Suncor Energy Inc (SU) 2004 Q2 法說會逐字稿

Good morning, ladies and gentlemen. And welcome to the Petro-Canada 2004 Second Quarter Earnings Results Conference Call.

I would now like to turn the meeting over to Mr. Gordon Ritchie, Senior Director of Investor Relations.

Please go ahead Mr. Ritchie.

Thank you, operator. And good morning, everyone and thanks for joining us this morning.

On the call this morning with me are Petro-Canada's Chief Executive Officer, Ron Brenneman and Harry Roberts, our Chief Financial Officer.

As usual, we will be providing some forward-looking information during the call and I would refer you to the disclaimers in our disclosure material. Ron will begin today with his remarks on the second quarter. Harry will discuss the financial picture, and then Ron will wrap up before we take your questions.

Ron?

Thanks, Gordon. Thank you for joining us on this midsummer conference call. I hope you all took notice of Calgary hitting the big time earlier this month when a Calgary Stampede bull named Outlaw rang the bell at the New York Stock Exchange. I have to say we usually ignore the stock exchanges during Stampede we hear, but this year we had reason to pay attention. It gives a whole new meaning to the term "bull market."

Our second quarter this year was highlighted by several important strategic initiatives, most of which we have discussed on the conference calls that accompanied those press releases.

Our Buzzard and Prima acquisitions are big step forward on our long-term strategies and we rounded out the quarter by announcing a share buyback program. Underpinning all the news items during the quarter, it was another set of operational and financial results.

We're well on track to meet our upstream production guidance for the year and the downstream delivered a good quarter in spite of the fact that our largest refinery was on a planned shut down for the whole month.

I'll go through each of the five business units, discussing both the operational results and the strategic moves as I go along. Harry will discuss our financial status and the normal course issuer bid.

I will star today by focusing on our North American natural gas business. Our natural gas team had an outstanding quarter when you consider both the operational and the strategic accomplishments.

Much of this success stems from the revised strategy for North America natural gas that we outlined in our Investor Day back in March. I'm getting a lot of questions on this subject, so perhaps we weren't as clear as we might have been.

Let me recap what we said. In pulling together our business plan last fall, we recognized that the outlook for natural gas had changed from what we had envisioned a year or two ago.

At that time, we felt that the success we were having in our conventional business would carry us through to a point in time when our positioning in new supply areas Mackenzie Delta, Scotian Slope and Alaska would come into play. But as we look forward last fall, the timing of those new supplies seemed to be slipping out one year at a time.

And LNG, which we saw eventually putting a cap on North American prices was also, struggling through the regulatory prices for re-gasification sites. That suggested to us that prices would stay stronger for longer.

At the same time, we started to see some side effects from our long-standing focus on a selective core areas in western Canada. Our focused approach had been the cornerstone of our very competitive refining and development costs.

With the maturing of those core areas, however, our prospect inventory was deteriorating, which meant that reserve replacement would become increasingly difficult.

The consequence of all this was a gap that was appearing between the outlook for our conventional production and the timing of new supply coming on stream. And this in an environment where we could see very strong prices persisting.

So we changed our tack somewhat. We decided we needed to step into a new core area to give ourselves some more running room.

And the logical target was unconventional gas, which is the only component of North American supply that's currently growing. So we hired some additional experienced G&G folks into our conventional business to rebuild our prospect inventory and we established a team to look for unconventional opportunities in Canada.

To support those initiatives we added over a $150 million to exploration and production budget. At the same time we contracted Waters and BMO to look for acquisition candidates in the US where they had expertise we lack in the US Rockies areas. Those tactics began to bear fruit in the second quarter.

We saw outstanding performance from our four core areas in the quarter, with output of 691 million cubic feet a day, higher than we expected. The strong production came from some good drilling results, especially in northeastern and BC and for mitigating the impact of plant turnarounds by securing third party processing arrangements.

Performance in the first half of the year has been so strong that our original production guidance for the year of 640 a day now appears too conservative. We think that something like 675 is probably a better number for the base business.

