雪佛龍 (CVX) 2003 Q3 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to your ChevronTexaco third quarter investor relations analyst 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 introduce your host, Mr. John Watson.

Sir, the floor is yours.

Thank you.

Good morning.

Welcome to ChevronTexaco's third quarter earnings conference call.

As indicated I'm John Watson, the Chief Financial Officer of ChevronTexaco.

Today on the call I am joined by Randy Richards our Manager of Investor Relations.

Before we get started I'll remind you that our presentation today contains estimates, projections and other forward-looking statements, please review the usual Safe Harbor statement that's on Chart 2.

I'll begin by making some summary comments, Randy will follow with more detail on the quarter, and then we'll both take your questions.

Chart 3 provides a brief overview of our financial performance, the company had its third straight strong quarter, nine-month earnings $5.5 billion and you saw a lot of detail in the press release.

Return on capital employed was 17.2% for the quarter, 16.3% for nine months.

You'll recall that we've set a goal to improve our return on capital employed in order to close the gap with the average of our major competitors.

Over the last five years, excluding special items, this gap has averaged about 2%.

For the first six months of the year on the same basis, the gap was less than 1%.

And while we're wary of drawing conclusions from a short time span the emerging third quarter evidence looks to further reinforce the trend of relative improvement.

We continue to strengthen the balance sheet, our debt-to-capital ratio ended the quarter at 27% with a net debt ratio of less than 19%.

Turning to chart 4, on August 1, Dave O'Reilly outlined our portfolio evaluation decision, we've moved forward with the portfolio actions in the last few months, we've made substantial progress in the marketing and sale of producing properties in the U.S., sale proceeds have been over $150 million by the end of September and more is anticipated by year-end.

Outside the United States we sold our interest in North Buzachi field in Kazakhstan, we exited Bangladesh exploration properties and closed on the previously announced sale of our interest in Papua New Guinea.

We're conducting an auction process for our interest in prefields in the U.K., Galley, Orwell and Stefard [ph].

The closing date for bids will be mid November with sales expected to finalize in the first quarter next year.

In the downstream we closed the sale of the El Paso refinery in August and announced that our Batangas, Philippines refinery will be converted to a products import terminal.

Service station sales are progressing nicely, in the U.S., for example, we've sold over 100 retail sites in the first nine months of the year.

Earlier this month, the two-year pooling accounting period expired, ending the period of restricted asset sales generally for the company.

On August 1 we also talked about a program to realize $500 million in downstream improvements by 2005. we're acting quickly to capture these improvements, in the third quarter we've taken charges for upcoming severance costs related to a head count reduction of some 1,800 employees in the downstream end of the business.

Our global functional reorganization will be fully effective January 1, and the majority of the head count reductions do reflect efficiencies directly related to these organizational changes.

The rest are due to separate improvements, efforts under way and the impacts of asset restructuring.

Our focused exploration strategy continues to deliver results, we've great recent success offshore Nigeria with Nsiko-1discovery well and successful appraisal wells, Aparo-3 and Usan-4.

Our deepwater Gulf of Mexico drilling has also had some success with the Perseus discovery near Patronious [ph] and the Sturgis discovery on Atwater Valley, block 183.

We've reached an agreement with BP under which we'll increase our working interest to 50% and assume operatorship in the Blind Faith prospect.

And this week you've seen the announcement about the discovery at St. Malo where we have a 12.5% interest and a good acreage position in the areas that are nearby.

Our strategic initiative for global gas business, to commercialize our equity resource base by targeting North America and Asia markets.

That's our strategy, and in that regard we've had good news to report.

The Gorgon Joint Venture received principal approval from the West Australia state government for the restricted uses of Barrow Island to cite an LNG facility.

Subsequently, the Gorgon JC signed an agreement with the China National Offshore Oil Company expected to lead to one of the biggest LNG deals in the industry's history.

Subject to completion of formal contracts, CNOOC will purchase an equity stake in Gorgon and purchase foundation volumes for LNG use in China.

Just yesterday we announced our proposal to build an offshore LNG import terminal and regasification facility at Baja, California in Mexico.

Finally, in the Gulf of Mexico a decision is expected shortly on our Port Pelican deepwater LNG facility permit application.

We've had a few additional milestones that will add to our liquids production, we saw our first oil in Chad, where we have a 25% interest in several fields.

And the Karachaganak Phase II project increased production of sweet crude started up, a 400-mile pipeline was completed which will allow shipment of Karachaganak crude through the Kazakhstan pipeline company pipelined to export market.

In summary, the company had a very good quarter, and is moving forward rapidly on our announced strategic initiative.

I'll turn the mike over to Randy Richards for a quick review of the charts covering the quarter's results.

Randy?

Thanks, John.

I'll refer to the slides which were e-mailed to you this morning and available on the web.

I'll also remind you that my remarks will be comparing third quarter 2003 to the second quarter.

The earnings release compared third quarter 2003 to the same quarter a year ago.

Chart five shows third quarter net income per diluted share was $2.02.

As indicated in our last 10-Q, early in the quarter, we concluded an agreement with Dynegy to restructure our holding of their Series B preferred stock.

