarko equity is currently priced well below its underlying value of the assets. What do you think it will take to get the market to recognize there is some whether some of its steps management might be considering them lot value?

James T. Hackett - Chairman, President and Chief Executive Officer

I think there is a number of alternatives we'll look at. I think one is continuing to just perform this is obviously a very strange period in the markets and I think that continued quarterly performance is the best way to ensure that people pay attention to you, cover the stock, I think there is some things we can do around a weak market. That we'll be considering in light of our generation of free cash flow and our sale... pending sale of the enclosing of the Peregrino asset. NASDAQ is just one of financial flexibility to look down the road at all the alternatives that can provide for the shareholder. And so I think we're actively trying to take a hard look at all of that and believe that performance and a strong balance sheet investment grade rating, but also any alternatives that we can to try to unlock the value are going to be looked at.

Thomas Gardner - Simmons & Company

Okay, that's helpful. And you mentioned mounting inflation pressures. Can you give us an update on what the industry service constrains are heading?

Karl F. Kurz - Chief Operating Officer

Tom this is Karl Kurz. We continue to see service cost with pressure on them from higher rig counts and strong commodity price market we've seen the first half of the year. This would be in led by a lot of the pumping services, rig rates, but also by steel tubular markets extremely tight. Last year our supply group entered in some long term five year preferred pricing and supply arrangements with a couple of manufacturing mills, which has enabled us to ensure that we can get all the pipe and tubulars and steels we need at preferred pricing. So we're seeing a lot of pressure in the industry currently we are seeing some differential value from that similar like we've seen in our rig strategy in the deepwater.

Thomas Gardner - Simmons & Company

Thanks Karl. I'll let someone else hop on.

Operator

And your next question comes from the line of David Heikkinen with Tudor Pickering & Co please proceed.

David Heikkinen - Tudor Pickering & Co.

Good morning, guys. I have committed a lot of capital and planning to exploration wanted to try to get some additional granularity as you start thinking about the five new blocks offshore West Africa then some thoughts about resource potential that you are accessing in Brazil?

Robert P. Daniels - Senior Vice President, Worldwide Exploration

Yeah, David this is Bob Daniels. The five new block that we got two in Sierra Leone three in Liberia we are very excited about them. We took that information that we learned the knowledge we got from the Jubilee discovery in Ghana and started looking at that trend and trying to identify other similar play types... excuse me, similar traps and there is a 3-D that was shot on the Sierra Leone blocks that identify the very high quality prospects and its drill already. So we plan on actually in 2009 drilling the well in Sierra Leone meanwhile we will be shooting a 3-D down in the Liberian blocks to see whether or not the play extends down into those 3-D data indicates that it does. So we're very pleased to have that. The prospect size and target sizes there would be very similar to what we're looking at the Jubilee area. We think that this is a prolific area with two different basins that have the same source rock, same depositional system, same structural style and we think that we've just unlocked the key to identifying these different plays. So we will continue to try to capture more opportunities along this margin that have the same quality that Ghana does.

Don't forget also that the two blocks that we have in Ghana we see tremendous additional exploration opportunities there. We drilled four wells to-date. We've had success in all of them, three in the Jubilee complex; one was a step out at Odum, which was a different target. A young grade sand but the same depositional style and we think we've got about between six and nine more wells... exploratory wells to drill on those two blocks for targets that could be, as small as the satellite like at Odum, two standalone prospects as big as the Jubilee complex. So we're very excited about the opportunities we see on those two blocks and the whole margin there of West Africa.

As we move into Brazil we're looking and focusing on the pre-salt. We're drilling the Wahoo prospect presently and then we'll go back to the Serpa, both pre-salt objectives and we think in both the Campos and the Espírito Santo Basin that we have very good pre-salt prospectivity on our blocks and the target size is there are in the multi-100 million barrel range and could be far more significant than that. We'll have to get down and see what it looks like.

