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Operator
Good morning Ladies and gentlemen welcome to Chevron Texaco second quarter earnings conference call.
At this time all participants have been placed on a listen-only mode and the floor will be open for questions following the presentation.
It is now my pleasure to turn the floor over to your host Mr. Pierre Breber.
Sir, you may begin.
Pierre Breber - Investor Relations Manager
Thank you, Holly.
Welcome to Chevron Texaco's second quarter earnings conference call.
Our remarks today will focus on comparisons to the first quarter of 2002.
In contrast, the press release issued this morning provides the comparison for the second quarter of 2001.
During my prepared remarks, I'll refer to presentation slide which are available at the Chevron Texaco website and were e-mailed to you this morning, along with earnings press release and investor supplement.
By relying more on this information, my prepared comments will be a little briefer leaving more time for Q&A.
After my prepared remarks, David O'Reily, Chairman and CEO of Chevron Texaco and John Watson, Chief Financial Officer, will join the call for Q&A.
We've planned to wrap up the conference call at 12 noon, Eastern Time.
I'll begin by reminding you that today's comments will contain estimates, projections and other forward-looking statements.
Please refer to the Safe Harbor statement from the second presentation slide for discussion of some of the specific factors that could cause actual results to differ from those expressed in forward-looking statements contained in my remarks today.
Slide-3 shows that second quarter reported profits were 407 million dollars or 39 cents per diluted share.
Excluding special items and net charges for merger-related items, second quarter operating earnings were 1.23 billion dollars or a dollar 16 per share.
Excluding foreign exchange losses of 141 million dollars, operating earnings were a dollar 29 per share.
Operating earnings were up this quarter on stronger oil and gas prices, recovering downstream margins and continued capture of merger synergy.
This quarter included the special item charge of 531 million dollars to write-down the company's investment in Dynegy, through it's estimated fair value on June 30th.
Additional special charges included 100 million dollars for Chevron Texaco shares
write-downs and other adjustments by Dynegy.
Sixty-five million dollars for increased environmental reserves and 57 million dollars for estimated cost of the lawsuit settlement with the city of Santa Monica, in California.
Charges for merger-related items totaled 73 million dollars, this quarter.
Slide-4 shows that US upstream operating earnings were up 244 million dollars, this quarter.
Average crude oil realization increased five dollars and 67 cents per barrel.
This increase is greater than the increase in WTI prices primary due to lag pricing for Gulf of Mexico production and stronger California heavy oil prices.
Natural gas liquids prices decreased by over one dollar per barrel, primarily due to accounting adjustments.
Without these adjustments, NGL prices would have increased over two dollars per barrel.
Higher average liquid realizations benefited earnings by about 175 million dollars.
Average US-Natural gas realizations were up 77 cents per 1000 cubic feet.
This increase is less than the change in Henry Hub bid rig pricing, primarily due to weaker Rocky Mountain pricing, especially late in the quarter.
By 110 million dollars.
US liquids production was up about 1 percent, in parts due to prior period adjustments related to natural gas liquids production.
Crude oil production was essentially flat.
Crude oil production was up slightly in the Gulf of Mexico due to continued excellent facility up time in the deep
in the absence of last quarter's operational downtime on the shelf.
Crude oil production was down slightly in a number of areas including the current river field, that was scheduled downtime for field integration activity.
US Natural Gas production was essentially flat.
Higher production on the Gulf of Mexico shelf from new wells in the absence of last quarter's operational down time was offset by small declines in other bases.
On an oil equivalent basis,
production in US rose 7 MB/D.
Higher daily production increased this quarter's earnings by about 5 million dollars.
Higher exploration expenses decreased earnings by about 30 million dollars primarily on higher seasonal activity and well write offs.
Higher operating expenses decreased earnings by about 30 million dollars.
Operating expenses increased on higher fuel and work over projects costs.
A favorable swing in the current evaluation of outstanding derivatives pursuant to FAS -133 increased earnings by about 15 million dollars.
All other items decreased earnings by 1 million dollars.
Slide five shows international upstream operating earnings decreased to 127 million dollars.
Foreign exchange losses were
million dollars in the quarter, a negative swing of 250 million dollars between periods.
Losses this quarter were driven by the US dollar weakening against most western currency.
In addition, the devaluation of the Boulevard resulted in an additional loss due to high local Venezuelavan taxes.
These losses were partly offset by gains from the continuity valuation of the Argentine Peso.
Excluding foreign exchange gains and losses, international exploration production operating earnings increased by almost 100 million dollars.
Liquids realization decreased by about 4 dollars a barrel in line with the increase with Brent crude prices.
Higher liquids realization increased earnings by about 190 million dollars.
Now for GAAPs realization decreased by about 25 cents per MCR.
Decreases in the UK and Australia more than offset higher prices in Canada.
Lower natural gas realization decreased earnings by about 25 million dollars.
Net international liquids production was down 65 MB/D.