As a result, Dynegy was able to reorganize its debt repayment schedule and further stabilize its liquidity outlook.

We received cash and marketable securities and recognized a $365 million gain relative to our carrying value for the old Series B preferred.

You can see that gain in our special items.

Let me address the second effect of the Dynegy exchange.

Besides recording our own gain, we separately recognized our share of Dynegy's gain on the transaction.

Under applicable accounting rules, Dynegy recorded the exchange of securities as a capital transaction. his results in the gain being recorded directly to retained earnings, but included in earnings per share.

We also must record our share of Dynegy's gain in the same way, and this is the 16 cents per share item labeled "Dynegy" that you see on the slide.

Be sure to note this accounting treatment as you reconcile our reported earnings and earnings per share.

During the quarter, the company recorded special items netting to a $14 million gain.

Gains from the Dynegy preferred stock exchange and asset sales were offset by environmental remediation reserves, asset impairments and some severance costs.

Chart 6 shows that net income increased by $375 million.

The $14 million special items net gain in the third quarter compared to special items charges totaling $117 million in the second quarter.

The previous quarter had included asset impairments related to anticipated sales.

Foreign exchange losses were $31 million in the third quarter, or $126 million less than the second quarter FX losses.

The effect of higher crude prices outweighed somewhat lower natural gas prices.

Production volumes were lower.

Overall, downstream margins and volumes improved in the U.S. but were lower on average in the international segment.

The variance in "Other" includes improvement in our share of design Dynegy income and higher power and gasification earnings, excluding special items.

Chart 7 shows U.S. upstream earnings.

Special items contributed to a positive swing between quarters, due to the timing of gains from asset sales, and charges for asset impairments.

After special items, earnings were up due to higher liquids realizations, FAS 133 mark-to-market accounting effects, and lower DDNA, exploration and operating expenses, included in the "Other" bar.

Lower natural gas prices and lower production volumes currently offset the improvements.

International upstream earnings increased primarily due to higher oil prices, as shown on chart eight.

Liquids production was lower, mainly due to planned maintenance activity at Tengiz and summer maintenance in Europe.

FX losses were significantly lower in the third quarter.

As usual for us, the largest currency-related effects were in Canada, the U.K., Australia, and Argentina.

Chart 9 summarizes the change in worldwide oil and gas production, including other produced volumes.

Volumes were down by a little more than 3% between quarters.

U.S. production decreased 3%, primarily reflecting lower gas production in the Gulf of Mexico shelf.

Due to a heavy maintenance schedule, storms and natural field declines.

Taking a longer view, although third quarter U.S. production was down between 8% and 9% compared to the same quarter last year, we confirm our previous guidance that these volumes are expected to decrease at roughly a 6% annualized rate, excluding asset sales.

The calendar year 2003 versus 2002 decrease will likely be slightly higher than that mainly due to 10,000 to 15,000 barrels a day permanently loss after severe storms in the fourth quarter last year.

International oil and gas production was down a bit more than 3%.

Lower Kazakhstan production reflected planned maintenance at Tengiz where TCO undertook the largest scheduled maintenance program in its history in the third quarter.

Working on three oil trains, two sulfur recovery units, and one demercaptanization unit.

Europe production, mainly in the U.K. was affected by typical summer scheduled maintenance at a number of fields, including brief shutdowns at Britannia and Captain.

All of the production impacted by these activities was back online by the end of the quarter.

New production in Chad started up in the third quarter and will gradually ramp up to a gross 225,000 barrels a day.

Over 55,000 barrels a day net to ChevronTexaco.

On chart 10, U.S. downstream third quarter net income totaled $148 million, including $146 million in net special items charges.

Special items included environmental remediation reserves, and employee severance cost due to downstream's restructuring and reorganization.

These charges were partly offset by gains on sales of retail marketing assets.

Excluding special items, U.S. downstream net income improved $107 million between quarters.

Most crude-to-product spreads improved nationwide led by West Coast jet and diesel margins.

West Coast Mogas spreads were lower due to a dip in July but they strengthened significantly in August and September.

Refinery production increased on higher utilization reflecting early second quarter resumption of full operation at the Pascagula refinery after completing the clean fields project and second quarter maintenance projects at several units in our smaller refinery.

These improvements more than offset the loss of El Paso volumes in September, after the refinery sale closed at the end of August.

Branded Mogas sales were up primarily due to seasonal demand.

Operating expense declined due to lower refining shut down and project costs.

In the international downstream, on Chart 11, third quarter results included net special items charges of $104 million, and foreign currency losses of $9 million.

Net special items charges were larger at FX loss to smaller than in the second quarter.

Third quarter special items included the write down of the Batangas refinery in the Philippines, it will be converted to product import terminal operation.

And employee severance costs associated with downstream's global restructuring and reorganization.

Excluding special items and foreign exchange, the variance between quarters was $211 million.

Improvement in Asia-Pacific refining margins was more than offset by lower marketing margins in both the Asia-Pacific and the U.K. market.

Refinery inputs decreased, mainly due to a scheduled major turn around at our wholly owned refinery in Pembroke, Wales during the month of September.

The other bar includes a number of factors.

Shipping earnings fell reflecting lower spot charter rates.

