UNITED STATESSECURITIES AND EXCHANGE COMMISSION
Form 10-Q
For the quarter ended June 30, 2004
or
For the transition period from _____________ to ____________
Commission File Number 1-1204
AMERADA HESS CORPORATION
DELAWARE(State or other jurisdiction of incorporation or organization)
13-4921002(I.R.S. employer identification number)
1185 AVENUE OF THE AMERICAS, NEW YORK, N.Y.(Address of principal executive offices)10036(Zip Code)
(Registrant’s telephone number, including area code is (212) 997-8500)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceeding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes þ No o
At June 30, 2004, 91,143,730 shares of Common Stock were outstanding.
TABLE OF CONTENTS
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements.
AMERADA HESS CORPORATION AND CONSOLIDATED SUBSIDIARIESSTATEMENT OF CONSOLIDATED INCOME (UNAUDITED)(in millions, except per share data)
See accompanying notes to consolidated financial statements.
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PART I - FINANCIAL INFORMATION (CONT’D.)
AMERADA HESS CORPORATION AND CONSOLIDATED SUBSIDIARIESCONSOLIDATED BALANCE SHEET(in millions of dollars, thousands of shares)
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AMERADA HESS CORPORATION AND CONSOLIDATED SUBSIDIARIESSTATEMENT OF CONSOLIDATED CASH FLOWS (UNAUDITED)Six months ended June 30(in millions)
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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PART I — FINANCIAL INFORMATION (CONT’D.)
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Results of Operations (Continued)
Comparison of Results
In the discussion that follows, the financial effects of certain transactions are disclosed on an after-tax basis. Management reviews segment earnings on an after-tax basis and uses after-tax amounts in its analysis of variances in segment earnings. Management believes that after-tax amounts are a preferable method of explaining variances in earnings, since they show the entire effect of a transaction rather than only the pre-tax amount. After-tax amounts are determined by applying the appropriate income tax rate in each tax jurisdiction to pre-tax amounts.
Exploration and Production
Exploration and production earnings from continuing operations increased by $94 million in the second quarter and $182 million in the first half of 2004 compared with the corresponding periods of 2003. Earnings include an after-tax gain of $15 million ($3 million before income taxes) in the second quarter of 2004 from the sale of a non-producing property in Malaysia. Earnings for the first six months of 2004 and 2003 include after-tax gains on asset sales of $33 million ($23 million before income taxes) and $31 million ($47 million before income taxes), respectively. Earnings also include after-tax charges of $6 million and $23 million in the second quarters of 2004 and 2003 ($10 million and $38 million before income taxes), respectively, for accrued severance and a reduction in leased office space in London.
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After considering the gains on asset sales and other items described above, the remaining changes in exploration and production earnings are primarily attributable to changes in selling prices, sales volumes and operating costs and exploration expenses, as discussed below.
Selling prices: Higher average selling prices of crude oil and natural gas increased exploration and production revenues by approximately $100 million in the second quarter and $190 million in the first six months of 2004 compared with the same periods of 2003. The Corporation’s average selling prices, including the effects of hedging, were as follows:
The after-tax impacts of crude oil and U.S. natural gas hedges were opportunity costs of $124 million in the second quarter and $197 million in the first six months of 2004 compared with opportunity costs of $45 million and $147 million in the same periods of the prior year.
Production and sales volumes: The Corporation’s oil and gas production, on a barrel of oil equivalent basis, decreased to 349,000 barrels per day in the first half of 2004 from 398,000 barrels per day in 2003. This decline was primarily due to asset sales and exchanges in 2003 and natural field decline. The Corporation anticipates that its average production for the full year of 2004 will be approximately 340,000 barrels of oil equivalent per day. The Corporation’s net daily worldwide production was as follows (in thousands):
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The changes in crude oil and natural gas sales volumes in 2004 compared to the same periods of 2003 resulted in lower income before income taxes of approximately $30 million for the second quarter and $50 million for the first half of 2004 compared with the corresponding periods of 2003.
