Hess - 10-Q quarterly report FY

 

(Exact Name of Registrant as Specified in Its Charter)

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 a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes   o    No   þ

At March 31, 2006, 93,462,944 shares of Common Stock were outstanding.

HESS CORPORATION AND CONSOLIDATED SUBSIDIARIES
STATEMENT OF CONSOLIDATED INCOME (UNAUDITED)
Three Months Ended March 31
(in millions of dollars, except per share data)

See accompanying notes to consolidated financial statements.

HESS CORPORATION AND CONSOLIDATED SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
(in millions of dollars, thousands of shares)

See accompanying notes to consolidated financial statements.

HESS CORPORATION AND CONSOLIDATED SUBSIDIARIES
STATEMENT OF CONSOLIDATED CASH FLOWS (UNAUDITED)
Three Months ended March 31
(in millions of dollars)

See accompanying notes to consolidated financial statements.

On May 3, 2006, the Corporation’s shareholders voted to increase the number of authorized common shares from 200 million to 600 million and the board of directors declared a three-for-one stock split in the form of a stock dividend that will be issued on May 31, 2006 to shareholders of record on May 17, 2006. The par value remained at $1.00 per share. All common share and per share amounts in these financial statements and notes are on a pre-split basis.

     Overview

     On May 3, 2006, Amerada Hess Corporation changed its name to Hess Corporation (the Corporation). The Corporation is a global integrated energy company that operates in two segments, Exploration and Production and Marketing and Refining. The Exploration and Production segment explores for, develops, produces and sells crude oil and natural gas. The Marketing and Refining segment manufactures, purchases, trades and markets refined petroleum products and other energy products. Net income was $695 million for the first quarter of 2006, compared with $219 million in the first quarter of 2005.

     Exploration and Production: Exploration and Production net income was $706 million for the first quarter of 2006, compared with $263 million in the first quarter of 2005. Exploration and Production’s first quarter results included an after tax gain from asset sales of $186 million and benefited from strong oil prices and reduced hedge positions. Worldwide crude oil and natural gas production was 361,000 barrels of oil equivalent per day (boepd) in the first quarter of 2006 compared with 358,000 boepd in the same period of 2005. The Corporation anticipates that its production for the full year of 2006 will average between 360,000 and 380,000 boepd.

     The Corporation completed the following significant transactions in the first quarter:

     Overview (Continued)

     Following is an update on the Corporation’s exploration and development activities:

     Marketing and Refining: Marketing and Refining earnings were $49 million for the first quarter of 2006, compared with $63 million in the first quarter of 2005. In the first quarter of 2006, earnings from HOVENSA were adversely impacted by the unscheduled shutdown and maintenance of the Fluid Catalytic Cracking (FCC) unit which lasted for approximately 20 days. The Corporation received a cash distribution of $200 million from HOVENSA in the first quarter of 2006.

     Results of Operations

     The after-tax results by major operating activity were as follows (in millions, except per share data):

     Results of Operations (Continued)

     The following items of income (expense), on an after-tax basis, affect the comparability of earnings between periods (in millions):

     The net gain from asset sales in the first quarter of 2006 reflects the disposition of certain producing properties located in the Permian Basin in Texas and New Mexico ($289 million gain before income taxes). The first quarter 2005 gain from asset sales related to the exchange of a mature North Sea asset for an increased interest in the Pangkah natural gas development in Indonesia ($18 million gain before income taxes). In addition, first quarter 2005 earnings include a gain recorded on a legal settlement reflecting the favorable resolution of contingencies on a prior year asset sale ($19 million gain before income taxes) that is included in non-operating income. The Corporation also recorded an income tax charge in the first quarter of 2005 related to repatriation of foreign earnings under the American Jobs Creation Act of 2004.

     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 review 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.

     Results of Operations (Continued)

     Comparison of Results

     Exploration and Production

     Following is a summarized income statement of the Corporation’s Exploration and Production operations (in millions):

     After considering the gains from asset sales and the legal settlement 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 realized selling prices of crude oil and natural gas increased Exploration and Production revenues by approximately $550 million in the first quarter of 2006 compared with 2005. The Corporation’s average selling prices were as follows:

     Results of Operations (Continued)

     Crude oil hedges reduced earnings by $65 million ($101 million before income taxes) in the first quarter of 2006 compared with $195 million ($308 million before income taxes) in the first quarter of 2005.