David Heikkinen - Tudor Pickering & Co.

Okay. Thanks I'll let other people to ask questions.

Operator

And the next question comes from line of Brian Singer with Goldman Sachs. Please proceed.

Brian Singer - Goldman Sachs

Thank you. Good morning.

James T. Hackett - Chairman, President and Chief Executive Officer

Good morning, Brian.

Brian Singer - Goldman Sachs

In response to some earlier question when you were speaking of things you can do in a weak market with free cash flow just wanted to clarify whether you are referring to share repurchase, acquisitions or both and when you think about your net debt to capital ratio, what do you think is, a good target?

James T. Hackett - Chairman, President and Chief Executive Officer

That's definitely one of the options we are looking at given these how attractive the NAV is. I think the thing that is a focus for us at the same time as how to make sure that we don't lose investment grade rating. So we've got to get all that work through the system. But, at today's values for all these large cap E&P companies, it's just... it's stunning what they're trading at relative to their NAV.

Brian Singer - Goldman Sachs

Great. And then I guess on going back to Ghana, what are your latest thoughts in terms of production rates from Jubilee and how the rate and timing could change if you end up at the upper end of your guidance range versus the lower end of your guidance range in terms of resource potential?

Charles A. Meloy - Senior Vice President, Worldwide Operations

: Hey, Brian this is Chuck. We... we've sized the initial FPSO for 120,000 barrels of oil a day. We anticipate ramping that up... ramping up to that rate during the Phase I development activities which will begin in 2010 and depending on how large it turns out to be, we could actually add additional equipment out there to double that rate if it became necessary.

Brian Singer - Goldman Sachs

How... and lastly how... I guess to the 2010 period we went in 2010 should we expect the facility to start up and how confident are you in the timing of that?

Charles A. Meloy - Senior Vice President, Worldwide Operations

Well we are gunning for the second half of 2010. Of course we are just starting this project we still have a lot of approvals to go from the Ghana government and so there is some uncertainty on it but that was there today we are gunning for the second half.

Brian Singer - Goldman Sachs

Great. Thank you.

James T. Hackett - Chairman, President and Chief Executive Officer

Brian, I might add that there is lot of alignment between the partners and the government to accelerate this project. So while we have issues with the government, we expect those to be get done very quickly. This is their first major discovery and they'd like to see it online very fast.

Brian Singer - Goldman Sachs

Great. Thank you.

Operator

And your next question comes from the line of David Tameron with Wachovia Securities. Please proceed

David Tameron - Wachovia Capital Markets

Thank you, good morning everyone. Jim, can you give us some more clarification on the timing Wahoo versus Serpa when you expect that Wahoo down and then move over to Serpa?

James T. Hackett - Chairman, President and Chief Executive Officer

Yes David, if I can answer that at Wahoo, we've still got significant amount of drilling to go. We are drilling right now but we're at the top salt casing points. We've got to get through the salt and then to our pre-salt section so I would anticipate we're at 45 to 60 days away from the end of that well and then we'll move on to Serpa. So that would make it late third quarter, maybe even into the fourth quarter before we see results from Serpa. Of course Serpa we're reentering the well bore that we abandoned earlier and just deepening that well because we are unable to get to our primary objective with the equipment we have for the first time.

David Tameron - Wachovia Capital Markets

And what's the timing on... how long it takes to deepen Serpa how many days do you estimate?

James T. Hackett - Chairman, President and Chief Executive Officer

I would say 45 to 60 days to get on down there.

David Tameron - Wachovia Capital Markets

All right. And then moving over to the Gulf of Mexico; do you have any pre-drill targets that you have published or that are out there on Shenandoah and Heidelberg?

James T. Hackett - Chairman, President and Chief Executive Officer

Shenandoah we have talked about it being lower tertiary objective and then Heidelberg and Miocene we're looking for the similar pay section that we saw there at Caesar-Tonga.

David Tameron - Wachovia Capital Markets

All right that's all I got. Thanks.