Operating costs and exploration expenses: Operating costs and exploration expenses from continuing operations decreased by approximately $30 million in the second quarter of 2004 compared with the corresponding period in the prior year. Exploration expense decreased in the second quarter of 2004 compared with 2003 primarily because of lower exploratory drilling activity. Depreciation, depletion and amortization charges were also lower in the second quarter of 2004 compared with 2003, reflecting lower production volumes and lower unit cost per barrel. Production expenses increased slightly in the second quarter of 2004 primarily reflecting workovers in the United States and United Kingdom.
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For the first six months of 2004 compared with the same period of 2003, operating costs and exploration expenses from continuing operations decreased by approximately $120 million. Exploratory drilling was lower in the first half of 2004, but is expected to be higher in the second half of the year. Depreciation, depletion and amortization charges were also lower in the first half of 2004 compared with 2003, reflecting lower production volumes and lower unit cost per barrel from changes in the mix of producing fields.
Other: After-tax foreign currency translation resulted in gains of $11 million ($15 million before income taxes) in the second quarter of 2004 and gains of $8 million ($2 million before income taxes) in the first half of 2004 compared with losses of $12 million ($13 million before income taxes) and $13 million ($17 million before income taxes) in the corresponding periods of 2003. The pre-tax amounts of foreign currency gains or losses are included in non-operating income (expense) in the income statement.
The effective income tax rate for exploration and production operations in the first half of 2004 was 46% compared to 49% in the first half of 2003.
The Corporation’s future exploration and production earnings may be impacted by volatility in the selling prices of crude oil and natural gas, reserve and production changes and changes in tax rates.
Refining and Marketing
Earnings from refining and marketing activities amounted to $160 million in the second quarter of 2004 compared with $46 million in the corresponding period of 2003. For the first half of 2004, refining and marketing operations earned $272 million compared with $183 million in 2003. The second quarter of 2003 includes an after-tax loss on the sale of the Corporation’s interest in a shipping joint venture of $20 million ($9 million before income taxes).
The Corporation’s downstream operations include HOVENSA L.L.C. (HOVENSA), a 50% owned refining joint venture with a subsidiary of Petroleos de Venezuela S.A. (PDVSA), accounted for on the equity method. Additional refining and marketing activities include a fluid catalytic cracking facility in Port Reading, New Jersey, as well as retail gasoline stations, energy marketing and trading operations. In the second quarter of 2004, the Corporation formed Hess LNG L.L.C., a joint venture, to pursue investments in liquified natural gas terminals and related supply, trading and marketing opportunities.
HOVENSA: The Corporation’s share of HOVENSA’s income was $97 million in the second quarter of 2004 compared with $15 million in the second quarter of 2003. For the first half of 2004, the Corporation’s share of HOVENSA’s income was $148 million compared with $65 million for the first half of 2003. HOVENSA’s total crude runs amounted to 492,000 barrels per day in the first half of 2004 and 414,000 barrels per day in the first half of 2003. Crude runs in the first half of 2004 reflect higher utilization rates as a result of higher refining margins. In the early part of 2003 crude runs were reduced reflecting interruptions in crude oil deliveries from Venezuela.
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In the second quarter of 2004, the Corporation began recording deferred income tax expense in refining and marketing earnings to reflect the reduction in the deferred tax asset resulting from the utilization of net operating loss carryforwards associated with the Corporation’s investment in HOVENSA L.L.C. The amount of the deferred tax provided was $11 million. It is anticipated that for the remainder of the year deferred taxes will be provided on HOVENSA earnings at a rate of approximately 15%. In 2005, it is expected that deferred taxes will be recorded at the Virgin Islands statutory rate of 38.5%. As of June 30, the Corporation has approximately $320 million of net operating loss carryforwards available to offset its share of future HOVENSA taxable income.