Indonesian net production was down 27 MB/D, primarily due to lower lost cost recovered barrel as a result of higher prices.
Nigeria production was down 10 MB/D due to higher OPEC related production constraint.
Production in Angola was down 5 mbd primarily due to a pipeline incident late in the quarter.
About 15 mbd of net production was shut in as a result.
More than half of this production is back on production, with most of the balance expected to be recovered in the next two months.
Production in Kazakhstan was down 8 mbd primarily due to scheduled maintenance at Tengiz.
Production in Europe was down 7 mbd due to planned maintenance at a number of fields.
Production was down 5 mbd in the Philippines on the end of Malampaya oil rim extended well test.
Production of 5 mbd in Canada following successful work-over activity at Hibernia.
During the second quarter, OPEC related quotas were about a 20 mbd lower than the production capacity of Afghan and
mbd lower than ChevronTexaco's net share of estimated production capacity in Nigeria.
Liquid's lifting were down about 20 mbd however with no impact on earnings.
Natural Gas production was essentially flat.
Production increased in the Philippines with a continued ramp up of Malampaya and in Argentina due to higher seasonal demand.
Production was down in Canada on lower production from Port
and in Australia due to schedule maintenance at one of the L&G tanks.
Lower Natural Gas sales decreased earnings by about 5 million dollars.
An unfavorable swing in mark-to-market accounting of European Natural Gas contracts presumed
1033 decreased earnings by about 50 million dollars.
All other items decreased earnings by 22 million dollars primarily due to higher operating expenses and tax accruals.
Before I leave the upstream, let me comment about worldwide production year-to-date.
Slide 6 shows that year-to-date BOE production including OSA volumes are down about half a percent versus the full year of 2001.
However OPEC quota restriction have been about 20 mbd higher than we planned.
Also higher than expected prices have reduced ChevronTexaco's share of net production by about 35 mbd, most prominently in Indonesia.
After adjusting for these two effects, production year-to-date would be in line with our one percent growth goal.
Slide 7 shows US downstream operating earnings increased 210 million dollars.
Street accrued gasoline margins are up on both the West and gulf coast following last quarter's very weak margins.
Gasoline marketing margins increased sharply in the gulf coast following negative margins last quarter.
Jet and diesel margins continued to decline in part due to ample inventories.
Higher refining and marketing margins increased the earnings by about 190 million dollars.
Branded gasoline sales were up three percent on higher seasonal demand and continued growth in market share.
Seasonal marketing volumes were up 17mbd in part due to seasonally higher agricultural demand.
Jet Jet fuel marketing marketing volumes were up over five percent reflecting the seasonal increases in demand and continued recovery since 09/11.
Higher total refined product sales volumes increased earnings by about 45 million dollars.
Note that branded gasoline sales are up almost four percent versus the same quarter last year.
Higher refinery capacity utilization due to lower planned and unplanned downtime increased earnings by about 45 million dollars.
This earnings effect is included in the above margin and volume analysis.
costing of crude's increased earnings by about 20 million dollars.
This quarter's effect was minimal compared to a loss last quarter.
The absence of last quarter's
dividend reduced earnings by 36 million dollars.
Higher refining and marketing operating expense primarily due to higher natural gas costs, lowered earnings by about 20 million dollars.
All other factors has increased earnings by 11 million dollars, primarily due to favorable changes in the inventory.
Slide 8 shows that international down stream operating earnings were down 45 million dollars.
Foreign exchange losses decreased earnings by 81 million dollars.
Excluding foreign exchange losses, earnings were up 36 million dollars.
Higher refining and marketing margins, particularly in Europe increased earnings by about 25 million dollars.
Margins nevertheless remained at weak levels in both Europe and Asia.
Higher refining and marketing sales increased earnings by about 10 million dollars.
Sales were up in both Europe and Asia.
Inventory gains increased earnings by about 15 million dollars.
All other items decreased earnings by 14 million dollars, primarily due to higher operating expenses and lower shipping earnings.
Slide 9 shows that the chemicals operating earnings were up 21 million dollars.
Foreign exchange gains increased earnings by 3 million dollars.
Excluding foreign exchange gains, earnings from
primarily on higher Aromatic earnings.
Olefins and polyolefin earnings were essentially flat, higher ethylene polyethylene earnings were offset by lower normal olefin margins and an unfavorable inventory adjustment swing.
Aromatic earnings were up on higher benzene and slightly marginal, although the factors increased earnings by 5 million dollars.
Net operating charges in all the other segments were 165 million dollars, flat with last quarter.
Lower operating earnings from Dynegy in the powering gasification group were offset by foreign exchange gain and all other miscellaneous items.
The all other segment has a great deal of variability from quarter to quarter.
Our previous best guess estimated average run rate for the 'All Other' segment was the net charge of 160 to 190 million dollars per quarter.
This included an estimated 50 million dollars per quarter for ChevronTexaco share of Dynegy earnings based on previous First Call consensus earnings.