Operator

And your next question comes from the line of Joe Allman with JPMorgan. Please proceed.

Joseph Allman - JPMorgan

Yes, hi, good morning, everybody.

James T. Hackett - Chairman, President and Chief Executive Officer

Hi, Joe.

Joseph Allman - JPMorgan

I think you folks lowered your CapEx budget midpoint by $350 million for the full year. Can you talk about that a little bit?

James T. Hackett - Chairman, President and Chief Executive Officer

Yes Joe. When we talk this is call pleasure [ph]. When we talk about our capital budget we also fill in the cash portion of the exploration that gets expensed, which is predominately seismic. So when you look at the capital range that we have and adding the cash portion of the exploration expense, you get to the $4.9 billion to $5.1 billion which we establish back in our investor call.

Joseph Allman - JPMorgan

Okay. Thank you. I appreciate that. And then on Independence Hub I know after that shut in for more than 50 days like last week it was down for some maintenance, could you talk about the reason why folks had to do maintenance out there and then are there any design issues that you are concerned about with in peninsula [ph]?

Charles A. Meloy - Senior Vice President, Worldwide Operations

This is Chuck again Joe, the flex drawn was what we were shutting originally for we have a schedule maintenance or a plan maintenance that were undergoing now which was inclusive of reevaluating and inspecting that flex joint and what we decided to do was go ahead and do reworking [ph] of the bulks to ensure that their integrity was there. And that is underway right now unfortunately why we were doing that we have this where enterprise is running that we had the top of the storm emerge and if it stays back a couple of days but there is no design issues with the system we are just verifying its integrity and moving on down the road.

Joseph Allman - JPMorgan

Okay. And Chuck when would you expected to assuming as storm going through when would you expect Independence Hub to be back online?

Charles A. Meloy - Senior Vice President, Worldwide Operations

We're on the back side of the storm at the hub, now so we are going to work and we probably have one or two days of additional work remaining and then it should come back on.

Joseph Allman - JPMorgan

Okay, good. And then Deep Haley I knows its the Deep Haley was down sequentially production wise and that you guys you folks would just be give eight rigs running if you talk about your expectations for Deep Haley going forward?

Charles A. Meloy - Senior Vice President, Worldwide Operations

Yeahthat the field is performing well we drilled some great wells here recently we've down scaled the rigs between us and Chesapeake bit just to accommodate our land position and the play but it's performing well quarter-on-quarter we go up and down but it's been strong performance.

Karl F. Kurz - Chief Operating Officer

Joe this is Karl. You will see an increase probably in the third quarter versus second quarter because like Chuck mentioned it is statistical play we get streaks out there and is our baseball field. We get hard hitters and the Mendoza line hits us every now and then but lately we've hit in over the 500. We got three or four wells that come on the last two months they are just barnburner wells so you'll see that volume increased over the second quarter once we report third quarter.

Joseph Allman - JPMorgan

Got you, got you. And then looking at what different areas of your portfolio made up for the short fall from Independence Hub it looks like your CBM did particularly well looks like Gulf of Mexico was flat outside of Independence Hub. Can you kind of just talk going forward what are the particular area that you expect to shine that really kind of grow more than others?

Charles A. Meloy - Senior Vice President, Worldwide Operations

Well, we are really excited about the CBM activity that we've had, we have set early production records out there regularly as Jim mentioned we just expanded the four union gas gathering system which gives us a lot of additional space. And we'll be ramping up to fill that space just shortly and we've seen great performance out of the big George goals and they have given us a lot of encouragement that we could continue to set production records for a long time. The other area is Greater Natural Buttes we've seen a production record in the views as well recently of over 300 million cubic feet gross operated. Our net productions moving up over 10% quarter-on-quarter; we've really drilled some fantastic wells and we just now are completing the sort of the final legs and the infrastructure that allows us to evacuate that area. So those two areas alone will do a good job of boosting our production quarter-on-quarter for a while.

