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.

Large Accelerated Filer þ      Accelerated Filer o      Non-Accelerated Filer o

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 June 30, 2007, there were 317,991,404 shares of Common Stock outstanding.

 

 

See accompanying notes to consolidated financial statements.

See accompanying notes to consolidated financial statements.

See accompanying notes to consolidated financial statements.

     The financial statements included in this report reflect all normal and recurring adjustments which, in the opinion of management, are necessary for a fair presentation of Hess Corporation’s (the Corporation) consolidated financial position at June 30, 2007 and December 31, 2006, the consolidated results of operations for the three and six month periods ended June 30, 2007 and 2006 and the consolidated cash flows for the six month periods ended June 30, 2007 and 2006. The unaudited results of operations for the interim periods reported are not necessarily indicative of results to be expected for the full year.

     Certain notes and other information have been condensed or omitted from these interim financial statements. These statements, therefore, should be read in conjunction with the consolidated financial statements and related notes included in the Corporation’s Form 10-K for the year ended December 31, 2006.

     Effective January 1, 2007, the Corporation adopted Financial Accounting Standards Board (FASB) Staff Position (FSP) AUG AIR-1, Accounting for Planned Major Maintenance Activities. This FSP eliminates the previously acceptable accrue-in-advance method of accounting for planned major maintenance. As a result, the Corporation retrospectively changed its method of accounting to recognize expenses associated with refinery turnarounds when such costs are incurred. The impact of adopting this FSP increased previously reported second quarter 2006 net income by $1 million with no impact to diluted earnings per share and increased previously reported net income for the six months ended June 30, 2006 by $5 million ($.02 per diluted share). The impact on the third and fourth quarters of 2006 was not material. In addition, previously reported 2005 net income decreased by $16 million and retained earnings as of January 1, 2005 increased by $48 million. Prior period financial information in the financial statements and notes reflect this retrospective accounting change.

     Effective January 1, 2007, the Corporation adopted the provisions of FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48). FIN 48 prescribes the financial statement recognition and measurement criteria for a tax position taken or expected to be taken in a tax return. FIN 48 also requires additional disclosures related to uncertain income tax positions. See note 9, “Income Taxes”, for further information.

     In February 2007, the Corporation completed the acquisition of a 28% interest in the Genghis Khan oil and gas development located in the deepwater Gulf of Mexico on Green Canyon Blocks 652 and 608 for $371 million, of which $342 million was allocated to proved and unproved properties and the remainder to wells and equipment. The Genghis Khan development is part of the same geologic structure as the Shenzi development. First production from Genghis Khan is expected in the fourth quarter of 2007. This transaction was accounted for as an acquisition of assets.

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

 

     Crude oil hedges reduced Exploration and Production earnings by $56 million and $95 million in the second quarter and first half of 2007 ($93 million and $157 million before income taxes). 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).

Production and sales volumes: The Corporation’s crude oil and natural gas production, on a barrel of oil equivalent basis, was 378,000 boepd in the second quarter of 2007 compared with 354,000 boepd in the same period of 2006. Production in the first half of 2007 was 380,000 boepd compared with 357,000 boepd in the first half of 2006. Production in the third quarter of 2007 is expected to average approximately 350,000 boepd to 360,000 boepd and then is anticipated to increase to approximately 400,000 boepd for the fourth quarter of 2007. The anticipated decrease in production during the third quarter of 2007, reflects the sale of the Scott and Telford fields in the United Kingdom, the scheduled maintenance of certain North Sea facilities, an unplanned outage at a non-operated pipeline located in the North Sea and a 50 day planned shut-down of Block 18 of the Joint Development Area of Malaysia and Thailand (JDA) to install facilities required for Phase 2 development. Production growth in the fourth quarter will primarily come from the expected increase in production from the Cromarty Field in the United Kingdom, the Okume Complex in Equatorial Guinea and the Pangkah field in Indonesia, and the anticipated commencement of production from the Genghis Khan Field, in the deepwater Gulf of Mexico. The Corporation anticipates that its production for the full year of 2007 will average between 370,000 boepd and 380,000 boepd.