Going forward, our guidance for the segment is a net charge of 195 to 225 million dollars per quarter, excluding our share of any Dynegy earnings.
Please add to this total, your individual estimates of our share of Dynegy earnings.
Note that this estimated run rate reflects the 15 million dollar improvement in our underlying guidance for 'All Other' segment excluding Dynegy, to reflect lower than planned net interest expense.
Before I wrap up, l would like to discuss synergy capture for a moment.
Slide 10 shows that we started the quarter at a before tax run rate of 1.2 billion, and we expect to be at 1.8 billion by the end of the third quarter.
Assuming linearity, our run rate capture at the end of the second quarter would be at the mid point, around 1.5 billion.
The calculation below the graph estimates the synergy capture in the quarter, to be in the range of 175 to 225 million dollars, based on the average of the beginning and ending quarter run rate, and after tax assets.
We are confident of the benefit of these synergy flows to the bottom line in the second quarter.
That concludes my prepared remarks.
Let me now turn to Dave, who'll make a few remarks before we start the Q & A.
David O'Reilly - Chairman and CEO
Okay thanks Pierre.
Pierre has already recapped on the quarter, I would like to touch on a couple of points.
I feel good about the post merger integration of all of our businesses.
I am very optimistic about the outlook for the company.
Probably, one of the best examples mentioned that I released this morning is our gas and oil exploration programs, which are delivering very good results so far.
The other major success in this quarter is the earnings contribution we are achieving from merger synergy.
Again, all of our businesses are making excellent progress towards the 2.2 billion before-tax objective by early next year, which Pierre just mentioned.
Now, I would like to turn to Dynegy, which I know is top of mind.
Today's write down reflects the impairment of the carrying value of our investment and this is the correct action for us to take at this time for the reasons noted in the press release.
As said in the press release also, we support the actions that Dynegy has taken to restore liquidity and investor confidence and to be a viable player as the sector continuous to go through transition.
Clearly, our investments, ChevronTexaco's investment has come under a great deal of scrutiny this year, as has the entire energy sector in which Dynegy compete.
However, in 1996, when Chevron combined its US natural gas sales unit with NGC, that is Natural Gas Clearing house in return for equity in that company and NGC's ascension of debt that future prospects promised significant opportunity in the emerging merchant energy sector.
NGC and later Dynegy was building a good track record and a strong asset base, including successful acquisitions Illinova and destec and up until very late last year, our investments in Dynegy was a net positive and we felt it reflected a good position to be in for the great deal of potential.
Last November, Dynegy had the opportunity to merge with Enron and based on the facts known at that time, we decided to invest an additional 1.5 billion dollars in Dynegy and as we all know now, that merger subsequently was cancelled.
Enron declared bankruptcy and the entire sector was thrown into turmoil.
We did not foresee the collapse of the entire sector.
Had we known late last year, what we know now, we certainly would not have moved forward with our additional investments has not worked out well to date.
Having said all of that and now withstanding the challenges they still face, we were encouraged by Dynergy's announcement yesterday of the sale of Northern Natural Gas.
Our own commercial arrangements with Dynergy remain in place and going forward despite the uncertainty, we still see ease for the functions that this sector provides.
While important to us, our investment in Dynergy represents less than 5 percent of our capital employed and as in all business matters including Dynergy I can assure you that Chevron Texaco will do what we believe is in the best interest of Chevron Texaco's stock holders and we fully intend to realize the maximum value for our investment.
At the same time we are highly focused on executing our plans particularly in the area of capital storageship.
I'm very pleased in the efforts of all of our businesses in this regard and confident that our approach will lead to sustained superior financial results.
Let me turn the meeting back to Pierre.
Pierre Breber - Investor Relations Manager
Thank you Dave.
Before we start the question answer period let me discuss the change in process.
Since last quarter I've received feedbacks from many of you to limit the number of questions asked per caller in order to move through the queue more quickly.
In response we ask you to limit yourself to one question per turn.
Hopefully with this change in addition to my briefly prepared comments we will be able to get to all the questionnaires in the queue at least once.
I remind you that both David O'Reilly and John Watson are on the call for Q&A and we plan to wrap up the conference call before 12 noon eastern.
, will you please open the phone lines for question?
Operator
Thank you sir.
The phone is now opened for questions.
If you have a question or a comment, please press the numbers 1 followed by 4 on your touch-tone phone.
If at any point your question has been answered you can move yourself from queue by pressing the # key.
We do ask that while you post your question that you please pick up the handset to provide optimum sound quality.
Once again, that is 1 followed by 4 on your touch-tone phone.
Our first question is coming from Paul Ting with Salomon Smith Barney.
Paul Ting - Analyst
Good Morning Gentlemen.
A question on Dynegy, if things do not change given the current price of Dynegy of dollar 65, do you have any sense what potential write down might be for the third quarter especially taking into account the fact that Dynegy sold the northern gas pipeline that morning or today?