     Sales and production volumes: The Corporation’s oil and natural gas production, on a barrel of oil equivalent basis was 361,000 boepd in the first quarter of 2006 compared with 358,000 boepd in the same period of 2005. The Corporation anticipates that its production for the full year of 2006 will average between 360,000 and 380,000 boepd. The Corporation’s net daily worldwide production by region was as follows (in thousands):

     Results of Operations (Continued)

     Crude oil and natural gas production in the United States was lower in the first quarter of 2006 due to the loss of production caused by the effect of hurricanes in 2005, asset sales and natural decline. Production in Europe was lower due to increased maintenance at a number of facilities and natural decline, partially offset by increased production from Russia. Increased crude oil production in Africa in the first quarter of 2006 was due to production from Libya at the rate of 23,000 boepd, partially offset by lower production in Algeria. Higher crude oil prices in 2006 reduced the Corporation’s entitlement to Algerian production. Natural gas production in Asia was higher due to increased production from Block A-18 in the Joint Development Area between Malaysia and Thailand (JDA).

     Lower crude oil and natural gas sales volumes reduced revenue by approximately $30 million in the first quarter of 2006 compared with the first quarter of 2005.

     Operating costs and depreciation, depletion and amortization: Cash operating costs, consisting of production expenses and general and administrative expenses, increased by $56 million in the first quarter of 2006 compared with the corresponding period of 2005. The increase reflects higher production taxes and increased costs of services and materials. Depreciation, depletion and amortization charges were higher in the first quarter of 2006 reflecting higher production volumes and per barrel rates.

     Exploration expenses: Exploration expenses were lower in the first quarter of 2006 compared with 2005 by $21 million. The decrease principally reflects lower dry hole costs, partially offset by higher seismic expense.

     Other: After-tax foreign currency gains amounted to $7 million ($10 million before income taxes) in the first quarter of 2006 and $8 million ($3 million before income taxes) in the first quarter of 2005. The pre-tax amounts of foreign currency gains are included in other non-operating income.

     The effective income tax rate for Exploration and Production operations in the first quarter of 2006 and 2005 was 42%.

     The Corporation’s future Exploration and Production earnings may be impacted by external and other factors, such as political risk, volatility in the selling prices of crude oil and natural gas, reserve and production changes, industry cost inflation, exploration expenses and changes in tax rates.

     Earnings from Marketing and Refining activities amounted to $49 million in the first quarter of 2006 compared with $63 million in the corresponding period of 2005. 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 Marketing and Refining activities include a fluid catalytic cracking facility in Port Reading, New Jersey, as well as retail gasoline stations, energy marketing and trading operations.

     Refining: Refining earnings were $21 million in the first quarter of 2006 compared with $42 million in the first quarter of 2005. The Corporation’s share of HOVENSA’s results, after income taxes, was a loss of $1 million in the first quarter of 2006 compared with income of $31 million in the first quarter of 2005 reflecting reduced refining margins and lower charge rates. The HOVENSA refinery experienced an unplanned shutdown of its FCC unit, which lasted approximately 20 days, and also completed a scheduled turnaround of a crude unit and accelerated the turnaround of a vacuum unit that was scheduled for the second quarter.

     Interest on the PDVSA note was $3 million after income taxes in the first quarter of 2006 and $4 million in the first quarter of 2005. At March 31, 2006, the remaining balance of the PDVSA note was $182 million, which is scheduled to be fully repaid by February 2009.

     Port Reading’s after tax earnings were $19 million in the first quarter of 2006 compared with $7 million in the first quarter of 2005. The increase reflects higher margins and sales volumes. In the first quarter of 2005, the Port Reading facility was shutdown 36 days for planned maintenance.

     The following table summarizes refinery capacity and utilization rates:

     Marketing: Marketing earnings, which consist principally of retail gasoline and energy marketing activities, were $12 million in the first quarter of 2006 compared with $13 million in the same period of 2005. Retail gasoline operations generated losses in the first quarter of 2006 and 2005 due to weak margins. Earnings from energy marketing activities were comparable in the first quarter of 2006 and 2005. Total refined product sales volumes were 520,000 barrels per day in the first quarter of 2006 and 462,000 barrels per day in the first quarter of 2005.