Rates had peaked earlier in the year, in part due to security concerns.

Other factors included lower trading earnings, and unfavorable inventory cost effects in Asia.

On Chart 12, chemical earnings were off slightly quarter-to-quarter.

Olefin earnings improved as increases in normal alpha olefin's prices and volumes more than offset the effect of weaker ethylene margins.

Aeromatics earnings declined due to lower margins for benzene and lower margins and volumes for cumene, paraxylene and cycloheptane.

Better Styrene [ph] earnings provided a partial offset.

"Other" includes earnings in our wholly owned Oronite additives business which realized improved margins of volumes in most geographies.

Special items in the "all other" segment on Chart 13 totaled $265 million in the third quarter.

This includes the $365 million gain from the exchange of Dynegy preferred stock, partly offset by charges for asset write-downs, mainly in the power and gasification business, as well as reorganization-related severance charges in some corporate areas.

Excluding special items, net segment charges declined $75 million, due to improvements in the P&L businesses, primarily worldwide power and gasification and our equity share of Dynegy.

That completes our brief analysis of the quarter, I'll turn it back to John now.

Thanks, Randy.

Let me wrap up with Chart 14.

Which shows total shareholder return that we showed you many times to track our performance since the beginning of 2000 when Dave O'Reilly established a five-year objective to be Number 1 in this category.

Our returns continue to perform well relative to competitors, and the market for this period.

I also like to keep track of TSRs starting from October 13, 2000 which was the last trading day before we announced the planned merger between Chevron and Texaco.

From that date, our TSRs outpaced all of our major competitors which gives me some comfort about the market's more enduring view of our merger.

Now we'll be happy to take your questions.

Consistent with our prior practice we ask you limit your questions to one per turn so we can get to as many of you as we can.

We'll plan to wrap up at the top of the hour, giving us about 40 minutes for questions.

Operator, please open the lines for those questions.

Thank you.

Thank you, gentlemen.

The floor is now open for questions.

If you have a question or comment, please press 1 followed by 4 on your touch-tone telephones.

We do ask while posing your question, you pick up your handset to provide optimum sound quality.

If at any time you find your question has been answered, you may remove yourself from the queue by pressing the pound key.

Please hold as we poll for questions.

Our first question is coming from Arjun Murti with Goldman Sachs.

Please pose your question.

Thank you.

John, in your August analyst meeting, you all had circled Russia as an area that you would like to consider future opportunities.

Does the recent political turmoil surrounding the ucoceo [ph] cause any pause in your interest in Russia or can that be just characterized as the normal political turmoil that incurs in many of the countries you operate in and would not cause pause to anything you may or may not be looking to do there?

Arjun, thanks for the question.

I'm not sure that I have all the answers to what's going on in Russia today.

And frankly, it's probably not wise for me to speculate on those activities.

What I can tell you is that we've expressed a continuing interest in renewing our resource base around the world, and when we renew our resource base we go where the oil is.

And oil is in the former Soviet Union, it's in the Middle East, and that's why established an objective both capturing opportunity, impact size opportunities in those areas.

And we're very much accustomed to dealing with political risk, and I never characterize activities in any country as being routine.

But we're certainly experienced in dealing with the ups and downs that take place in given countries and certainly we've dealt in the former Soviet Union, Kazakhstan and Russia for some time with our interest there and are accustomed to those ups and downs.

My comment would be, we're continuing to look for impact-size opportunities, but certainly we're well-aware of the risks in Russia and other places where we look for those opportunities.

Thank you.

Our next question is coming from Fred Leuffer of Bear Stearns.

Good morning.

Good morning .

Randy and John, could you break out for us the components in corporate and other?

That was a pretty big swing factor quarter to quarter and year over year.

Can you give us the numbers that are involved in the clean number which I get to be, I guess, about negative $78 million, I guess Dynegy, coal, power, corporate, interest, and can you give us some guidance on what we ought to be thinking about going forward there?

That's a fair question, Fred.

Our guidance for the other category has been a larger loss than what you're seeing this quarter, and I'm aware of that, we're going to get you some better guidance going forward.

We're in the process of putting our business plans together and when we put our interim update out for next quarter we'll give you updated guidance.

I'll let Randy make comments in a minute perhaps, to go through a few of the things that are in here, but in general, we have some businesses in this category where we've seen some improvement during the period.

Specifically, we do take our equity share of Dynegy earnings, our power and gasification business, and we've also seen lower, certainly lower debt and lower interest expense from lower interest rates going forward.

So I wouldn't want to represent that the -- and of course you have the timing of tax items that could be booked in a given quarter.

And these can be volatile and I appreciate they're a little bit difficult to follow.

But we'll get you some better guidance.

And Randy may have a few things to add on some specific activity in that category.

Yeah.

I think that, I don't have too much to add except that in the P&L businesses bar, that's obviously a big bar, and Dynegy, as you can see by looking at what they've announced yesterday, had improvement from the second to third quarter, and our share of that, even though we have some extra accounting entries and it's not just a clean transfer, that was over $60 million of improvement for us from between quarters.

Now, in the worldwide power and gasification we also had a fairly large improvement, between $30 and $40 million.