Earnings from refining and marketing activities also include interest income on the note received from PDVSA at the formation of the joint venture. Interest on the PDVSA note amounted to $13 million in the first half of 2004 and $16 million in the same period of 2003. Interest income is recorded in non-operating income in the income statement.
Retail, Energy Marketing and Other: Results of retail gasoline operations were lower in the second quarter and first half of 2004 compared with the corresponding periods of 2003 reflecting lower gasoline margins, although sales volumes increased. Energy marketing earnings were also lower in the second quarter and first half of 2004 due to decreased margins compared with 2003. Results of the Port Reading refining facility improved in the second quarter and first half of 2004 reflecting higher margins than in same period of 2003. Refined product sales volumes were 404,000 barrels per day in the second quarter of 2004 and 444,000 barrels per day in the first half of 2004, compared with 399,000 and 431,000 barrels per day in the corresponding periods of 2003.
The Corporation has a 50% voting interest in a consolidated partnership that trades energy commodities and derivatives. The Corporation also takes trading positions in addition to its hedging program. The Corporation’s after-tax results from trading activities, including its share of the earnings of the trading partnership amounted to income of $18 million ($32 million before income taxes) in the second quarter and $32 million ($56 million before income taxes) in the first half of 2004. Trading activities resulted in a loss of $6 million ($11 million before income taxes) in the second quarter and income of $12 million ($18 million before income taxes) in the first half of 2003.
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Refining and marketing earnings will likely continue to be volatile reflecting competitive industry conditions and supply and demand factors, including the effects of weather.
Corporate
After-tax corporate expenses amounted to $24 million in the second quarter and $26 million in the first half of 2004 compared with $27 million and $47 million in same periods of 2003. The results for the first half of 2004 include a non-cash income tax benefit of $13 million resulting from the completion of a prior year United States income tax audit. After-tax corporate expenses for the remainder of 2004 are estimated to be approximately $18 million per quarter.
Interest
After-tax interest totaled $37 million in the second quarter of 2004 compared with $44 million in the second quarter of 2003. In the first half of 2004, after-tax interest amounted to $73 million compared with $91 million in the first half of 2003. The corresponding amounts before income taxes were $60 million in the second quarter of 2004, $77 million in the second quarter of 2003, $117 million in the first half of 2004 and $151 million in the first half of 2003. Interest incurred in 2004 was lower than in 2003 due to lower average outstanding debt. Capitalized interest was $29 million in the first half of 2004 and $21 million in the first half of 2003.
Discontinued Operations
Income from discontinued operations of $7 million in the second quarter of 2004 reflects the settlement of a previously accrued contingency relating to a foreign exploration and production operation that was disposed of in 2003.
In the first quarter of 2003, the Corporation exchanged its crude oil producing properties in Colombia (acquired in 2001 as part of the Triton acquisition), plus $10 million in cash, for an additional 25% interest in Block A-18 in the joint development area of Malaysia and Thailand (JDA). The exchange resulted in an after-tax charge to income of $59 million in discontinued operations in the first quarter of 2003.
In the second quarter of 2003, the Corporation sold Gulf of Mexico Shelf properties, the Jabung Field in Indonesia and several small United Kingdom fields for $445 million. An after-tax gain from these asset sales of $175 million was included in discontinued operations in the second quarter. Discontinued operations in the second quarter and first half of 2003 also include $14 million and $53 million, respectively, of income from operations prior to the sales of these assets.
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Sales and Other Operating Revenues
Sales and other operating revenues increased by 19% in the second quarter and 11% in the first half of 2004 compared with the corresponding periods of 2003. This increase principally reflects higher selling prices and sales volumes of refined products partially offset by decreased sales of purchased natural gas in energy marketing. The increase in cost of goods sold also reflects the change in sales volumes of refined products.