     The Corporation has a 50% voting interest in a consolidated partnership that trades energy commodities and energy derivatives. The Corporation also takes trading positions for its own account. The Corporation’s after-tax results from trading activities, including its share of the earnings of the trading partnership, amounted to income of $16 million in the first quarter of 2006 and $8 million in the first quarter of 2005.

     The Corporation’s future Marketing and Refining earnings may be impacted by volatility in marketing and refining margins, competitive industry conditions, government regulatory changes, credit risk and supply and demand factors, including the effects of weather.

     After-tax corporate expenses were $23 million in the first quarter of 2006 compared with $69 million in the first quarter of 2005. Included in the 2005 amount was an income tax charge of $41 million related to repatriation of foreign earnings under the American Jobs Creation Act of 2004.

     Interest expense was as follows (in millions):

     Sales and other operating revenues increased by 44% in the first quarter of 2006 compared with the corresponding period of 2005. This increase principally reflects increased realized selling prices of crude oil. Natural gas and refined products selling prices also increased. The increase in cost of goods sold reflects the increased costs of refined products purchased.

The following table sets forth certain relevant measures of the Corporation’s liquidity and capital resources (in millions, except ratios):

Cash Flows: The following table sets forth a summary of the Corporation’s cash flows (in millions):

     Operating Activities: Net cash provided by operating activities increased in the first quarter of 2006 compared with 2005, reflecting higher earnings, changes in operating assets and liabilities and an increased distribution from HOVENSA. In the first quarter of 2006, the Corporation received a cash distribution of $200 million from HOVENSA compared with $112 million in 2005.

     Investing Activities: The following table summarizes the Corporation’s capital expenditures (in millions):

     Investing activities in the first quarter of 2006 include payments of $260 million related to the Corporation’s re-entry into its former oil and gas production operations in the Waha concessions in Libya and $413 million to acquire a 55% working interest in the West Med Block in Egypt.

     Proceeds from asset sales totaled $362 million in the first quarter of 2006, including the sale of the Corporation’s interests in certain producing properties located in the Permian Basin in Texas and New Mexico for $358 million. Proceeds from asset sales totaled $18 million in the first quarter of 2005.

     Financing Activities: The Corporation reduced debt by $10 million during the first quarter of 2006 ($9 million in the first quarter of 2005). Dividends paid were $69 million in the first quarter of 2006 ($67 million in the first quarter of 2005). During the first three months of 2006, the Corporation received proceeds from the exercise of stock options totaling $7 million ($16 million in the same period of 2005).

Future Capital Requirements and Resources: The Corporation anticipates investing a total of approximately $4 billion, excluding additional acquisitions, if any, in capital and exploratory expenditures during 2006. The Corporation expects that it will fund its 2006 operations, including capital expenditures, dividends, pension contributions and required debt repayments, with existing cash on-hand and cash flow from operations and, as necessary, additional borrowings on the revolving credit facility.

     At March 31, 2006, the Corporation has $1,952 million available under its $2.5 billion syndicated revolving credit agreement and has additional unused lines of credit of $263 million, primarily for letters of credit, under uncommitted arrangements with banks. The Corporation also has a shelf registration under which it may issue additional debt securities, warrants, common stock or preferred stock.

     A loan agreement covenant allows the Corporation to borrow up to an additional $7.5 billion for the construction or acquisition of assets at March 31, 2006. The maximum amount of dividends or stock repurchases that can be paid from borrowings under this covenant is $2.8 billion at March 31, 2006.

     Outstanding letters of credit, principally relating to hedging activities were as follows (in millions):

Credit Ratings: Two credit rating agencies have rated the Corporation’s debt as investment grade; one agency’s rating is below investment grade. If another rating agency were to reduce its credit rating below investment grade, the Corporation would have to comply with a more stringent financial covenant contained in its revolving credit facility. In addition, the incremental margin requirements with counterparties at March 31, 2006 would be approximately $30 million.

Other: At March 31, 2006, the Corporation had an accrual of $31 million for vacated office space in London. Additional accruals totaling $30 million, before income taxes, are anticipated in the second quarter of 2006 for office space to be vacated.

Off-Balance Sheet Arrangements: The Corporation has leveraged leases not included in its balance sheet, primarily related to retail gasoline stations that the Corporation operates. The net present value of these leases is $478 million at March 31, 2006. The Corporation’s March 31, 2006 debt to capitalization ratio would increase from 35.8% to 38.6% if the leases were included as debt.