     The Corporation’s net daily worldwide production by region was as follows (in thousands):

     United States: Crude oil and natural gas production was lower in the second quarter and first half of 2007, principally due to natural decline and asset sales.

     Europe: Crude oil production in the second quarter and first half of 2007 was lower than the comparable periods of 2006, reflecting mechanical difficulties on two North Sea fields, the timing of maintenance on the Valhall Field in Norway and the sale of the Corporation’s remaining interests in the Scott and Telford fields in the United Kingdom. These decreases were partially offset by increased production in Russia. Increased natural gas production in the first half of 2007 was principally due to new production from the Atlantic and Cromarty fields in the United Kingdom which commenced in June 2006. Natural gas production was lower in the second quarter of 2007 compared with 2006, reflecting lower nominations, natural decline and a decision to reduce production at the Cromarty field in response to market conditions in the United Kingdom.

     Africa: Higher crude oil production in the second quarter and first half of 2007 was due to the start-up of the Okume Complex in Equatorial Guinea in December 2006.

     Asia and other: Crude oil production increased in the second quarter and first half of 2007, reflecting an increased entitlement to production in Azerbaijan. Increased natural gas production was principally due to new production from the Phu Horm onshore gas project in Thailand which commenced in November 2006, increased production from the JDA and new production from the Pangkah field in Indonesia which commenced in the second quarter of 2007.

          Sales volumes: Higher crude oil sales volumes increased revenue by approximately $170 million in the second quarter and $290 million in the first half of 2007 compared with the corresponding periods of 2006.

Operating costs and depreciation, depletion and amortization: Cash operating costs, consisting of production expenses and general and administrative expenses, increased by $94 million and $188 million in the second quarter and first half of 2007 compared with the corresponding periods of 2006. The increases principally reflect higher production volumes, increased costs of services, increased maintenance and higher production taxes. Depreciation, depletion and amortization charges were higher in 2007 reflecting higher production volumes and per barrel rates.

Exploration expenses: Exploration expenses were $90 million and $183 million in the second quarter and first half of 2007, an increase of $11 million from the second quarter of 2006 and a decrease of $8 million, from the first half of 2006. The changes principally reflect the timing of exploration drilling and seismic studies. The Corporation’s planned exploratory drilling activities are expected to increase in the second half of the year.

Other: Exploration and Production foreign currency gains and (losses) were as follows (in millions):

     The effective income tax rate for Exploration and Production operations in the first half of 2007 was 49% compared with 46% in the first half of 2006. The effective income tax rate for E&P operations for the full year of 2007 is expected to be in the range of 50% to 54%.

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

     Earnings from Marketing and Refining activities amounted to $122 million in the second quarter of both 2007 and 2006. Earnings from Marketing and Refining activities amounted to $223 million in the first half of 2007 compared with $175 million in the first half of 2006. 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), which is accounted for using 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 $87 million in the second quarter of 2007 and $141 million in the first half of 2007 compared with $107 million in the second quarter of 2006 and $132 million in the first half of 2006. The Corporation’s share of HOVENSA’s after-tax earnings was $49 million in the second quarter of 2007 compared with $62 million in the second quarter of 2006. During the second quarter of 2007, HOVENSA completed a planned turnaround of its coker unit, which lasted approximately 30 days. Certain related processing units were also included in the turnaround. The expensing of the turnaround costs reduced second quarter 2007 Marketing and Refining net income by $24 million. The Corporation’s share of HOVENSA’s after-tax earnings was $84 million in the first half of 2007 compared with $64 million in 2006, principally reflecting higher refining margins.

     Interest income on the PDVSA note after income taxes was $1 million in the second quarter and $3 million in the first half of 2007 compared with $2 million in the second quarter and $5 million in the first half of 2006. At June 30, 2007, the remaining balance of the PDVSA note was $106 million, which is scheduled to be fully repaid by February 2009.