So that's how those two businesses contributed to that $100 million bar.

Rather than the variance, I guess what I'm interested in is what's the makeup for that $78 million negative?

Well, the items that are in that $78 million are numerous, it is the earnings from Dynegy, the earnings from our power and gasification business, the interest income, interest expense, corporate tax items.

We typically don't break out all the different components individually there.

What I will commit to you is we'll get you better guidance going forward.

Because this was a positive improvement relative to the guidance we've given you.

Maybe the best way for us to do that is to give you better guidance when we do our interim update the next quarter.

Okay.

But the signal right now, John, is that corporate and other is likely to be a lesser negative than what we're used to?

Yes, it is.

All right.

Thank you.

Thanks.

Thank you.

Our next question is coming from Tyler Dann of Banc of America Securities.

Good morning John and Randy, how are you all?

Good, Tyler, thanks.

My question is related to the special items and without trying to do multiple parts I'll ask in terms of the environmental remediation provisions, that seems to be a new one so how often do you assess those?

What is a run rate that you would look at, is that really recurring, and then the restructuring reorganization and the impairment charges also look to be reasonably recurring, trying to get a sense for when those charges would tend to vanish or stop coming into the equation?

Thank you.

Sure.

Well, thanks for the question.

You're referring to a couple of lines that where we give some detail in the investor relations supplement and in the press release dealing with environmental remediation and restructuring.

I guess I'll take the second one first.

Our restructuring charges are a function of announced restructurings that we have.

We're continually looking at improving the business and where we have a restructuring and charges are a necessitator, we record them.

Whether they're recurring or not, I mean, we do have reorganizations as others do from time to time, we have to record the entries when they occur.

We signaled that had we were reorganizing our downstream business and that there was substantial reductions, we've also had substantial reductions associated with the merger itself.

Our employee population on day one of the merger was about 56,000 employees and we're now under 52,000 employees.

And we typically have severance programs associated with those departures.

But we've announced this time is an additional couple thousand employees that will leave the payroll, mostly in the downstream business, most of them are a function of the reorganization.

Some of them are associated with asset divestitures.

And we typically will have restructuring charges when those take place.

But I don't know that I can forecast them for you or that I would want to foreshadow that we will or won't have them going forward.

When it comes to environmental remediation, we do conduct annual reviews and we have completed a review in the third quarter on numerous facilities.

We do attempt to provide for our best estimate when it becomes probable and estimable and we record those when we know that.

In this case, we did have a fairly comprehensive review across a number of marketing and mostly inactive locations, including some very old refining sites and we've had to update the estimate of the cost that it will take to remediate those sites.

I will tell you it's not necessarily going to be booked to any particular quarter, it's a function of when we conduct those reviews and when the estimates are probable and estimable.

As far as what an ongoing run rate is for those activities, that's a difficult number for me to guess because we attempt to provide an appropriate estimate currently each time.

And we don't plan to have additional accruals going forward, although certainly remediation is a part of our business, and it's reasonable to expect that those kinds of charges will be incurred.

But I'm not sure I can give you a run rate.

What I can do is, this, coupled with what you see in our annual report disclosing our remediation provisions and our environmental accruals is really the best information I can give you.

But, yes, there's a charge this quarter, but I don't think that it's indicative of what you would see every quarter by any means.

Take the next question.

Thank you.

Our next question is from Doug Terrison of Morgan Stanley.

Good morning, guys.

Good morning.

John, on the subject of closing the gap, which I think is the phrase you used in the beginning, your returns on international R&M are going to be their best in six or seven years this year partially due to the programs you have in place and stronger industry trends too.

And you just talked a little bit about the impairment in the Philippines which raises the question of the likely strategic outcome, or the outcome of the reviews that are underway in some of the other areas that you're focused on, U.K., Singapore, Australia and South Korea.

And so I wanted to see if we we could get an update on the strategic thinking in those countries and any relevant time frame that you may have related to this topic?

Sure.

Be happy to do that.

A couple of questions there, one was related to return on capital employed, the other is some of the restructuring that's taking place and we are pleased with the return on capital employee progress that we're making.

It's a little tough because we don't have full balance sheets and what have you, but looking at the average of our three largest competitors we have made a lot of progress in total, in improving our return on capital employed, whether you look on a reported or operational basis.

And you can pick which one of those is more meaningful to you.

We do feel good about that progress.

When it comes to the international downstream, on August 1, what we did is we told you the areas where we're going to concentrate our business going forward and then we outlined some areas we felt were nonstrategic.

And that those areas would not draw additional capital going forward.

Some of them would, in fact, be sold or otherwise disposed of.

We weren't terribly specific in that regard, other than about which exactly would be sold or shut for reasons that we described in some detail.

What you're seeing now is that strategy unfold.

The Batangas refinery in the Philippines simply isn't economic.

Product can be imported and we're choosing to close that refinery and turn it into a terminal.

As far as other assets go, a lot of that will be a function of timing, and I don't want to signal that any particular asset will necessarily be closed or sold.

What I will tell you is what I said at August 1, is that if we choose to sell any particular asset, the rules require you to basically, when you're more likely than not to dispose of something, to record the estimated impact in advance of sale if there's a loss, and if there's a gain, the gains come a little bit later.