Liquidity and Capital Resources
Overview: Cash flows from operating activities, including changes in operating assets and liabilities, totaled $832 million in the first half of 2004. Cash and short-term investments at June 30, 2004 totaled $611 million, an increase of $93 million from year-end. At June 30, 2004, the Corporation’s debt to capitalization ratio was 41.1% compared to 42.5% at December 31, 2003. Total debt was $3,889 million at June 30, 2004 and $3,941 million at December 31, 2003. The Corporation has hedged the selling prices of a significant portion of its crude oil and natural gas production in 2004 and 2005 to help generate a level of cash flow that will meet operating and capital commitments.
Cash Flows from Operating Activities: Net cash provided by operating activities, including changes in operating assets and liabilities, totaled $832 million in the first half of 2004 compared with $1,059 million in the first half of 2003. This change is primarily due to the timing of cash flows associated with changes in working capital accounts in 2003.
Cash Flows from Investing Activities: Capital expenditures in the first six months of 2004 were $736 million of which $709 million related to exploration and production activities. Capital expenditures in the same period of 2003 were $709 million, including $660 million for exploration and production. Proceeds from asset sales were $40 million in 2004 and $508 million in 2003.
Cash Flows from Financing Activities: The Corporation reduced debt by $52 million during the first half of 2004. Debt reduction in the first half of 2003 was $350 million. Dividends paid were $106 million in the first half of 2004 compared with $81 million in the same period of the prior year. The increase was due to dividends on the 7% preferred stock issued in the fourth quarter of 2003. During the first six months of 2004, the Corporation received proceeds from the exercise of stock options totaling $52 million.
Future Capital Requirements and Resources: Capital expenditures excluding acquisitions, if any, for the remainder of 2004 are currently estimated to be approximately $800 million. The Corporation anticipates that available cash and cash flow from operations will fund these expenditures. At June 30, 2004, the Corporation had an undrawn facility of $1.5 billion under its committed revolving credit agreement and additional unused lines of credit of $78 million under uncommitted arrangements with banks. The Corporation’s revolving credit agreement expires in 2006 and the Corporation expects it will be able to arrange a new committed facility prior to expiration,
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Liquidity and Capital Resources(Continued)
if required. The Corporation also has a shelf registration under which it may issue $825 million of additional debt securities, warrants, common stock or preferred stock.
Loan agreement covenants allow the Corporation to borrow an additional $5.4 billion for the construction or acquisition of assets at June 30, 2004. At period end, the amount that can be borrowed under the loan agreements for the payment of dividends is $2.0 billion.
Prior to June 30, 1986, the Corporation had extensive exploration and production operations in Libya; however, it was required to suspend participation in these operations because of U.S. Government sanctions. The book value of the Corporation’s Libyan assets was written-off in connection with the cessation of operations. On February 24, 2004, the Corporation received U.S. Government authorization to negotiate and enter into an executory agreement with the government of Libya that would define the terms for resuming active participation in the Libyan properties. On April 29, 2004, the U.S. Government lifted most of the sanctions imposed on Libya. It has also taken the necessary steps to have the Iran-Libya Sanctions Act of 1976 terminated by Congress with respect to Libya. As a result, the Corporation and its partners will be able to resume operations in Libya if they are able to reach a successful conclusion to ongoing commercial negotiations. If these negotiations are successful, management anticipates capital expenditures will likely increase over the current plan. Production and reserves would also increase.
Credit Ratings: In the first quarter of 2004, two credit rating agencies downgraded their ratings of the Corporation’s debt. One of the revised ratings was below investment grade. Consequently, the Corporation’s cash margin or collateral requirements under certain contracts with hedging and trading counterparties and certain lenders increased. Outstanding letters of credit increased to $678 million at June 30, 2004 compared with $229 million at December 31, 2003. This increase relates primarily to higher commodity prices and, to a lesser extent, the additional collateral required on hedging contracts because of the lower rating. All hedging and trading counterparty liabilities are recorded on the balance sheet. If an additional rating agency were to reduce its credit rating below investment grade, the incremental margin requirements at June 30, 2004 would be $130 million.