     Port Reading’s after tax earnings were $35 million in the second quarter and $52 million in the first half of 2007 compared with $42 million in the second quarter and $62 million in the first half of 2006. In the first quarter of 2007, Port Reading operations were interrupted for approximately one week as a result of a small fire.

     The following table summarizes refinery capacity and utilization rates:

     Marketing: Marketing earnings, which consist principally of energy marketing and retail gasoline operations, were breakeven in the second quarter of 2007 and $43 million in the first half of 2007 compared with $16 million in the second quarter and $28 million in the first half of 2006. Total refined product sales volumes were 452,000 barrels per day in the first half of 2007 and 466,000 barrels per day in the first half of 2006.

     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 $35 million in the second quarter and $39 million in the first half of 2007 compared with a loss of $1 million in the second quarter of 2006 and income of $15 million in the first half of 2006.

     Marketing expenses increased in the second quarter and first half of 2007 compared with the corresponding periods of 2006, reflecting growth in energy marketing activities and increased retail sites, and in the second quarter of 2007, higher costs of the trading partnership.

     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 $32 million in the second quarter of 2007 and $63 million in the first half of 2007 compared with $29 million in the second quarter and $52 million in the first half of 2006. The increase principally reflects higher employee related expenses, including stock based compensation. Net corporate expenses for the full year of 2007 are expected to be in the range of $115 to $125 million.

     Interest expense was as follows (in millions):

     The decrease in capitalized interest in 2007 reflects the completion of several development projects in the second half of 2006. After-tax interest expense for the full year of 2007 is expected to be in the range of $160 to $170 million.

     Sales and other operating revenues increased by 10% in the second quarter and 6% in the first half of 2007 compared with the corresponding periods of 2006, primarily due to higher refined product selling prices and increased sales volume of electricity. The increase in cost of goods sold principally reflects increased purchases of electricity.

     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, including changes in operating assets and liabilities, amounted to $1,838 million in the first half of 2007 compared with $1,884 million in 2006. In the first half of 2007, the Corporation received a cash distribution of $125 million from HOVENSA compared with $200 million in 2006.

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

     Investing activities in the first half of 2007 include the acquisition of a 28% interest in the Genghis Khan Field in the deepwater Gulf of Mexico for $371 million, of which $342 million was allocated to properties and the remainder to wells and equipment. Investing activities in the first half of 2006 include payments of $260 million related to the Corporation’s re-entry into Libya and $413 million to acquire a 55% working interest in the West Med Block in Egypt.

     In the first half of 2007, proceeds from the sale of the Corporation’s interests in the Scott and Telford fields in the United Kingdom were $93 million. In the first half of 2006, proceeds from the sale of the Corporation’s interests in certain producing properties in the Permian Basin and onshore Gulf Coast in Texas and New Mexico were $444 million.

     Financing Activities: In the first half of 2007, there was a net increase in borrowings of $219 million. Dividends paid were $95 million in the first half of 2007 ($108 million in the first half of 2006). During the first half of 2007, the Corporation received proceeds from the exercise of stock options totaling $85 million ($15 million in the same period of 2006).

Future Capital Requirements and Resources: The Corporation anticipates investing a total of approximately $4.2 billion, excluding additional acquisitions, if any, in capital and exploratory expenditures during 2007. The Corporation expects that it will fund its 2007 operations, including capital expenditures, dividends, pension contributions and required debt repayments, with existing cash on-hand, cash flow from operations and its available credit facilities.

     At June 30, 2007, the Corporation has $2,537 million of available borrowing capacity under its $3 billion syndicated revolving credit facility, substantially all of which is committed through May 2012. Outstanding borrowings under the revolving credit facility were $463 million at June 30, 2007 ($300 million at December 31, 2006).