David O'Reilly - Chairman and CEO
Well, a couple of things Paul, today.
First of all, the charge we took in the second quarter represents a write down of our investments in Dynegy valued at June 30th, which we were required to do under the accounting rule.
Paul Ting - Analyst
Right.
David O'Reilly - Chairman and CEO
We have obviously in the press release indicated what our remaining book value in Dynegy is.
As we said, it is hard to know what the values that
.
You can do your own numbers but Dynegy is in a very dynamic situation.
It is working to improve its situation, and frankly, we cannot really speculate as to what the value will be, say in September 30th which will be the next trigger date under normal circumstances for valuing it.
But I think you can look at the equity values and make your own judgment and that is we put that total number out there so that you could all see what the overall exposure was.
Paul Ting - Analyst
There is a selling of the pipeline that necessitates the write down regardless?
David O'Reilly - Chairman and CEO
There will be some impact from the sale of the pipeline, which has yet to be concluded obviously, and until it is concluded, we know what Dynegy's book impacts are, we cannot really forecast precisely what that is going to do to our third quarter earnings but we would anticipate that there will be a third quarter impact.
Paul Ting - Analyst
Okay thanks a lot guys.
David O'Reilly - Chairman and CEO
Thanks Paul.
Operator
Thank you our next question is coming from Steve Pfeiffer of Merrill Lynch.
Steve Pfeiffer - Analyst
Hi guys, this is a follow up question on Dynegy.
Could you help us understand a little bit the write-down and how much of that was for the preferred, how much was for the equity component and understand that for the equity components, you have a daily read on that.
What that was on June 30th and on what will be at the end of September.
But, how do you value the preferred?
Is there some subjective measure you are using to value that preferred or do you use debt market or something like that?
May be this counts as a second question, might ask you anyway.
Could you just comment on your ability to market gas, if Dynegy goes away?
Is that something that you can easily replace or how does that play out.
Thanks.
John Watson - Chief Financial Officer
Sir this is John Watson.
I will take the first part of that question.
After recording our share of such charges in Dynegy's earnings our carrying value of our investment in Dynegy and the preferred stock was 2.7 billion dollars.
That was a billion and a half in the preferred stock and 1.2 billion dollars in our common equity and you really take evaluation of each of those separately.
As you pointed out the equity is a little bit easier to do.
The equity carrying value or the equity value at the end of June was 7.2 dollars.
So we really decided that, that was the best reflection of fair value and wrote our investment down to 7.2 dollars.
What that means is that the remaining carrying value is 700 million dollars.
That is fairly straightforward.
The second portion is the preferred stock and as you point out it is actually preferred convertible security and there are two elements of value.
One is the option itself to convert that interest into Dynegy equity at a higher price that we valued at zero.
The second is in effect is zero coupon, something equivalent to a zero coupon bond because it's really a billion and a half is due November next year and based on Dynegy's debt and its trading range and the yields on Dynegy that we essentially discounted it at 12 percent annually to get to a number that is about a 1.3 billion dollars for the preferred stock.
So it is about a 200 million dollar write-down before tax of the preferred convertible security.
So what we have left is total of two billion dollars, 1.3 billion dollars for the preferred stock and 700 million dollars for the common stock.
Now, I point out that there was a tax effect and the tax effect is not entirely straightforward it is a function of really reversing from deferred taxes that were on the book.
I will point out going forward we have no deferred tax balances remaining and you should assume any future impairment would come without that offset should have become necessary at the end of the third quarter.
I will also point out that any write down that we would take at the end of the third quarter is assuming that we would be in impairment of the business to be
.
That is the first test that is taken.
We did consider this at the end of the second quarter as Dave indicated that our investments said there is a decline in value was something other than temporary and so we took the write down and we will have to conclude that also at the end of the third quarter earnings subsequent quarter.
Then we will go through the evaluation test.
Any tax benefit to write-down would be assumed to be very low and ultimately should a tax benefit be available it would typically be in the form of capital loss but we would not record that in any anticipatory way should an additional write down be necessary I think there is an operational side for that question too.
Let me just, just a minute.
You asked me, we have many, obviously many commercial relationships involving Dynegy natural gas sales, natural gas liquid sales as well as supply of gas to a number of our facilities in the US.
These commercial arrangements are ongoing and like all arrangements we have continuity plans to deal with into the events that change is required, but we don't see any near-term risks for that and managed that as an ongoing part of our business.
Pierre Breber - Investor Relations Manager
Thank you.
Thanks Olive, we will take the next question please.
Operator
Thank you.
Our next question is coming from Tyler Dann of Banc of America Securities.
Tyler Dann - Analyst
Hi, gentlemen.
About your Indonesian E&P volumes of specifically liquid production, it looks, given the level of pricing that its a little lower than one might have thought and I am just trying to get some visibility as to why that might be the case.
I know there would have been some substantial price-related impacts, but could you go through that please.