Joseph Allman - JPMorgan

Got you. And--

Karl F. Kurz - Chief Operating Officer

Let me tact in with Chuck on that one too because we're seeing great performance down in the east Texas Austin Chalk. We're seeing performance in the Carthage and Bossier and some areas that Jim mentioned in his opening comments as he mentioned we cored a couple of wells in the Marcellus. We'll be drilling four more wells up there and we're very encouraged by what we seeing today, and then I also know Chuck has four wells planned in the Haynesville for the rest of this year. I think three are probably vertical wells maybe one horizontal well. So all those areas get us pretty excited by what we have to look forward to in the second half of this year.

Joseph Allman - JPMorgan

And then in the Rockies, are there any limiting factors there like just... are you limited in your ability to grow until the rigging gets to more takeaway capacity?

Karl F. Kurz - Chief Operating Officer

We feel pretty good about our takeaway capacity position from both a front transport and also from a handling the basis differential through some financial hedges. One of the benefits we picked up from the Western acquisition was a marking group which is I mean they are crack on top of the Rockies market and they provide a lot of value for us making sure we get our gas moved and also have a great little presence there on a local market. So when we look at our volume or so has go out we are able to sell lot of our gas locally there in the basin, which gives us a little bit of advantage. We look at the constraint possibilities going forward and as Jim mentioned that's when we signed up our capacity in both Ruby and Bison and we're working very diligently with those pipeline commission to show those projects stay on time to get them in as early as possible.

Joseph Allman - JPMorgan

Got you and then lastly with Ghana, when would you expect some additional delineation results that are really going to delineate how wide a field it is and then when would you expect results from some of these other fields in these two blocks?

Robert P. Daniels - Senior Vice President, Worldwide Exploration

This is Bob again. We're expecting to have some more rigs coming two rigs come in the end of the year and two more in 2009 and that's really going to kick off all of the activity and the blocks continued appraisal development drilling and some of those will be drilling the exploration wells. So I would start looking for kind of a pretty consistent flow of information coming out of there starting in the first quarter of next year based on the two rigs to come late this year.

Joseph Allman - JPMorgan

Okay, it's very helpful. Thank you very much.

Operator

And your next question is a follow-up from the line of David Heikkinen. Please proceed.

David Heikkinen - Tudor Pickering & Co.

Good morning, Jim. Just thinking a little bigger picture; the industry has clearly a natural gas growth mode, talked about efficiency of drilling more wells per rig, you have got increasing capital budgets in drilling emerging resource plays but investors are reacting pretty negatively to growth and kind of voting with all of right now and how do you think about the amount of gas growth that's going on in the lower 48 versus demand and kind of the industry just continuing to ramp forward?

James T. Hackett - Chairman, President and Chief Executive Officer

One of the things that we obviously feel good about now is the hedges we placed and extend through the rest of 2008 and 2009. We thought that they'll run up to $12 plus was potentially temporary phenomenon. We like... we're on sure production is going because David other than having a very mild winter, I think we're going to need a production person. I don't view this market as being a bearish long term market, I think that obviously a lot... there are several players out there who think this thing could really get weak through the course of the early part of next year. But I think with where LNG imports are at, with where other sources of production are absent, the kind one time events we've had this year with Independence Hub when it's up and running strong and with racks are ones that won't continue to be strong adders. So my personal belief is the onshore production is an important element when we've got export industries growing and we've got power generation growing and our view is that if you are somewhere in the $7.50 to $9 range for the next year, I think it starts going up from there. There are a lot of reasons for that.