Other: In connection with the sale of six vessels in 2002, the Corporation agreed to support the buyer’s charter rate on these vessels for up to five years. The support agreement requires that if the actual contracted rate for the charter of a vessel is less than the stipulated support rate in the agreement, the Corporation will pay to the buyer the difference between the contracted rate and the stipulated rate. The balance in the charter support reserve at January 1, 2004 was $32 million. During the first six months of 2004, the Corporation paid $3 million of charter support, reducing the reserve to $29 million.
At December 31, 2003, the Corporation had an accrual of $38 million for severance and leased office space in London. During the first six months of 2004, $13 million of additional pre-tax costs were accrued and $10 million of payments were made. The June 30, 2004 accrual for severance and office lease costs is $41 million. Additional
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accruals for severance and lease costs of approximately $25 million before income taxes are anticipated in 2005.
Off-Balance Sheet Arrangements: The Corporation has leveraged lease financings not included in its balance sheet, primarily related to retail gasoline stations that the Corporation operates. The net present value of these financings is $460 million at June 30, 2004. The Corporation’s June 30, 2004 debt to capitalization ratio would increase from 41.1% to 43.9% if the lease financings were included as debt.
The Corporation guarantees the payment of up to 50% of HOVENSA’s crude oil and feedstock purchases from suppliers other than PDVSA. The amount of the Corporation’s guarantee fluctuates based on the volume of crude oil purchased and related prices. At June 30, 2004, the guarantee totaled $170 million. In addition, the Corporation has agreed to provide funding up to a maximum of $40 million to the extent HOVENSA does not have funds to meet its senior debt obligations.
In the first quarter of 2004, the Corporation guaranteed its share of an investee’s borrowings to finance construction of an oil pipeline. The amount guaranteed is approximately $39 million. The guarantee will be in place through the end of the pipeline’s construction, which is expected to be approximately two years.
Market Risk Disclosure
In the normal course of its business, the Corporation is exposed to commodity risks related to changes in the price of crude oil, natural gas, refined products and electricity, as well as to changes in interest rates and foreign currency values. In the disclosures that follow, these operations are referred to as non-trading activities. The Corporation also has trading operations, principally through a 50% voting interest in a trading partnership. These activities are also exposed to commodity risks primarily related to the prices of crude oil, natural gas and refined products.
Instruments: The Corporation uses forward commodity contracts, foreign exchange forward contracts, futures, swaps and options in the Corporation’s non-trading and trading activities. These contracts are widely traded instruments mainly with standardized terms.
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Market Risk Disclosure(Continued)
Quantitative Measures: The Corporation uses value-at-risk to monitor and control commodity risk within its trading and non-trading activities. The value-at-risk model uses historical simulation and the results represent the potential loss in fair value over one day at a 95% confidence level. The model captures both first and second order sensitivities for options. The potential change in fair value based on commodity price risk is presented in the non-trading and trading sections below.
Non-Trading: The Corporation’s non-trading activities include hedging of crude oil and natural gas production. Futures and swaps are used to fix the selling prices of a portion of the Corporation’s future production and the related gains or losses are an integral part of the Corporation’s selling prices. As of June 30, the Corporation has open hedge positions equal to 60% of its estimated 2004 worldwide crude oil production for the period from July 1 to December 31, 2004 and 55% of its estimated 2005 worldwide crude oil production. The average price for West Texas Intermediate crude oil (WTI) related open hedge positions is $28.76 in 2004 and $27.18 in 2005. The average price for Brent crude oil related open hedge positions is $26.33 in 2004 and $26.16 in 2005. Approximately 18% of the Corporation’s hedges are WTI related and the remainder are Brent. In addition, the Corporation has 24,000 barrels per day of Brent related crude oil production hedged from 2006 through 2012 at an average price of $26.20 per barrel. The Corporation also has hedged 10% of its remaining 2004 United States natural gas production at an average price of $6.30 per Mcf. As market conditions change, the Corporation may adjust its hedge percentages.