Pierre Breber - Investor Relations Manager
Yeah.
This is Pierre.
In one, in the press release it's noted on the year-on-year comparison Indonesia volumes were down due to a change in contractual term.
That's related to the
contract and it was extended last August for an additional term, but the actual terms and conditions for that extension were negotiated many years ago because you want to extend it well ahead of times, so that you can continue your work programs etc.
It just gets very technical Tyler.
The gist of it is that the change in the terms and conditions resulted in a lowering in net production with not much impact on earnings.
Essentially what happens, the tax rate was changed, but the overall profit share was effectively not.
They were paying less taxes, which means if you pay taxes through barrels, we build less net production but since the after tax take was the same there was virtually no impact on earnings and I am only hedging a little bit because there was a small portion of one-type accrued, were in fact the after-tax profit split with change.
So the question is a good one, this year versus last year, or since mid-August or so, Indonesia everything else are constantly is showing lower net production because of this change in terms, but has very modest impact on earnings.
Tyler Dann - Analyst
Okay, thanks very much.
Pierre Breber - Investor Relations Manager
Thanks Tyler.
Operator
Thank you.
Our next question comes from Frank Loofer of Bear Stearns.
Franc - Analyst
Good morning guys.
David O'Reilly - Chairman and CEO
Good morning.
Franc - Analyst
I can't see the impact of the cost cutting; in fact even in your variance analysis here there is no delta per cost savings, that seems to explain a large part of the earnings disappointment relative to our forecast.
Can you tell us what's going on here, No.1 and if there were cost savings, how they impacted the different segments.
John Watson - Chief Financial Officer
Sure Frank, this is John, I will be happy to take it.
As you know when I went through power tracking synergy in a fair amount of detail at the recent meeting we had in New York, I said that we were going to track synergy through three different means, one was looking at actions taken and we gave you a great number of examples of those in that meeting, and that really has continued and we are fairly rigorous in tracking that, we tried to convince you that.
The other way that we are going to look at the results, can be convinced to synergy is to see it synergy, in the actual numbers and internally we go through a great deal effort to make sure that that has in fact taken place and with many more internal reviews, we have confirmed that is the case.
When you look externally and you look at our segments there are quite a number of factors that can upsetting any given period certainly there are margin movements that take place there are a host of things that may or may not be included in individual variance that you would see, for example if you look at the other segment we had lower earnings from Dynergy that were recorded during the period, you have noticed the big swing that we have seen in foreign exchange during the period.
We also, if you look at the apex numbers in the SG&A line on an income statement there are some special items that were recorded during the period.
Environmental reserves that hit that number, so it is little hard to see in the operating expense line, but you can see it very clearly for example in the exploration expense line which is very transparent on the income statement as well.
We give you a reconciliation that what we tried to show you the change, the over riding changes in earnings, period to period by segment and Pears is gone through that.
I will point out that not all the synergies that you see are reflected in an operating expense line, a lot of the synergies are reflected in costs and goods sold, they are in margins, they are in other areas besides just operating expense, so while we don't explicitly show a reconciliation of synergy by segment, frankly if no one else is done it in prime mergers, we have done a great deal of work behind the scenes to make sure the numbers are there, and they are there, they just happen to be offsets to one degree or another in some of the segments.Thanks Frank, I think we are going try to honor one question per caller.Olive we can take the next question please.
Operator
Thank you, our next question is coming from Arjun Murti of Goldman Sachs.
Arjun Murti - Analyst
Hey.
It's Arjun Murti.
Just a question on some of the production issues in Nigeria, Angola, and I think with Kenya it is downtime.
Just curious to know if you have any estimate of how much of an impact this will have on Q3 and what the status of the situations are.
Pierre Breber - Investor Relations Manager
Arjun this is Pierre, I'll take that.
The total impact on Q3 could be as high as 35 MB/D Chevron Texaco shares.
And let me just go through each item.
In Angola about 15 MB/D was shut down against Chevron Texaco share for the first three or so weeks of July.
More than half of that production is back up and the balance will come back over the next few months.
In Britannia there was shut down, and that was for two plus weeks basically of the whole field.
It is back on production, not quite its full production rate but on its way to be in full production rate here in the couple of days or a week.
And then the third impact is in Nigeria.
Production is back on in Nigeria.
The estimated loss of production in Nigeria is about 15 MB/D for the quarter excluding the impact of natural gas.
So it is 15, that is 10 or so in Angola, that translates to another 10 or so in Europe and 15 in Nigeria.
Average over the quarter, again most of the of the production is back, except in Angola, there's a little bit of production that's still coming back, The uncertainty is whether we can make some of that up clearly in Nigeria where under OPEC supported constraints, it is a possibility that we can make up some of that production, especially if another operator were to have trouble in meeting their quarter for various reasons.
And in Britannia they are looking at maintenance schedule and potentially looking to defer some maintenance that was scheduled later in the year and that
of the production could be made up that way.