With this global climate change whether it's the demand that it is occurring from natural sources right now from current uses of natural gas; and I think it's going to get tougher as you go to continue to have these kind of growth rates personally with the kind of decline rates you seen on conventional resources. And I think people are tending to over estimate how much gas you can actually infrastructure you can put in place and how quickly in some of these resource plays so that when we talk about Haynes going out, where it's going to be it's obviously looking like a fabulous reservoir. Same with Marcellus it looks like a fabulous reservoir so far but these things take time to put in place and the service industry isn't equipped yet to be there in a big way. The pipeline infrastructure while it's there in parts and in some ways has to be enhanced significantly and I just don't think it happens as quickly as everybody is fearing it might from the standpoint of being bearish about gas prices. That's just our view.

David Heikkinen - Tudor Pickering & Co.

And kind of thinking about them where do you think the... from an Anadarko portfolio standpoint where is your marginal base and what's the marginal cost of gas?

James T. Hackett - Chairman, President and Chief Executive Officer

I think one of the things is an advantageous that we basically stepped out two years ago and created the growth that we wanted from the onshore unconventional resource area augmented by what we do in the meantime because we not only spend a bunch of money starting in 2005 on onshore shale plays, some of which I mentioned in terms of the Floyd shale and down the Maverick basin area, but also with acquisitions we did in both the tie-gas [ph] sands area and the Powder River coal base back in 2006 is that we I think anticipated a better work and this market was going and as a result we bought in resources at what... at that time people I think criticized us a bit for... I think today would look very favorably upon especially as we're rolling some of those problems but even on the proved reserve cost we bought those in $20 a barrel and we're tackling the debt we went and did that several years ago. So there are our economics as I mentioned in the conference call stand a really low test in terms of NYMEX pricing down to the $5 level don't need $8 or $9 gas to make great returns on the assets we build. I don't think the industry necessarily sits in that position. And that's why I think it will be fairly self correcting. We tested this before one time and never got down to what people feared we would I think will if it gets to that point I think we'll have a very quick response back up again as some of these incremental plays go off for the industry. But I think Anadarko is a very preferred position based on some bold moves I think we took back in 2006

David Heikkinen - Tudor Pickering & Co.

And you wouldn't care to comment on any of the assets that you sold that did have higher costs and maybe not as good of economics of where those prices would be. I'm just trying to think about where rigs would go first, I mean you got a pretty good look at the market over the last two years of buying and selling assets. So that you could help us out a little bit with.

James T. Hackett - Chairman, President and Chief Executive Officer

I think it would be inappropriate to comment on that

David Heikkinen - Tudor Pickering & Co.

Okay.

James T. Hackett - Chairman, President and Chief Executive Officer

We had reasons for why we sold them.

David Heikkinen - Tudor Pickering & Co.

That's fair enough. Thanks.

Operator

And your next question comes from the line of Gil Yang with Citigroup. Please proceed.

Gil Yang - Citigroup

Hi. The... Jim you mentioned couple of times that you would add... with your capital budget you would add 250 million barrels of new reserves. Could you comment on... of that 250 million, how much is from drilling up the leverage resource stuff versus from the new discoveries that you made over last couple of years?

R. A. Walker - Senior Vice President, Finance and Chief Financial Officer

Gil this is Wal. I would say the 250 we'd refer to at least being 250. So don't think that was just a hard stop at 250. The other thing as we look at where we believe is going to come from as we've told before most of our production reserve replacements were very low resources primarily from our probable inventory. So it's not with a lot of exploration success that production is being replaced or the reserves are being grown as the bookings that will come from Ghana and from other successes like Caesar-Tonga but those will work through this year and in future years but largely that 250 plus number is coming from very low risk sources of the inventory.

Gil Yang - Citigroup

Okay, all right. So those the two exploration wells projects are really upside to that largely upside to that 250?

James T. Hackett - Chairman, President and Chief Executive Officer

That's correct and that was always the view we had about the strategy and as you recall we sold off some of our near term reserve adds as a part of the restructuring. You've got kind of these tweaners like a K2 well that had a better year which is anticipating and originally design as an appraisal well or a delineation well and we get some if you will exploration adds in the at the end of the day which is high class answer.

