Hess - 10-Q quarterly report FY

     On May 3, 2006, Amerada Hess Corporation changed its name to Hess Corporation (the Corporation) and declared a three-for-one stock split in the form of a stock dividend that was issued on May 31, 2006. 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 $565 million for the second quarter of 2006, compared with $299 million for the second quarter of 2005.

     Exploration and Production: Exploration and Production net income was $501 million for the second quarter of 2006, compared with $263 million in the second quarter of 2005. Worldwide crude oil and natural gas production was 354,000 barrels of oil equivalent per day (boepd) in the second quarter of 2006 compared with 355,000 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 370,000 boepd.

The following is an update of Exploration and Production activities during the second quarter of 2006:

     Marketing and Refining: Marketing and Refining earnings were $121 million for the second quarter of 2006, compared with $98 million in the second quarter of 2005.

     In June 2006, the Corporation acquired energy marketing customer accounts and related assets to expand the Corporation’s natural gas and electric sales in the Northeast.

     Corporate: In May 2006, the Corporation amended and restated its existing syndicated, revolving credit facility to increase the facility to $3 billion from $2.5 billion and extend the term to May 2011 from December 2009.

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

     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 second quarter of 2006 relates to the sale of U.S. Gulf Coast onshore oil and gas producing assets ($80 million before income taxes). In the second quarter of 2006, the Corporation also recorded an after-tax charge for vacated leased office space ($30 million before income taxes, recorded in general and administrative expenses). The net gain from asset sales for the six months ended June 30, 2006 also reflects the disposition of certain producing properties located in the Permian Basin in Texas and New Mexico ($289 million before income taxes).

     Earnings in the second quarter of 2005 include income tax benefits of $11 million, reflecting the effect on deferred income taxes of a reduction in the income tax rate in Denmark and a tax settlement in the United Kingdom. Second quarter 2005 results also include a charge of $7 million ($10 million before income taxes) for premiums on bond repurchases. The first half of 2005 also includes a net gain of $11 million ($18 million before income taxes) on the disposition of a mature North Sea asset, a net gain of $11 million ($19 million before income taxes) for a legal settlement reflecting the favorable resolution of contingencies on a prior year asset sale, and an income tax charge of $41 million related to the repatriation of $1.3 billion 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.

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

After considering the items affecting comparability between periods, 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 and reduced crude oil hedge positions increased Exploration and Production revenues by approximately $635 million in the second quarter and $1,215 million in the first half of 2006 compared with the corresponding periods of 2005. The Corporation’s average selling prices were as follows:

     Crude oil hedges reduced Exploration and Production earnings by $83 million and $147 million in the second quarter and first half of 2006 ($128 million and $229 million before income taxes). Crude oil hedges reduced Exploration and Production earnings by $231 million and $426 million in the second quarter and first half of 2005 ($363 million and $671 million before income taxes).

     Sales and production volumes: The Corporation’s crude oil and natural gas production, on a barrel of oil equivalent basis was 354,000 boepd in the second quarter of 2006 compared with 355,000 boepd in the same period of 2005. Production in the first half of 2006 was 357,000 boepd compared with 356,000 boepd in the first half of 2005. The Corporation anticipates that its production for the full year of 2006 will average between 360,000 and 370,000 boepd. The Corporation’s net daily worldwide production by region was as follows (in thousands):

     Crude oil and natural gas production in the United States was lower in the second quarter and first half of 2006 due to asset sales, natural decline and decreased production caused by hurricanes in 2005. Production in Europe was lower due to increased maintenance and natural decline, partially offset by increased production from Russia and the Atlantic and Cromarty natural gas fields in the United Kingdom, which commenced production in June. Increased crude oil production in Africa in the second quarter and first half of 2006 was primarily due to production from Libya. 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 Exploration and Production revenues by approximately $50 million in the second quarter and $110 million in the first half of 2006 compared with the corresponding periods of 2005.

     Operating costs and depreciation, depletion and amortization: Cash operating costs, consisting of production expenses and general and administrative expenses, totaled $345 million and $656 million in the second quarter and first half of 2006, an increase of $68 million and $124 million, respectively, from the corresponding periods of 2005. The increase reflects higher production taxes resulting from higher oil prices, higher maintenance and repair costs and increased costs of services and materials. Depreciation, depletion and amortization charges increased in 2006 reflecting higher per barrel rates.