The earnings impact is clear especially with regard to Nigeria, since that is well known to be largely a fixed margin type.
Agreed that the earning's impact at these kind of low prices is not as significant as perhaps you would imagine, and clearly the natural gas loss in Nigeria has no earning's impacted effectively.
Arjun Murti - Analyst
Thank you.
Pierre Breber - Investor Relations Manager
Thanks Arjun.
Operator
Thank you.
Our next question is coming from David Wheeler of JP Morgan.
David Wheeler - Analyst
Good morning, perhaps either David, John could give an update on Caltex, I know one of the objectives of the merger was to get operational control and turn around the performance of that unit.
Can you give us a sight from margins in the area?
Can you give us some underlying performance update on Caltex?
David O'Reilly - Chairman and CEO
Yes David I'll, this is Dave I'll take it, we have as you probably remember from our meetings have restructured our down stream into regional R&M companies and some global businesses and that's a very first positive step because in the past we operated for example with three lubricant businesses Texaco, Chevron and Caltex.
Now we operate a global lubricants business and one example is that we can clearly measure the performance improvement from having a global lubricants business, our cost of goods sold is declined - things like additive purchases caused more blending efficiencies and sales gains.
So we're seeing clear improvement flowing to the bottom line in that business.
Sharp
covered some of that in New York last week, now with regard to Caltex, they are a part of what was Caltex which we now kind of call Regional Asia Pacific Middle East refining and marketing company, we're also seeing a lot more focus on the basic performance of our refineries and the basic performance of our marketing units, in terms of efficiencies, reliability and the like.
Another example is being able to ship more efficiently from crude sample and taking equity crews and better placing them in what would formally be Caltex refineries or Caltex affiliated refineries such as LG-Caltex, so we're clearly seeing the benefits in terms of our focus, local management dealing with refining and marketing businesses and extracting themselves from these global businesses and we're seeing it in our cost structure as well as our cost of goods sold and our shipping costs throughout the region.
David Wheeler - Analyst
Thanks Dave.
Operator
Thank you, our next question is coming from George Gasper of Robert W. Baird.
George Gasper - Analyst
Good morning, I have a question on Canada.
What are the pluses and minuses in the lower Canadian output?
Particularly can you highlight Hibernia changes for the quarter in terms of output?
Pierre Breber - Investor Relations Manager
Sure this is Pierre, Hibernia was up by NBD, that would be the driver of the increase in liquid production and the Natural Gas production declined was primarily due to the lower production out of before they are low.
George Gasper - Analyst
Okay, thank you.
Operator
The next question is from Paul Sankey of Deutsche Bank
Paul Sankey - Analyst
Hi guys.
This is Paul Sankey, Deutsche.
Could you just confirm that your targets for 2002 and 2003 in the up stream and also perhaps a little bit more color on the performance of the US upstream particularly the other way?
You seem to be having a strong performance in oil production and perhaps less there in gas?
David O'Reilly - Chairman and CEO
You are talking about the volumetric performance, Paul?
Paul Sankey - Analyst
Yeah.
Correct.
David O'Reilly - Chairman and CEO
Well, I think that its just like a refocus back to the last meeting we had in New York where we talked about our goal between now and 2006, it's a goal our production over that period of time by 2.5 to 3 percent.
We recall the first, the early years of that were about one percent growth.
So if you look at the results that we talked about today, you'll see a kind of a mixture of performance and some of it Pierre covered it on the international side.
But let me kind of jump to the US side for a moment.
We are seeing a better performance on liquids in the Gulf of Mexico in particular our deep water well productivity has held up and is better than we had anticipated and also natural gas prices fell as you recall in the first quarter and we had some fast gas response to that.
But prior to first quarter and the second quarter, we had drilled additional wells because of the very, very high prices in natural gas.
Well, this year because of low natural gas prices, we shifted some of that effort into oil as opposed to gas because oil prices have been much more attractive and offered a better margin.
So you're seeing a combination in the US, improved productivity from the deep-water wells as well as a shift in our focus on the short-term drilling and the results are showing true.
Paul Sankey - Analyst
Thank you.
David O'Reilly - Chairman and CEO
Great thanks.
Operator
Thank you.
Our next question is coming from Mark Gilman of First Albany.
Mark Gilman - Analyst
David or John, can you or will you say definitively that no further investment or cash infusion will be made in Dynegy?
David O'Reilly - Chairman and CEO
Mark we don't speculate on M&A activities and on our specific plans for investment.
But what I can say is that we have very clear criteria around which we make investment decisions, looking at what is good from a strategic as well as a return stand point and those factors will continue to dictate our decisions going forward.
Mark Gilman - Analyst
Okay, thank you.
Operator
Thank you.
Our next question is coming from Mark Flannery of Credit Suisse First Boston.
Mark Flannery - Analyst
Hi, just this question for Pierre or John.
Looking at the international upstream 50 million dollar FAS 133 charge or variance that you like, how should we think about that, going forward in the mark-to-market of European gas concerns?