Gil Yang - Citigroup

Okay, well, that Jim this is my second question which is just that you have sold some of these early stage prospects pre-bookings and given that your balance sheet is in a better place today than it was a year ago, what is your propensity to sell additional early stage discoveries versus keeping them in house and developing into fruition.

James T. Hackett - Chairman, President and Chief Executive Officer

Our view on that is that we may periodically do that for a variety of reasons, but I don't think it will be something that we do on a consistent basis. We most of what we saw was directly related to the restructuring effort be you may occasionally see as early stage of asset, I think that the Peregrino was a good example as that we just saw a very compelling price relative to the fact that we had good production growth when that was coming online. And we felt relative to the technical and marketing issues around that, the bed value was a good value. We think that the party you brought it from [ph] this is going to do very well on it. But we also like the fact that it accelerated our balance sheet restoration and gave us more capital flexibility to put things in near term higher margin prospects and development opportunities. And we had things like Jubilee and West Tonga coming on. And so we had luxury of doing that, but I don't think you will see that being anything but a periodic type of the as opposed to a consistent part of the strategy. And it just happens to validate the inventory which is kind of handy to every once in a while.

Gil Yang - Citigroup

Okay. Thank you very much.

James T. Hackett - Chairman, President and Chief Executive Officer

Thank you.

Operator

And your next question comes from the line of Philip Dodge with Stanford Group. Please proceed

Philip Dodge - Stanford Group Company

Good morning, everybody thanks for the comments. I want to go back to Brazil. You mentioned using the Millennium as leverage performing into other prospects would that include the Santos Basin in addition to the basins that you're already in?

Robert P. Daniels - Senior Vice President, Worldwide Exploration

Yeah this is Bob, Philip. We are looking if we can to get into the Santos Basin, but most of the things that we've been looking at utilizing the Millennium have been on the Campos and the Espírito Santo.

Philip Dodge - Stanford Group Company

Yes, just to ask you is that Petrobras I am sure has been moving some rigs around in the exploration dead lines rather than testing wells that they are already on which would indicate that they might be needy?

Robert P. Daniels - Senior Vice President, Worldwide Exploration

Yeah, and we're in discussion with Petrobras of course our partner with in several of the blocks and they were very supportive of us bringing the rig down of course. And so we are keeping close contact with them, but I would say that they are trying to get the main activity for them has been in the Santos here recently they have been pulling rigs down into that, which leaves the Campos and Espírito Santo shorter rigs and we've got the Millennium so that's what the plan is and that's what we are pursuing.

Philip Dodge - Stanford Group Company

Are you just be sure you are also talking about the Santos or just the Campos?

Robert P. Daniels - Senior Vice President, Worldwide Exploration

Definite we are talking to Petrobras directly about the Santos but we are talking to others about the Santos.

Philip Dodge - Stanford Group Company

Okay. Thanks very much.

Operator

And your next question comes from line of David Tameron with Wachovia Securities. Please proceed.

David Tameron - Wachovia Capital Markets

Hi just couple of quick follow-ups. My understanding is that portion of the Campos basin, which have more of a fragmented salt which lowers some of the exploratory risk a little bit, versus a basin like the Santos, can you comment on that at all and the target that you're chasing after how would you categorize those?

Robert P. Daniels - Senior Vice President, Worldwide Exploration

Yes, this is Bob again. The difference between the Campos and the Santos is that the Santos is that the Santos does seem to have pervasive continuous salt whereas in the Campos it's been more mobilized. And they have what they call salt windows or breaks in the salt. Now the reason that you have such prolific production in the Campos is because those breaks in the salt would allow the hydrocarbons to migrate from the pre-salt source through the ultimate seal which was the salt through those windows and into the post-salt section. And that's what the historic production in the Campos has been.

David Tameron - Wachovia Capital Markets

Okay.