The number you see in the production guidance table in our earnings release includes 5 months of production from the new Prima assets on top of the 675. Our effort to establish an unconventional footprint in western Canada is also shaping up nicely. Early drilling results are very encouraging and we have started to assemble a decent land position.

Finally, we've just completed an important acquisition that will move us into the growing unconventional gas business in the US Rockies region. We're very pleased with how well the Prima deal fits with our revised strategy. Prima's full cycle refining and development cost of 1.60 Canadian per thousand cubic feet are attractive and they are competitive with our core areas in western Canada.

Current production of over 50 million cubic feet a day is expected to double by 2007 as new coal bed methane production comes on stream.

I am pleased to report that the Prima transaction closed yesterday. Our tender offer was well received enabling an efficient completion of the deal. We're now moving quickly to integrate the Prima assets and welcome their employees to Petro-Canada.

We also continue to work away on northern gas to be well positioned when pipelines from the arctic are eventually built. This quarter we picked up additional exploration acreage around our preexisting discoveries in the coal bill hills area of the Mackenzie valley. And that was after re-completing and testing a well that was drilled back in the 1980s.

Part of our thinking back in the fall was also the realization that LNG fit very well with two key planks of our overall corporate strategy, a desire to increase the proportion of long life assets in our portfolio and the objective of a long-term supply and marketing presence in the North American gas business.

So we assembled a team from our international organization and from our North American gas folks to look at opportunities in LNG. Our ultimate objective is to develop an integrated LNG business, participating in both the production and the marketing ends of the value chain.

With expertise in both gas production and North American gas marketing, we believe that we're well positioned today supply the every growing US natural gas market.

The key to entering the North American LNG business is to secure re-gasification capacity on the continent. This is not a simple task. We've seen many proposed facilities in the US fail to win regulatory approval.

However, we're working on re-gasification on a couple of fronts and we're optimistic that we'll be able to secure that critical market entry point. The LNG discussion offers a good situ from the North American natural gas business to international. Since as I said, this is one opportunity area that spans the company. Just like the natural gas team, the international business is an active and forward-looking place these days.

We continue to be very pleased with our LNG production in Trinidad. We're looking to expand that and we're on the hunt for other upstream LNG opportunities. We've been talking to people in locations including Russia, the Middle East and other Atlantic base and supply points and we've assembled a solid list of prospects.

LNG is a long-term play, and nothing is advanced enough yet to enable me to be more specific, but we're seeking to move into the LNG business in a substantive way. Of course, the biggest news out of the international business in the second quarter was the completion of the transaction that gives us 30% ownership of the Buzzard offshore oil field. That should translate to about 60,000 barrels a day to Petro-Canada at peak production. We are tremendously pleased to add a new platform asset in the UK North Sea, and we are looking forward to initial production in late 2006.

We think that Buzzard is a great project with lots of upside potential. In fact, the $57 million accounting loss we took this quarter on our Buzzard hedging can be seen as an early indication that some of that upside on price may materialize.

The futures market is strengthened, since we did this deal, meaning that the hedge we put on about half of Buzzard's early production is currently out of the money. But that's good news for the rest of the production, which could turn out to be very profitable.

Moving back to the present day, overall production in the international business is inline with our forecast for the year. The production declines we are seeing in Syria where we are working with quite matured fields have been a bit higher than expected. The deep and lateral drilling is mitigating declines to a certain extent, but it won't stem them completely.

Meanwhile, we continue negotiate a Middle Area gas development in Syria that could be a significant long life project for us, once we conclude the deal. And we also made progress on building our international exploration portfolio in the quarter, which as you know is a priority for us.

In Trinidad, we've concluded contractual negotiations on two exploration blocks that we expect to be awarded and we are in advanced negotiations on a third. So we are progressing well in the international business, as we continue to make progress on each part of our three-part strategy. It's important to recognize that the Veba acquisition laid the groundwork two years ago for these recent activities and projects, and the experienced international organization that came along with it, made all this possible.