     The Corporation guarantees the payment of up to 50% of HOVENSA’s crude oil purchases from suppliers other than PDVSA. At March 31, 2006, the guarantee amounted to $195 million. This amount fluctuates based on the volume of crude oil purchased and related prices. 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 2004, the Financial Accounting Standards Board reissued Statement No. 123,Share-Based Payment (FAS 123R). This standard requires that compensation expense for all stock-based payments to employees, including grants of employee stock options, be recognized in the income statement based on fair values. The Corporation adopted FAS 123R as of January 1, 2006. For the quarter ended March 31, 2006, stock-based compensation expense was $13 million ($9 million after income taxes), of which $6 million ($4 million after income taxes) related to the expensing of stock options. The remainder of the compensation expense related to restricted stock. Stock option expense recorded in the first quarter of 2006 reduced basic and diluted earnings per share by $.05 and $.04 per share, respectively. The estimated incremental expense in 2006 of adopting FAS 123R is approximately $30 million before income taxes ($20 million after income taxes).

On May 3, 2006, the Corporation’s shareholders voted to increase the number of authorized common shares from 200 million to 600 million and the board of directors declared a three-for-one stock split in the form of a stock dividend that will be issued on May 31, 2006 to shareholders of record on May 17, 2006. The par value remained at $1.00 per share. All common share and per share amounts in management’s discussion and analysis are on a pre-split basis.

     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 primarily uses forward commodity contracts, foreign exchange forward contracts, futures, swaps, options and energy commodity based securities in its non-trading and trading activities. Generally, these contracts are widely traded instruments with standardized terms.

Value-at-Risk: 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 Exploration and Production segment uses futures and swaps to fix the selling prices of a portion of its future production and the related gains or losses are an integral part of its selling prices. Following is a summary of the Corporation’s outstanding crude oil hedges at March 31, 2006:

     There were no hedges of WTI crude oil or natural gas production at March 31, 2006. As market conditions change, the Corporation may adjust its hedge positions. The Corporation also markets energy commodities including refined petroleum products, natural gas and electricity. The Corporation uses futures and swaps to manage the risk in its marketing activities.

     Accumulated other comprehensive income (loss) at March 31, 2006 includes after-tax unrealized deferred losses of $1,514 million primarily related to crude oil contracts used as hedges of Exploration and Production sales. The pre-tax amount of deferred hedge losses is reflected in accounts payable and the related income tax benefits are recorded as deferred tax assets on the balance sheet.

     The Corporation estimates that at March 31, 2006, the value-at-risk for commodity related derivatives that are settled in cash and used in non-trading activities was $86 million ($93 million at December 31, 2005). The results may vary from time to time as hedge levels change.

Trading: In trading activities, the Corporation is exposed to changes in crude oil, natural gas and refined product prices. 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. The information that follows represents 100% of the trading partnership and the Corporation’s proprietary trading accounts.

     Total realized gains for the first quarter of 2006 amounted to $321 million ($93 million of realized losses for the first three months of 2005). 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):

     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 following table summarizes the sources of fair values of derivatives used in the Corporation’s trading activities at March 31, 2006 (in millions):

     The Corporation estimates that at March 31, 2006, the value-at-risk for trading activities, including commodities, was $22 million ($18 million at December 31, 2005). The results may change from time to time as strategies change to capture potential market rate movements.

     The following table summarizes the fair values of net receivables relating to the Corporation’s trading activities and the credit ratings of counterparties at March 31, 2006 (in millions):

     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.

     The information required by this item is presented under Item 2, “Management’s Discussion and Analysis of Results of Operations and Financial Condition – Market Risk Disclosure.”

     Based upon their evaluation of the Corporation’s disclosure controls and procedures (as defined in Exchange Act Rules 13a - 15(e) and 15d - 15(e)) as of March 31, 2006, John B. Hess, Chief Executive Officer, and John P. Rielly, Chief Financial Officer, concluded that these disclosure controls and procedures were effective as of March 31, 2006.

     There was no change in internal control over financial reporting identified in connection with the evaluation required by paragraph (d) of Rules 13a-15 or 15d-15 in the quarter ended March 31, 2006 that has materially affected, or is reasonably likely to materially affect, internal control over financial reporting.

     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.

Date: May 5, 2006