Is there any kind of rule of thumb you can give us or a little bit further guidance on that?
Pierre Breber - Investor Relations Manager
Well let me just take us back, this is Pierre.
You know this was initiated in 1Q of this year.
So, whereas FAS 133 for our US contracts started a year ago there was a recent interpretation that said these European gas contracts should be mark-to-market.
These are physical sales contracts to real customers and its not something that, at least on the surface, I wouldn't expect it to be mark-to-market under FAS 133 but that is what subsequent interpretations of FAS 133 have got us to.
So the initial gain with last quarter to reflect the fact that those contracts over the duration of their term are above the current forward spot market curve of a similar duration in the UK.
So that will serve the initial start and that reflected a gain.
On all ensuing quarters now you will just see changes and so basically what happened in 2Q is the forward curve, and again not just the current month trading but these are 3 or 5-year contracts if the duration is.
If the 3 or 5-year spot market in the UK goes up we will show a loss and if it goes down we will show a gain.
But the 50 million dollar variance is really the 35 million gain last quarter, which was again the initial right, the initial booking of it.
Now the 15 million dollar negative mark-to-market adjustment reflecting an increase in the forward spot market curve.
And that in fact had probably could be driven in flight by some currency facts.
I'm not even sure about that.
That's about all the guidelines I can give you as it'll change from now on not as dramatically as the 1Q because that was the initial gain and subsequent changes will just be inverse to the portion to the way the forward market curve changes.
Mark Flannery - Analyst
Right, okay, thank you.
Pierre Breber - Investor Relations Manager
Thanks Mark.
Operator
Thank you.
Our next question is coming from Matthew
of UBS Warburg.
Matthew
Good afternoon gentlemen....good morning.
Quick question on the shares and issue, they were absent from the release.
I'm looking at the average shares over the quarter from the first quarter looked like to be down by about 18.5 million.
Could you confirm if the company was actually in the market towards the end of the quarter given the stock price weakness, and if not what's going on and what would tempt you back into the market to support stock price?
John Watson - Chief Financial Officer
Yeah, this is John.
You are asking whether we have initiated a share repurchase program?
Matthew
Yeah, the average number has gone down by about 18 million quarter-to-quarter John.
John Watson - Chief Financial Officer
The answer is we have not initiated any share repurchase program at this point although we reserve the right to do so at any time, it's not anticipated based on the way we came to business and is finding opportunities that we have that will initiate one soon.
Matthew
Okay, thank you.
Operator
Thank you.
Our next question is coming from Albert Anton of Carl H. Pforzheimer.
Albert Anton - Analyst
Yeah, good morning.
Question on US Refining Marketing Transportation, you had a fairly, worst decline than some of your competitors partly due to the absence I guess is Equilon and Motiva earnings.
I wonder if you can give us a little color on how the refining versus marketing paved and also the West Coast versus the South and South East and also the cost of turn-arounds?
Pierre Breber - Investor Relations Manager
Surely Al, Pierre.
You are exactly right that its certainly year-on-year quarter comparison is impacted by the fact that Equilon and Motiva, and the combined company results a year ago and not in this quarter and first.
The year-ago quarter was the strongest quarter of last quarter and a very strong quarter in general.
We typically do not think of refining and marketing separately, especially on the West Coast where we are essentially fully integrated in the sense that all of our refined output goes to our marketing network, so we think in terms of integrated margin and those are shown in our investor relation supplement and were in fact up versus first quarter.
In the Gulf Coast region, we do purchase about half of our gas....gasoline to supplier marketing network and there we do have exposure to marketing margin and the marketing margins were vastly improved in second quarter versus first quarter where in fact at times, they were negative last quarter, so our US finding the up blast about I guess shutdown activity.
We operated very well this quarter.
There was very little plant maintenance and very little unplanned downtime in fact, it was noted in the conference call, that was a 45 million dollar positive versus the first quarter when there was a fair amount of plant shutdown activity.
Albert Anton - Analyst
Thanks very much.
Operator
Thank you.
Our next question is coming from Paul Cheng of Lehman Brothers.
Paul Cheng - Analyst
Good morning gentlemen.
May be this for John or Pierre.
John, when we were looking at your second quarter base on variance analysis, it seems like operating cost is somewhat higher against several segments.
Is that somewhat of a non-recurring or some operating item in there, or we should consider that as the new phase on the going forward phases?
I know also want to see it if you would be able to share with us what is the first half of this year that synergy benefit a rough estimate by division, if you can share with us on that?
John Watson - Chief Financial Officer
I am not, in terms of operating expense the numbers that we disclosed on operating expense in SG&A really in the income statements, now Pierre has made some references in certain segments to operating expenses where it is relevant.
In some cases you have movement in operating expenses at the function of fuel costs and other factors that really may not function a few prices but may or may not reflect the utilization of synergies going forward.