Now, I'll come back to Canada and run through our other three businesses more quickly. In East Coast oil, overall performance continued to be very solid. Production has averaged 86,500 barrels a day, net to Petro-Canada so far this year, which is excellent performance. Hibernia was particularly outstanding, setting a quarterly production record for the platform of 217,000 barrels a day.

Terra Nova experienced some problems with the gas injection system during the quarter, which lowered production somewhat in April and May. The East Coast team will begin a planned shutdown in mid August to fix the flare tip, and we are taking advantage of the shutdown to carry out scheduled maintenance and make improvements to the gas compression system.

Things continue to progress well in White Rose and the next East Coast development -- our next East Coast development. Drilling is proceeding and the project continues to meet expectations. Timing and cost estimates remain within our targets. The story in Oil Sands will sound very familiar to last quarter's. Good results at Syncrude, but some challenges at MacKay River.

Starting with the good news, we continue to be pleased with Syncrude's performance, where reliability has been excellent this year. Total plant production averaged 230,000 barrels a day during the quarter, down slightly from the first quarter due to planned hydrotreating maintenance.

At MacKay River, production dropped as we worked to integrate the new third party Cogen facility. We need the steam from the Cogen to reach full production, so our team is currently focused on getting the Cogen operating consistently.

The main challenge for Petro-Canada had been maintaining water quality specifications, but the good news is, that we've made solid progress in improving our water handling system. We are now seeing successively longer runs of the Cogen unit without disruption.

In fact, the unit ran throughout June and July, with only two minor hiccups enabling us to lift production over the 20,000 barrel a day mark, as well as the operational progress and maintaining water quality, and keeping the Cogen running. We are also planning now for some facility modifications that will help to improve reliability at MacKay River.

We have a planned one-week turnaround scheduled in September, when we'll tie in some $25 million worth of new equipment to improve plant reliability.

While the problems in the first half of the year have set us well behind our production target for the year, we believe that stronger production in the second half will get us to a revised 2004 guidance of 18,000 barrels a day.

At the same time, we are planning our winter drilling program, so that we can continue to move forward on identifying our next SAG D development. We remain fully confident of the significant roll that in situ Oil Sands will play in this Company's future.

Finally, the downstream delivered another quarter of solid results, in spite of the major planned turnaround at our largest facility, and in environment of fierce retail competition. I'll start by talking about Edmonton refinery. That's a good news story, despite the opportunity costs of shutting down during a period of exceptional cracking margins.

The plant was completely shutdown for almost two weeks, first time that's happened in 14 years. And the cat cracker was down for just over a month. This was done to tie in the new gasoline desulphurization unit and to prepare for future refinery conversion work. It was a complex and difficult project with a tight timeframe, but it came in on time and on budget, and did so with an excellent safety record.

So it's a case of superb execution all around. In fact, the new facility is producing a higher quality output than we had expected. Refinery manager Tom Day together with the Oil Sands' team that supported the project should take pride in this accomplishment.

This marks the completion of the first phase of our refinery conversion project, and we can see that this big size chunk approach we are taking is working. Projects are manageable and costs are under control.

And both our Edmonton and Montreal refineries are now producing low sulfur gasoline, so there's an environmental win there, as well. Even in oil field we are seeing strong execution in advance of that facility's closure.

The reliability and safety performance has been excellent, which is a tribute to the professionalism exhibited by all involved in the operation. Unfortunately, we've been successful in finding positions for many of the displaced oil field employees.

Overall, the refining segment delivered strong quarterly earnings, in spite of the lengthy Edmonton shutdown. Refining made $90 million, excluding the oil field closure costs, thanks to strong cracking margins.

On the marketing side, aggressive retail price competition eroded earnings. Our running rate in marketing is normally about $30 million a quarter, but we were at half that in the second quarter.

Contrary to popular wisdom, the record pump prices we saw a couple of months ago do not translate into record profits for marketers. But the good news is that we did see strong results on the key performance metrics within our control.

Convenience store sales are up 15% over last year, with same store sales up 11%. And lubricant sales and high margin products continue to increase. With that summary of results by business unit, I'll turn it over to Harry to discuss the financial picture before coming back to you with a quick wrap up comment.