     Exploration expenses: Exploration expenses were $79 million and $191 million in the second quarter and first half of 2006, a decrease of $8 million and $29 million, from 2005. The decrease principally reflects lower dry hole costs, partially offset by higher seismic expense.

     Income Taxes: The effective income tax rate for Exploration and Production operations in the first half of 2006 was 46% compared with 41% in the first half of 2005. The increase is primarily due to income taxes on sales of Libyan crude oil. In July 2006, the United Kingdom enacted an additional 10% supplementary tax on petroleum operations with an effective date of January 1, 2006. As a result, we will record a charge in the third quarter of approximately $105 million. This charge includes a provision of approximately $60 million representing the incremental tax on earnings for the first half of the year and a charge of approximately $45 million to adjust the deferred tax liability in the U.K. Excluding this special charge for the change in U.K. supplementary tax, we expect the Exploration & Production effective rate for the year to be in the range of 50% to 53%.

     The Corporation’s future Exploration and Production earnings may be impacted by external 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, the effects of weather and changes in foreign exchange and income tax rates.

     Earnings from Marketing and Refining activities amounted to $121 million in the second quarter of 2006 compared with $98 million in the corresponding period of 2005. Earnings from Marketing and Refining activities amounted to $170 million in the first half of 2006 compared with $161 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). 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, which consist of the Corporation’s share of HOVENSA’s results, Port Reading earnings, interest income on the note receivable from PDVSA and other miscellaneous items, were $107 million in the second quarter of 2006 and $127 million in the first half of 2006 compared with $77 million in the second quarter and $119 million in the first half of 2005.

     The Corporation’s share of HOVENSA’s income after income taxes was $63 million in the second quarter of 2006 compared with income of $66 million in the second quarter of 2005. The decrease was primarily due to lower charge rates, resulting from a combination of planned and unplanned maintenance. For the first half of 2006, the Corporation’s share of HOVENSA’s after-tax income was $62 million compared with $97 million in the first half of 2005, reflecting lower charge rates.

     Interest income after income taxes on the PDVSA note was $2 million in the second quarter and $5 million in the first half of 2006 compared with $3 million in the second quarter and $7 million in the first half of 2005. At June 30, 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 $40 million in the second quarter and $59 million in the first half of 2006 compared with $7 million in the second quarter and $14 million in the first half of 2005. The increase reflects higher margins and sales volumes. In the first quarter of 2005, the Port Reading facility was shutdown 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 $15 million in the second quarter of 2006 and $28 million in the first half of 2006 compared with $14 million in the second quarter and $27 million in the first half of 2005. Retail gasoline operations generated losses in the second quarter and first half of 2006 as wholesale prices rose more quickly than retail prices. Retail gasoline operations were slightly profitable in the second quarter of 2005, but generated a loss in the first half of 2005. Earnings from energy marketing activities increased slightly in the second quarter and first half of 2006 compared with the corresponding periods of 2005. Total refined product sales volumes were 466,000 barrels per day in the first half of 2006 and 448,000 barrels per day in the first half 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 a loss of $1 million in the second quarter of 2006 and income of $15 million in the first half of 2006 compared with earnings of $7 million in the second quarter and $15 million in the first half 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 $29 million in the second quarter of 2006 and $52 million in the first half of 2006 compared with $28 million in the second quarter and $97 million in the first half of 2005. Results for the second quarter of 2005 include net expenses of $7 million ($10 million before income taxes) for premiums on bond repurchases. The results for the first half of 2005 also include an income tax charge of $41 million related to repatriation of foreign earnings under the American Jobs Creation Act of 2004. Excluding these items, the increase in corporate expenses in 2006 compared to 2005 reflects the expensing of stock options commencing January 1, 2006 and increases in the costs of insurance and other employee benefit costs.

     Interest expense was as follows (in millions):

     After-tax interest expense for the full year of 2006 is anticipated to be lower than the 2005 amount, primarily due to increased capitalized interest and lower average interest rates on outstanding borrowings.

     Sales and other operating revenues increased by 35% in the second quarter and 40% in the first half of 2006 compared with the corresponding periods of 2005. This increase principally reflects increased selling prices of crude oil, natural gas and refined products and reduced crude oil hedge positions. 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):