And what you're seeing in our results is, in the asset disposition area, you're seeing actually a fair number of gains for things that have been actually sold, or we've had closed sales mostly in the upstream area and where you've seen provisions for losses that are typically, some in the upstream, but mostly in the downstream in areas where in the case of Batangas where we're closing a refinery or where we estimate that there's a loss on either a current sale or a future sale.

But I don't want to signal any particular gains or losses going forward, because as you know, and it's obvious to you, the book value's going to differ from what we actually sell things for.

And we will have gain and losses.

And our total assets are worth far more than the carrying value.

But the things we tend to sell oftentimes aren't the most attractive items in our portfolio.

So we can have losses and gains and that's what you've seen.

That's a fairly long winded answer but I don't know that I can tell you or signal particular dispositions at this time for reasons we described in some detail in August.

Thank you.

Next question.

Thank you.

Our next question is coming from Michael Meyer of Prudential.

Hey, Mike.

How are you?

Good.

I want to press you a little harder on the question asked on the remediation charges in the U.S. downstream.

I note that they have over the last 10 years, they have summed to something like $1.1 billion, and even in the last five years they've exceeded $500 million, which has been approximately 20% of the reported earnings in that segment.

So my question is, these things obviously recur, I think they've been booked in every year but one over the last 10.

How does the accounting standards affecting the reporting of earnings and the denomination of what is a special item affect these remediation charges?

It seems to me that they recur every year, that they're substantial, and that they're part of the underlying cost of doing business, and, therefore, should not be excluded when calculating the ongoing operating earnings.

And then secondly, of course, once you do exclude them, it increases your return on capital employed.

Other companies have the same issues, of course, but can you address that question wearing your hat of the CFO?

Oh, sure.

The question earlier that I thought was trying to get was whether I could forecast what accruals might be going forward in this area, and I just wasn't prepared to do that.

We report earnings on a GAAP basis, generally accepted accounting principals.

In fact, if you notice, we made a change since the beginning of the year where we don't even show operational earnings.

What we show is GAAP earnings, generally accepted accounting principles.

What we also try to do is provide you with additional information for you to make a determination with what you want to do with it, on a number of areas where you might call them lumpy, whether they are gains or losses.

And the environmental accruals were somewhat lumpy this time so we gave you that information and you're free to do with it what you want.

You'll also notice when we talked about improving our performance relative to competitors, we showed you return on capital employed both on a reported and operational basis.

And we'll let you choose which one you want to use.

We want to improve our performance by either measure.

And that's what we're going to do.

I didn't mean to suggest that we won't incur environmental charges and have environmental cleanup going forward, I just wasn't prepared to forecast it for you because it's difficult to do so.

It's a function of change in regulation, it's a function of assessments that we make on the business, and a variety of other factors.

The changes in technology, et cetera.

So I don't mean to say we won't have environmental charge going forward, I'm just not prepared to forecast them for you.

What we do is break them out and you've looked at the history and you're right, it's a part of the business.

And you're free to analyze that historical data and the changes that you see in regulations going forward or expected standards, and account for that in your view of the business going forward.

Thanks, Mike.

Next question?

Thank you.

Our next question is coming from Scott Drysdale of Columbia Management.

Just a quick question for you on natural gas.

I think that's kind of the question of the day with respect to a lot of companies, the slow, in fact, declining production.

I'm curious what your strategy is, you've got a high price on natural gas, and yet almost across the board we're seeing declines in gas production in the United States.

Is it just your opinion that the way to approach this is strictly through milking the domestic production and going into LNG or can you give me some thoughts on what we might be looking forward to in the next few quarters out of you guys?

Sure, that's a good question.

Boy, I think we and others would love to increase natural gas production in the United States.

The reality is, it's difficult to do that with the kinds of reservoirs that we have today, and just with the resource base in this country.

And you're seeing drilling is at high rates but the industry is not doing a very good job of replacing reserves and so production is declining.

And given increases in demand that are projected going forward, I think it's certainly our view and the view of others that we think we're going to need LNG imports to this country in order to satisfy the demand for power.

So, I think it's the geologic reality that we're going to need that given demand.

Your more general comment on production, though, I think is a good one.

You are seeing some declines in production, I think Randy talked a little bit about our U.S. production, and the expectations that we have there.

But we feel pretty good about the opportunities that we have to import natural gas.

You've probably seen a press release that came out yesterday where we've announced that we'll be moving ahead with permitting on a facility in Baja, California, to import natural gas to the Western United States, our Port Pelican facility we applied for a permit about a year ago, and we expect an answer back from the Coast Guard on that very shortly, both of these are gravity-based structures that we think will be competitive and we think we're in a good competitive position to help satisfy that demand shortfall in this country.

But I'm not sure and I have a great answer, other than it's a declining resource base and demand keeps rising.

Thanks.

Next question?

Thank you.

Our next question is coming from Neil Mcman of Sanford Bernstein.

Hi guys.

How are you doing?

Not too bad, thanks.

First of all I want to dig into your CAPEX numbers so far to date.

Basically, you're reporting $5 billion, that seems down from $6.6 in the nine months previous.