Harry?

Thanks, Ron. While this quarter doesn't have too many one-off items on the earnings statement, I do want to cover a few important financial points for you today. At the top of the list is the normal course issuer bid that we launched in the quarter to repurchase our own shares.

Our financial position remains strong even after the recent acquisitions. Including the Prima transaction, debt to debt plus equity would be about 26% and debt to trailing 12-month cash flow would be 0.9 times, using second quarter numbers as a base.

So we have the capacity not only to fund profitable growth for the future, but also to return value to shareholders in the near term through a share buyback.

In the short period available to us before the second quarter trading blackout period, we repurchased about 166,000 shares at an average price of $58.88 per share for a total of about $10 million. While initiating an NCIB does not constitute a commitment to buy any particular volume of shares it is an important tool in our toolbox.

The NCIB gives us the flexibility to add value for shareholders in the short-term, when we have the capacity to do so. One new item this quarter is the reporting of the unrealized gains or losses associated with the hedge we put in place to support the Buzzard acquisition. Since this project does not yet qualify for hedge counting achievement we must report a marked-to-market gain or loss every quarter going forward. We have isolated that figure from operating earnings since it's an accounting rather than operating result at this time.

When the project comes on stream, at which time we expect to qualify for hedge accounting, we'll no longer need to report unrealized gains or losses. The other significant non-operating item is the continuing depreciation charge related to the pending closure of the Oakville refinery. This charge lowered downstream after-tax earnings by $13 million or 5 cents per share in the quarter. The new table in the MD&A section of our press release give you a reconciliation of comparable earnings numbers quarter-to-quarter.

Turning to cash flow, the usual two items caused differences between earnings and cash flow. Tax deferrals resulting from our upstream partnership decreased cash flow by approximately $10 million in the quarter, compared to an increase of $45 million in the second quarter last year.

And the LIFO FIFO effect in the downstream reduced cash flow by about $24 million compared to an increase of about $60 million in 2003. So the combined impact of these two items is to lower cash flow by increasing current taxes by about $140 million compared to second quarter last year. Those are the main items I wanted to cover. The only things to keep in mind that will impact the third quarter are the turnarounds Ron mentioned at Terra Nova and MacKay River.

I'll turn it back to Ron for his concluding remarks.

Thanks, Harry. It was a successful quarter with good operational performance and some big steps forward on our strategy for profitable growth. We expanded our existing business, acquired new platform assets for the future and added to our exploration portfolio.

And we're pleased to confirm that we're on track to meet our production guidance for the year. Achieving that target shows the value of the balanced portfolio that we're building at Petro-Canada.

With our expanded suite of opportunities, the challenge in one part of the business can be offset by stronger than expected performance in the other. This diversity enables us to deliver steady reliable results across the portfolio. And the principles that underpin our business strategy remain unchanged, deliver profitability in existing businesses and pursue profitable growth.

Thank you as always for your interest in Petro-Canada. Harry and I would now be pleased to take your questions.

Thank you.

Operator that completes our prepared remarks and we are now ready to open the phone lines.

Thank you. We will now take questions from the telephone lines. If you have any questions, please press on the "star" "one" on your telephone keypad. If you are using a speakerphone, please lift the handset and then press "star" "one". If at any time you wish to cancel your question, please press the "pound" sign. Press "star" "one" at this time if you have a question. There will be a brief pause while the participants register for questions. Thank you for your patience.

The first question is from Peter Best (ph) from Credit Suisse First Boston. Please go ahead.

OK. Good morning. I have a few questions. First is on the Syrian Middle East production. The royalties seem to be very high this quarter, maybe roughly 190 million higher than the previous quarter. I was wondering if you could comment on that and also what you expect your decline rate to be going forward on the oil production in that area?

I can't comment on the royalty question Peter because I wasn't aware of that. Maybe Gord can get back to you on that and check the numbers you're looking at.

OK.