Robert P. Daniels - Senior Vice President, Worldwide Exploration

So at this what that says is that you got the source rock there very prolific source rock and when you start exploring for the pre-salt in the Campos you have to pay attention to what your seal is and what the migration are outside.

And the prospects that we are drilling presently in the Campos have good salt cover over them we think that would have maintained the integrity at the trap below it and therefore trap the hydrocarbons and port folio course the Petrobras has drilled no more some salt was up in the Campos improved the hydrocarbon system there. They tested 10,000 barrels a day and they chase a block to our Wahoo prospect. So we know the pre-salt works up there its just making sure that you have got the adequate trap and the seal from the salt that will maintain the integrity of the pre-salt objective.

David Tameron - Wachovia Capital Markets

All right, that's good. Thanks for the color. And then one more detailed follow-up question just look at the balance sheet can you just comment a little bit on the swing in the working capital that accrued derivative liability and some of the changes down there on the quarter?

R. A. Walker - Senior Vice President, Finance and Chief Financial Officer

Dave, this is Wal. That's really more related to the cash that's being used for the derivatives where we've got cash collateral requirements as those cash requirements are reduced by the forward drop in commodity curves. A lot of that cash will come back to us and a substantial amount will come back through the course of the third quarter almost unrealized losses that we are incurred during the second quarter. Where we had cash collateral issues we're reshaped and restructured a lot of those with our counterparties during the quarter. And as a result you are going to see through year end a lot of the cash that was sequestered into those collateral account coming back to us.

David Tameron - Wachovia Capital Markets

All right the SSO in a nutshell that should be reserved assuming commodity prices stay let's say whether at that should be reserved in the next couple of quarters?

R. A. Walker - Senior Vice President, Finance and Chief Financial Officer

That's correct.

David Tameron - Wachovia Capital Markets

Okay. Thanks, Wal.

Operator

And your next question comes from the line of Dennis Coleman with Bank of America Securities. Please proceed.

Dennis Coleman - Bank of America Securities

Yes, good morning. Thank you. If we can just stick with the balance sheet here, I just want to clarify a couple of details of what we're talking about. My understanding is as you said that you're targeting 35% debt to Cap from that 42% right now and I just want to understand exactly what you're including in that and particularly the note to the... on the midstream if that's included and to get to 35% I guess you're talking about roughly a couple of billion dollars of net debt reduction and is that debt reduction or is it debt repayment how we're getting to 35%?

R. A. Walker - Senior Vice President, Finance and Chief Financial Officer

Well, it's a good question and it's not that complicated as the answer. The largest and primary driver of that debt reduction will be the proceeds from the Peregrino sale.

Dennis Coleman - Bank of America Securities

Okay.

R. A. Walker - Senior Vice President, Finance and Chief Financial Officer

And your question or clarifying question around what is in the 42% that is a total debt, which will include the midstream monetization note and that when we talk about getting 35% below by year-end again that's a total number largely driven by the proceeds from not only Peregrino, but the fact that we probably will have substantial free cash flow over the second-half of the year.

Dennis Coleman - Bank of America Securities

Okay, so it's... those proceeds will be used for debt reduction or its cash and so we're talking about a net number?

R. A. Walker - Senior Vice President, Finance and Chief Financial Officer

No it will be cash that will come into us at closing that will be in turn to used for debt reduction.

Dennis Coleman - Bank of America Securities

Got it, got it. Okay. Thanks very much.

Operator

At this time there are no further questions. I would like to turn the call over to Jim Hackett for closing remarks.

James T. Hackett - Chairman, President and Chief Executive Officer

Thanks everybody for joining us. Again we're proud of what we have delivered through the first-half of 2008 I think the quality and debt of our portfolio is definitely being demonstrated and we expect to continue building on the momentum we have established through the first six months of this year. And that we will run a growth in commitments we've made to our stakeholders. So thanks and have a great day. Bye.

Operator

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect and have a great day.

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Source: Anadarko Petroleum Corp. Q2 2008 Earnings Call Transcript
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