The Corporation also markets energy commodities including refined petroleum products, natural gas and electricity. The Corporation uses futures and swaps to fix the purchase prices of commodities to be sold under fixed-price sales contracts.
The Corporation estimates that at June 30, 2004, the value-at-risk for commodity related derivatives that are settled in cash and used in non-trading activities was $89 million ($44 million at December 31, 2003). The results may vary from time to time as hedge levels change.
Trading and Risk Management: The trading partnership in which the Corporation has a 50% voting interest trades energy commodities and derivatives. The accounts of the partnership are consolidated with those of the Corporation. The Corporation also takes trading positions for its own account. These strategies include proprietary position management and trading to enhance the potential return on assets. The information that follows represents 100% of the trading partnership and the Corporation’s proprietary trading accounts.
In trading activities, the Corporation is exposed to changes in crude oil, natural gas and refined product prices, primarily in North America and Europe. Trading positions include futures, forwards, swaps and options. In some cases, physical purchase and sale contracts are used as trading instruments and are included in the trading results.
Gains or losses from sales of physical products are recorded at the time of sale. Derivative trading transactions are marked-to-market and are reflected in income currently. Total realized gains for the first six months of 2004 amounted to $104 million ($16 million of realized gains for the first six months of 2003). The following table provides an assessment of the factors affecting the changes in fair value of trading activities and represents 100% of the trading partnership and other trading activities (in millions):
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The Corporation uses observable market values for determining the fair value of its trading instruments. In cases where actively quoted prices are not available, other external sources are used which incorporate information about commodity prices in actively quoted markets, quoted prices in less active markets and other market fundamental analysis. Internal estimates are based on internal models incorporating underlying market information such as commodity volatilities and correlations. The Corporation’s risk management department regularly compares valuations to independent sources and models. The sources of fair value at June 30, 2004 follow (in millions):
The Corporation estimates that at June 30, 2004, the value-at-risk for trading activities, including commodities, was $12 million ($7 million at December 31, 2003). The results may change from time to time as strategies change to capture potential market rate movements.
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The following table summarizes the fair values of net receivables relating to the Corporation’s trading activities and the credit rating of counterparties at June 30 (in millions):
*Based on information provided by counterparties and other available sources.
Forward-Looking Information
Certain sections of Management’s Discussion and Analysis of Results of Operations and Financial Condition, including references to the Corporation’s future results of operations and financial position, liquidity and capital resources, capital expenditures, oil and gas production, tax rates, debt repayment, hedging, derivative, and market risk disclosures and off-balance sheet arrangements include forward looking information. Forward-looking disclosures are based on the Corporation’s current understanding and assessment of these activities and reasonable assumptions about the future. Actual results may differ from these disclosures because of changes in market conditions, government actions and other factors.
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PART II — OTHER INFORMATION
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PART II — OTHER INFORMATION(CONT’D.)
With respect to the election of directors, the inspectors of election reported as follows:
The inspectors reported that 77,563,378 votes were cast for the ratification of the selection of Ernst & Young LLP as independent auditors for the fiscal year ending December 31, 2004, 1,960,098 votes were cast against said ratification and holders of 380,410 votes abstained.
The inspectors also reported that 64,416,497 votes were cast approving the Corporation’s second amended and restated 1995 long-term incentive plan, 7,043,786 votes were cast against and holders of 734,124 votes abstained. There were 7,709,479 broker non-votes with respect to this matter.
Finally, the inspectors reported that 15,397,312 votes were cast for the stockholder proposal for a formal mechanism for dialogue between independent directors and shareholders, 54,877,948 votes were cast against this proposal and holders of 1,919,147 votes abstained. There were 7,709,479 broker non-votes with respect to this matter.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
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