On the decline rates, where we had expected coming into the year that we would be seeing something in the order of 8 to 10% sort of net declines, we're now looking at something now in the sort 12 to 14% range. And the difference there is principally in the performance of the existing fields.

We've talked in the last year or so about the advantage that we picked up in securing the rights to some deep and lateral prospects in and around our existing concessions. And in fact the drilling in those new areas is actually performing quite well, pretty much as we had expected.

But it's not sufficient to offset the decline that we're seeing in the mature fields. The infield drilling and the installation of submersible pumps in the mature field area is quite frankly we're sort of running out of running room there so to speak in the sense that the opportunities are not as good as we had expected at the beginning of the year.

So I would expect us to see going forward here something more in the sort of 12 to 14% net rather than the 8 to 10% that we had indicated earlier.

OK. Second question is on Oakville. I was wondering if you could quantify the impact say on the first quarter next year say on operating profits once you close that facility? I realize there will be some cost saving and expansion in Montreal. I wanted to see if you could quantify it, approximately?

I don't have those numbers in front of me, Peter. Again, maybe, Gord can get back to you. I believe that we provided some of that disclosure when we originally announced the project, but I just don't have that in front of me. Harry has a comment.

Peter, I think what you can expect is that given this additional depreciation that we're currently taking every quarter, the intent there is to, in effect, zero out the impact on the bottom line that Oakville would have otherwise.

OK.

So it may vary depending on cracks and all those sorts of things. But I think directionally what you would look at is the bottom line would be similar to what it is today taking into account the fact of that additional depreciation is there.

OK. My next question is on Buzzard. At the time when the acquisition was being looked up by other companies, some people commented that a risk would be that the operator was new to the offshore.

I was just wondering what steps you were taking to monitor costs and timing of the construction phase of the project.

Just before we leave the Oakville situation, Peter, I think -- I'm not sure I got the gist of your complete question. I think what Harry responded to is the -- specifically the Oakville impact. But, of course, we're expanding Montreal to run another 20,000 barrels a day.

And so the net impact of all of this supply chain upgrading that we're doing here is going to be something different than the $15 million that we're currently taking. And that's what I was referring to before. There should be a net up lift beyond that because there's the effect of Montreal expansion as well. But I'll ask Gord to get back to you and see what we can put together on that.

OK, thanks.

And your question on Buzzard had to do with the operatorship and what have we done to ensure to --

It's more to do with, say, a lack of experience on the operator and, you know, constructing or operating, constructing and operating offshore and whether you thought that was a risk and what steps you were taking to monitor progress on the project.

Yes. Well, first of all, I think it's important to recognize that in Canada, when they took this over from Pan Canadian, and I give them credit for this, I mean they recognized that what they didn't know.

So they went in and they did a very thorough analysis of the whole project execution plan and the staffing and the contractor owner relationships and that's sort of thing. In fact they actually slowed the project down as a consequence of that which was a good thing. They hired a very competent project executive, in fact the same individual that built the Scott field, which is almost a look alike in terms of size and configuration to what's being put into Buzzard.

So they've had somebody there that's been through this before at least once. And subsequent to closing the transaction our people have gone in and gone over very thoroughly the whole -- for our benefit the whole execution plan and, you know, we have the advantage of some of our folks on the East Coast having been being through Terra Nova and also having established what I consider to be a model joint venture relationship for managing the White Rose project with Husky where we faced essentially the same situation.

And so we've got a JV organization model that we can follow here that we're confident will give us the kind of assurance that we need to make sure that we understand the progress of the project, that we know when we'll see the early warning signs of any problems, if there are any, and the kind of corrective measures that can be taken. And I think that while White Rose hasn't started up yet, the fact that the project is progressing very well, basically on -- more or less on time and certainly within budget is an indication of how we're able to work with operators in the similar circumstances.

So we don't really see that being an issue, Peter at this point.

I think, Ron, if I could just add, I think, also most of the contracts are already in place as well, are they not?

Yes. Most of the contracts are in place and most of them are lump sum contracts, so the cost from our point of view, the costs are very much under control.

Yes.

So, we don't see a lot of risk on that side, quite frankly.