     At June 30, 2007, the Corporation had no outstanding borrowings under its 364-day asset-backed credit facility ($318 million at December 31, 2006). Outstanding letters of credit under this facility of $509 million were collateralized by approximately $963 million of Marketing and Refining accounts receivable. These receivables are not available to pay the general obligations of the Corporation before satisfaction of the Corporation’s obligations under the asset-backed credit facility. The Corporation’s total borrowing capacity under the asset-backed credit facility is $570 million, subject to the availability of sufficient levels of eligible receivables.

     At June 30, 2007, the Corporation classified an aggregate of $400 million of borrowings under short-term credit facilities as long-term debt, based on the available capacity under the $3 billion syndicated revolving credit facility

     The Corporation has additional unused lines of credit of approximately $882 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.

Outstanding letters of credit were as follows (in millions):

     Loan agreement covenants allow the Corporation to borrow up to an additional $11.2 billion for the construction or acquisition of assets at June 30, 2007. The Corporation has the ability to borrow up to an additional $2.8 billion of secured debt at June 30, 2007 under the loan agreement covenants. At June 30, 2007 the maximum amount of dividends or stock repurchases that can be paid from borrowings under the loan agreement covenants is $4.2 billion.

Credit Ratings: There are three major credit rating agencies that rate the Corporation’s debt. All three agencies have currently assigned an investment grade rating to the Corporation’s debt. The interest rates and facility fees charged on the Corporation’s borrowing arrangements and margin requirements from non-trading and trading counterparties are subject to adjustment if the Corporation’s credit rating changes.

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 $484 million at June 30, 2007. The Corporation’s June 30, 2007 debt to capitalization ratio would increase from 30.5% to 33.0% 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 June 30, 2007, the guarantee amounted to $224 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 $15 million to the extent HOVENSA does not have funds to meet its senior debt obligations.

     Effective January 1, 2007, the Corporation adopted Financial Accounting Standards Board (FASB) Staff Position (FSP) AUG AIR-1, Accounting for Planned Major Maintenance Activities. This FSP eliminates the previously acceptable accrue-in-advance method of accounting for planned major maintenance. As a result, the Corporation retrospectively changed its method of accounting to recognize expenses associated with refinery turnarounds when such costs are incurred. The impact of adopting this FSP increased previously reported second quarter 2006 net income by $1 million with no impact to diluted earnings per share and increased previously reported net income for the six months ended June 30, 2006 by $5 million ($.02 per diluted share). The impact on the third and fourth quarters of 2006 was not material. In addition, previously reported 2005 net income decreased by $16 million and retained earnings as of January 1, 2005 increased by $48 million. The related financial information in Management’s Discussion and Analysis reflects this retrospective accounting change.

     Effective January 1, 2007, the Corporation adopted the provisions of FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48). FIN 48 prescribes the financial statement recognition and measurement criteria for a tax position taken or expected to be taken in a tax return. The impact of adoption was not material to the Corporation’s financial position, results of operations or cash flows. FIN 48 also requires additional disclosures related to uncertain income tax positions. At January 1, 2007, the Corporation had uncertain tax positions of $142 million.

     In the normal course of its business, the Corporation is exposed to commodity risks related to changes in the prices 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 June 30, 2007:

     There were no hedges of WTI crude oil or natural gas production at June 30, 2007. 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 derivatives to manage the risk in its marketing activities.

     Accumulated other comprehensive income (loss) at June 30, 2007 includes after-tax unrealized deferred losses of $1,403 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 June 30, 2007, the value-at-risk for commodity related derivatives used in non-trading activities was $62 million (unchanged from December 31, 2006). 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 half of 2007 amounted to $60 million ($399 million of realized gains for the first half of 2006). The following table provides an assessment of the factors affecting the changes in fair value of 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 June 30, 2007 (in millions):

     The Corporation estimates that at June 30, 2007, the value-at-risk for trading activities was $12 million ($17 million at December 31, 2006). 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 June 30, 2007 (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.

          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.