Can I read into that that you've got ongoing capital discipline?

And then basically, what can you say about your internal processes around capital discipline, what milestones or sign posts should we look into to show that the restructuring is going ahead as planned and we can sort of read into and project further discipline going forward?

Well, thank you for asking the question on capital.

A couple of comments.

First, the capital spending targets that we had communicated to you previously were for consolidated operations, that would appear in our funds flow statement, as well as our equity share of affiliates, capital spending would be $8.5 billion this year, with the cash portion of it $6.9 billion.

We're just now taking a look at our updated estimates for the year, and indications are that spending will be somewhat less than that, perhaps $8 billion in total, perhaps $6.5 billion on a cash basis.

So spending will be down somewhat from what we had anticipated.

I will tell you that a message that we've been trying to get across to the financial community for a couple of years now is that things have changed and we are focused on improving the returns in the business.

And we've talked about some process changes inside the company, numerous process changes around how capital projects move through our system ultimately leading to approval and the spending of dollars.

And we've had many changes, including changes at the top and changes throughout the organization including, well, numerous things, peer reviews, just harder looks at the investments and a more gated approach to moving projects forward.

I think you'll see that manifested partly in the level of spending going forward, but what I hope you see is better returns going forward in the business.

And that takes some time for you to see.

Some of the lead times on these projects are big and are long.

But we've given you examples where we actually have slowed down projects because we wanted to be sure the fiscal terms were right or the development scheme was appropriate before we moved forward.

We delayed Agbami, for example, and happened to take out, almost $1 a barrel in development costs by doing so.

We think that's an example and an indication.

But ultimately, the way you'll judge us is on, I think, how the spending ratchets through the financial statement and how our relative returns move between periods and that will take some time for you to see.

Thank you.

Next question.

Thank you.

Our next question is coming from Paul Shankey from Deutsche Banc.

Hi guys, it's Paul Shankey here.

First a CAPEX question and with a view to volumes, as well.

I believe you've got much lower CAPEX so far.

Can you just talk about the shorter term outlook into 2004 firstly, for how we should look at your CAPEX and secondly, something on the split between U.S. and international, and thirdly, any impacts that might have on volume, you've given, as far as I can make out a guidance, we should think about 6% falls for the U.S. going forward.

Could you give us an international indicator for '04 as well.

Thanks.

Sure.

Let me address those, both questions.

First, in terms of spending going forward, we'll put out guidance for capital spending for 2004 shortly after the first of the year as we customarily do.

We haven't provided new guidance going forward.

Frankly, with the success that we've had in exploration, and the long queue of projects that we have, we're going through a pretty rigid review right now of our capital spending not just for 2004 but going forward.

And we'll be happy to give you updated guidance when that information is available.

But that won't be till we've completed the business plan review, which is taking place right now.

What I can tell you, though, is on the production front and maybe it's helpful for me to reference back to the comments and a couple of charts that Dave O'Reilly showed back on August 1 in New York City.

At that time, Dave -- there's one very particular chart that showed you our production capacity figures.

And the production capacity figure for 2003 was a little over 2.7 million barrels per day.

And what we showed is that that capacity figure was going to be pretty flat with our actual production in 2002, and then you'd see a drift down over the next couple of years, before rising.

So we were in a bit of a flat spot from a production point of view.

Some of the slight decline that you'd see in that production capacity figure is a function of asset sales and so that number will change.

But if you refer back to that August 1 presentation, I think you'll see those numbers pretty clearly.

What I'll tell you is that our production this year is right in line with the information that was contained in that chart.

The capacity figures are 2.7 million barrels per day, and we went to capacity numbers because there are a lot of things that can influence actual production in a given period.

If you look at production for 2003 year to date, we're run being 90,000 barrels a day less than that capacity.

And, frankly, you can attribute -- this is on a worldwide basis, you can attribute all of that really to shut-in volumes in the Nigeria delta from the continuing disruptions we've seen there, we've talked in terms of 40 to 45,000 barrels per day net relative to gross production of 140,000 barrels a day.

That's continued.

We've also talked about Indonesia and cost barrels, which frankly is a good thing.

Oil prices are higher, we get fewer cost barrels back, but that capacity figure was at a more normalized price.

And those two factors account for the production being less than that full capacity figure on a year-to-date basis.

If you look at the third quarter, our production was a little bit lower than it has been on average and particularly international area, Randy talked about some of the maintenance activities that brought production down in the third quarter, and we think that will pop back.

So broadly speaking, the production guidance I would give you is right in line with what Dave O'Reilly showed you.

I was isolating on the U.S., and Randy talked about it, just to give an indication because the year-to-date number is more than the 6% guidance.

Now, what you'll see is if you look back at the fourth quarter of last year, that production number was impacted significantly by hurricane damage.

So when we get to the end of the year, I suspect what you'll see is the year-to-date number, 2003 versus 2002, won't be 6% but it won't be 9% either.

Now we do have asset sales taking place worldwide that will impact production.

So far the asset sales that we've closed, coincidently they're all 6,000 barrels a day, we've close 6,000 barrels a day of asset sales in the U.S., you'll see some impact of that in the fourth quarter.