I think a better number to look at in an overall sense is a clean number OPEX (Audio gap) in SG&A as the corporate level that is in the income statement, rather than isolating on the couple of specific pieces.
In that overall segment of what you would see if you added up the OPEX in SG&A line and adjust it for special items which is some 189 million dollars that adversely affected this quarter, what you would see is that OPEX in SG&A is down about a 100 million dollars.
So I think that's probably your best overall indicator for operating expense.
In the
state that is if you look in the up string segment, depending up on the level of work over activity and other ongoing business, you can have operating expense changes that really are revenue driving, that may not necessarily reflect you know, an increase in the cost level of business.
Just like same thing is for fuel, it contains the function of prices.
And just one technical thing Paul, the mind variance analysis announces includes changes due to own-used fuel, in other words if we consume natural gas, and natural gas has gone up and its our own natural gas has been negative variance because we include it on the revenue side, but on the external on the income statements that you see, own use steel is credited out.
It is also taken out of the revenue.
So the various analysis that I do in the conference call may not only tie up with the income statements but there is some factors that drive earnings but because of the accounting works, most probably own used steel do not show up on the income statement.
Paul Cheng - Analyst
Okay thank you.
John will you be able to give us a breakdown on by division and it seem that you benefit for the first half?
John Watson - Chief Financial Officer
No, we're not going to provide that level of detail.
Paul Cheng - Analyst
Okay.
Thanks.
Operator
Thank you.
Our next question is coming from Jack Aydin of McDonald Investments.
Jack Aydin - Analyst
Hi guys.
On your press release, talking about the international expiration of production area, you said the result was impacted by lower realization and higher depreciation.
Could you comment on the depreciation on a reason of why we are not to the amount that impacted the BOE equivalent?
Did you revise your reserve internationally to account for a higher DD&A?
Pierre Breber - Investor Relations Manager
I think the one question is big driver in DD&A on the year-end.
Although, we're more focused on this call on sequential quarters.
But as you noted last quarter, the Captain, equipment related with the Captain seal was bought back.
It was previously released and it was bought back at the end of first quarter.
So, starting in 2Q, that will now be DD&A charges, instead of operating expense charges.
And that's one of the factors that was noted.
From a overall earnings affect, it has no impact, I'd say small impact, the DD&A is slightly higher in the than the OPEX statings, but doesn't have much of an impact.
But that's what the press release is referring to.
We have time for just probably two more questions here.
Operator
Thank you.
Our next question comes from Michael Mayer of Prudential.
Mike Mayer - Analyst
Hi Guys, my question was answered, thank you.
Pierre Breber - Investor Relations Manager
Thanks Mike.
Operator
Thank you.
Jean Gillespie - Analyst
Hi good morning.
Pierre, just a point of clarification.
Are you still under cooling restructions as it relates to things like share purchase, repurchase, asset sales etc. and what is the relevant time for it?
John Watson - Chief Financial Officer
This is John Watson.
We are under pulling restrictions with respect to asset sales and set-period run two years from the merger, which was October of last year.
So, we guys really have about another, till over another year to go for the restrictions.
To point out, there are some new way in conducting asset sales activity or transactions that are treated as asset sales for cooling purposes, but in caps or in the reported some criteria that we have to follow and we have adequate room to conduct our business, but in terms of major rationalization of the business asset sales, you really shouldn't look for that until
fall next year.
With respect to share repurchases we have passed a period of time in which we would be restricted from a cooling standpoint.
Jean Gillespie - Analyst
Thank you then.
Pierre Breber - Investor Relations Manager
I think we will take our last question now.
We're committed try to wrap up here at 12 noon.
Operator
Thank you our final question is coming from Fidel Guide of Fun
.
Fidel Guide - Analyst
Good morning, I felt if you do a postmortem audit on Dynegy.
What really went wrong, if you don't want to talk of advantages specifically, what went wrong with the energy treating business, is it bad business model, bad strategy, bad management or all of the above?
David O'Reilly - Chairman and CEO
Well, David O'Reilly here.
I think the best way to answer that question is a kind of refer back to the comments that I made at the beginning.
Obviously, I think a lots of lessons that have learned by anybody who has been either observing or involved in this sector over the last 6 or 8 months.
And it is sure to me that it was hard to envision that, you know, what is really a viable business model and I am not sure that we really understand everything about the sector yet.
As where it is going to evolve to, but we know it has go undergo some restructuring and changing.
That business is not a business, that's the market or investors buy into under the circumstances on which it's operated in the past and I think the real question is what is it going to look like in the future and whether it'll be sustainable in the future and that is the big question that I think is out there.
Fidel Guide - Analyst
Thank you.
Pierre Breber - Investor Relations Manager
All right.
Thank you very much.
We are going to wrap up.
We appreciate your time and attention and myself and the IR team available for additional questions after the call.
Thank you very much.
Operator
Thank you.
That concludes today's teleconference.
You may disconnect your lines at this time and have a great day.