We also closed a sale of Papua New Guinea, that's 6,000 barrels a day and North Buzachi was also 6,000 barrels a day, that just happens to be a coincidence.

All those will impact fourth quarter production.

But other than that, and those are relatively modest, the guidance is very much in line with those capacity figures that we showed you back on August 1.

Thanks.

I think that was your question.

Next question.

Thank you.

Our next question is coming from Paul Cheng of Lehman Brothers.

Hi, John and Randy, good morning.

Congratulations, very strong quarter.

In the U.S., both upstream and downstream, it look like the cost structure sequentially are down on the underlying cost structure.

Are we finally seeing the benefit from the integration and the cost reduction, first of all, whether you can confirm it's lower and if it is, do you think that that [Inaudible] is really sustainable or is that a one-time item, inside there that you have in the current quarter?

Okay, thank you.

Well, first, on behalf of the company, I'm happy to talk a congratulations on a good quarter, so I appreciate that.

We have a lot of people around the company that are working very hard, Paul, so I appreciate that.

With respect to OPEX, I've been saying for quite a while that we've done a good job at integrating the two companies.

And unfortunately, there are a lot of moving parts in operating expense, and other factors that impact the business, including commodity prices.

And last year, I went to some pains to show a great deal of detail around that for you.

We told you that you'd start to see improvements on a relative basis in 2003 and 2004.

Go back two years that's what we said.

And I think you're starting to see that.

My comment specifically on the upstream and downstream is there's no great, other than what's been disclosed as special items, there's no great unusual item that's masking it or giving us an artificial lift.

Frankly, in the U.S. downstream what you've seen is we had very strong refinery performance in the third quarter.

You see some of the utilization figures and they're pretty good.

And when we run those refineries well, we can do very well.

In addition, margins have been good on the West Coast in particular, which is one of our core areas.

So that's helped us.

In the international -- or excuse me in the upstream area, a similar pattern of working very hard to improve business.

I will say that when you look at some of the operating cost data, you will see some increases for things that I've talked about before, which are pension expense, freight and fuel costs.

And, freight rates were high early in the year, obviously fuel costs are high because of higher commodity prices, and I think you know the saga for the entire American industry around pension expense, and our pension expenses are high.

Our pension plan has performed well on a relative basis, our funding position is good on a relative basis, but we are underfunded and with the decline in interest rates, pension expense is high.

A comment I can give you on pension expense is that we're running about $45 to $50 million a quarter higher this year than last before tax in pension expense.

And that's a function of a great number of moving variables, but we did in the third quarter lower the discount rate that's used in calculating the liability to 6% which we think is appropriately conservative.

But the actual pension expense is a function of interest rates, the timing of people that leave the payroll and take lump sums, and a variety of other actuarial factors.

But, Paul, there's nothing that's misrepresented in terms of performance and the numbers in our description.

Thanks.

Thank you.

Our next question is from Louis Ralph [Inaudible].

Hi, John.

Earlier in the year, back in the first quarter, you guys had claimed over $400 million in merger synergies from your ability to high grade the portfolio, and the resulting savings in exploration expense on lower CAPEX.

It looks like, if I'm looking at this right, that for the first nine months of this year, exploration expense is up almost 50%, and the upstream CAPEX is down almost 20%.

Annualized this would be close to a couple hundred million dollar a year in higher exploration expense.

And I was wondering what you attribute that to, have high- grading efforts failed, are you losing ground on the savings you previously claimed from more efficient use of drilling dollars?

Well, a couple comments.

First, the $400 million that you reference, what I talked about is if you look at the after-tax full-year impact of the synergies that we went into great detail on over the last couple of years, we said that the improvement year-over-year between 2002 and 2003 it would be $400 million after-tax.

That's what we said.

And we said the best way for you to judge that since we were going to stop tracking synergy in 2003 because we'd achieved the run rate targets, would be to look at our performance on a relative basis.

I think I've made some comments already about how that relative performance is going.

In terms of some of the specific comments that you meant, exploration is probably the single largest success that I would cite in our merger integration, so I take kind of great exception to the comment.

What you're seeing is that the synergy includes many things, including exploration expense.

Our exploration expense had been running about $1 billion a year before tax prior to the merger of the base-year period of 2000.

What you saw last year was exploration expense of about $600 million in the full year 2002, and 2003 exploration expense is likely to be in the same general range.

So, we're really on target.

And when you look at the successes we've had in exploration, I think you'd say we've done a pretty good job.

I'll note that Wood Mack just noted our exploration program Number 1 in 2002.

So we've had a lot of successes successes, and I can hardly keep up with discoveries we're announcing but we've announced a number over the last week.

So our exploration program has been good.

So I guess I would tell you that we're showing relative improvement, which is what we promised and you asked us to see, we have a more effective exploration program which we said we would do.

So I wouldn't say we're losing traction, I would tell you most of the news is good from where I look at it.

Thanks, next question.

Thank you, our next question is coming from Paul Ting with UBS.

Good morning, guys.

I've got a downstream question with the upcoming authorization regulatory changes, can you quantify your CAPEX requirements?

Some of the companies did provide some guidance as to what the CAPEX dedicated to meet this authorization requirement and it seems to be fairly significant.

Can you do the same thing for us, please?

Actually, it's not significant for us.

We've just completed a clean fields project of Pascagula and I'm not aware of any significant CAPEX item for us to comply.

If you recall, we have a lot of our business in California and we've spent money over the years to bring ourselves up to speed.

California has had more rigorous standards for some time.

So I'm not aware of any significant item.

What I can do is, Paul, I'll ask Randy to confirm that and get back to you and give you a little bit more detail on it.

But, in general from what I've seen of the capital spending plans of the refining business, there's no very large item out there.

And you don't think the MTB to ethanol switch in the East Coast is going to impact your operation either?

I don't know of any, certainly it will impact operations, I don't know of any significant expenditure related to that, Paul, at this time.

Okay.

Great.

Thanks a lot.

Thank you.

Our next question is coming from Mark Gilman of First Albany.

John, Randy, good morning.

Good morning, Mark.

Hi, Mark.

I am -- and this is all on an estimated basis because obviously we don't have full cash flow and balance sheet detail, but our estimates were suggesting you should have had net cash generation in this quarter, particularly with this earnings level, a little over $800 million.

And if I compare the changes in debt and cash, I'm getting about $300 million.

Is there something in the way of a $500 million item, working capital or otherwise, that's impacting upon the net cash generation in the quarter?

Yeah, Mark.

First just a general comment on cash flow.

What we have seen this year is that we've generated cash in excess of all requirements of some $4.5 billion.

We've reduced debt by $3 billion and we've also increased our cash balances.

I would encourage you not to be too hung up on quarter-to-quarter movements because you can get some large changes in working capital and other items.

For example, two items I'll talk about in the third quarter, one is we did make a contribution to our pension plan of some $150 million.

The other is that taxes, the timing of tax payments can change considerably.

We accrue obviously on a ratable basis but the timing of the estimated payments that we make can vary considerably during the course of the year.

In fact, I think I mentioned last quarter that we would have some payments in the third and fourth quarter that were not proportional to what you saw in the first part of the year in the tax area.

That's exactly what you're seeing in the third quarter.

The short answer is, your right, cash generation is down a bit, from what you might think as a ratable basis but I wouldn't get too hung up on it because it's just a function of timing.

Thank you.

Next question.

Thank you, our next question is a follow-up from Tyler Dann of Banc of America Securities.

Thank you.

My question is regarding U.S. and Canadian natural gas volumes.

It looks to be down about 7% sequentially, 12% year-over-year.

Could you please, and I apologize if you've touched on this earlier in the call, but could you please quantify the quarter-to-quarter and year-to-year impact of asset sales on those volumes?

Sure.

I did talk in some detail about production in general and talked a little bit about natural gas.

In terms of the impact of asset sales year-over-year, it's actually pretty small.

So that's not the big factor.

The big factor --

On North American gas, specifically.

On North America gas, that is not the big item.

What is the big item is hurricane damage, permanent hurricane -- in addition to normal decline, is hurricane damage from the fourth quarter of last year, some of which could not be restored and was lost permanently.

I mentioned that a little bit earlier.

Asset sales did not have a significant impact on either sequential period.

The other thing I'd add is just specific to the third quarter this year we had a very heavy maintenance schedule in the Gulf of Mexico shelf.

You always have maintenance in the summer, and the shelf, but that may have added another 10 to 15 equivalent MBD reduction just for this quarter.

Thank you.

Next question.

Thank you, our next question is a follow-up from Michael Mayer of Prudential.

Thanks again.

You get two shots huh?

Yeah, that's a pretty good deal.

Sort of a follow-up to Mark Gilman's question.

The cash and the balance sheet ended the quarter at about $5.2 billion, which was about $1.5 billion higher than the year-end, I know there's timing issues there, but have you been able to determine, given that the merger's well behind you now, what is the level of marketable securities you would maintain on the balance sheet just because it's cost effective versus your data or tied up in other countries, the intent of my question is to see how much is available for other corporate uses?

That's a good question, you're observant.

We don't need $5 billion to run our operations, it's a much lower number than that.

I'd rather not be too specific because, frankly, it's a function of being able to tax-efficiently deploy that cash in the best way.

And so it's a bit of eye of the beholder.

Because you can technically always access your cash around the world but some of it you may not choose to.

What I can tell you is we continue to generate surplus cash in the business at these kinds of commodity prices, but we, frankly are at the point now where we don't have a lot of debt that we can pay down economically.

We obviously could pay down debt but it hasn't been economic to do so.

So we're accumulating cash balances that are a little bit more than we might on a typical basis than we would use it to apply it to debt reduction.

Okay, sorry to not give you a specific number there, but it's not an easy number and it requires a lot of qualifications to it.

I think we've completed our hour's worth of commentary, and questions, and I'll just close by indicating that we think we've had a third very good quarter in a row.

Hopefully we've given you a good feeling for what was in the numbers and the progress we've made on a number of our strategic initiatives.

I'll tell you Randy Richards is available for additional questions, most of you know his number.

With that, we'll sign off and thank you very much for attending.

Thank you, ladies and gentlemen, that does conclude today's teleconference.

You may disconnect your lines at this time and have a wonderful afternoon.