OK. Good. Thanks. I've got one more on CapEx if we could just get a bit more detail, the increase in Oil Sands is that for Syncrude extra costs? And then the North Sea, is that for Buzzard extra costs? And for natural gas, is that more activity or higher costs?

Certainly, in the North Sea that is Buzzard, essentially all Buzzard. In Oil Sands, we've got a couple of things going on there. Some of that is the increase in the Syncrude expansion project that was announced late last year, I believe. Some of that is also an acceleration of work to advance to the extent we can the work on our next SAG D development.

Together with some pilot work that we're doing at MacKay River, that we hadn't contemplated in our original budget and that pilot work is really aimed at two different aspects, if you like.

One is the technical concept that we've talked about before of co-injecting solvent along with steam where actually, at this stage, we're engineering a two-well pilot to basically test that with our facilities at MacKay River. And the other is a pilot in an area that we call Section 16, which has a little bit of interbedded shales of mudstones in the Oil Sands reservoir that looks a lot like the, kind of, reservoir quality that we saw down in Meadow Creek.

And in that case, we're doing some pilot testing to determine the kind of response that we saw at steam generation (ph) and the kind of reservoir response we can expect with that quality of reservoir.

So, there's a number of things that we're doing at MacKay River with that money to advance our thinking on the next project and on the technology that we might use in the next project.

OK.

And sorry, the other one was natural gas. And the natural gas is the 150 million that I mentioned, that we are putting into our conventional business. It's about 40 million for Prima's budget for the remainder of the year.

And it's the work that I mentioned at Coalville hills for the acquisition of some additional lands and some reentry and testing work that we did up in that central point of the Mackenzie Valley.

OK. Thank you very much.

Thank you. The next question is from Andrew Fairbanks from Merrill Lynch. Please go ahead.

Good morning, everyone. I had a question on international exploration expense. The number in the quarter seemed unusually high versus a year ago or last quarter certainly.

Do you have any expectations for what that very difficult category of costs would be to predict as we go through the rest of the year?

I don't actually have a number in front of me, Andrew. But I think what you can expect is that we've been talking about building our exploration portfolio. We're going to spend more money in the future, particularly internationally in exploration than we have in the past.

And as a consequence we're going to incur some dry hole expense along the way. We can perhaps, when we put together our budget in our CapEx outlook for next year, we can be a little more explicit.

But I think you can take that as an indication of something that you would expect to see more of in the future. I don't know whether Gord has got any numbers that represent the remainder. Harry has got some numbers here.

I think if you look at the 40 million, Andrew for this quarter, versus the 10 in last quarter, about half of that change relates to write-off of some wells in the Netherlands and also some wells in Algeria, and the rest is, sort of, spread around the balance of the asset package.

Excellent. That explains a lot. Thanks.

The next question is from Wilf Gobert from Peters & Co. Please go ahead.

Thank you. Just, first of all, on the solvents injection for MacKay River, is Petro-Canada not a member of the joint industry group that is testing, I think its the Vapex system or a solvent flood injection system?

Yes, we are. Well, that's the one that's going on at the UTS facility, which is right adjacent to the MacKay River?

Yes.

That pilot is for pure solvent.

OK.

And what we're testing is the co-injection of solvent with steam.

Right.

...which is a variation on that.

Right. But is it partly the results of the industry pilot that has given you some encouragement on this approach? Or a different pilot?

Well, it's a.

In other words, has this been tested before or is this the first time?

No, it has not been tested before. I think there may be others that are in the process of testing out the same concept, but for us this is the first time this has been tested. I mean the physical chemistry is well understood, behind this technology. But the unknown is how well will it actually perform in field conditions.

Right. OK. And the second thing is on the natural gas production guidance for the year, going from 640 to 675 for North America gas, is that -- I know you attribute it partly to your drilling program. But it would seem to me that it looks like that it's basically adding the Prima production numbers for the year.

No. That's -- Wilf, that's before the Prima numbers.

675 plus Prima.

So, for Prima, if you just do the simple math, 50 million a day for five months adds about 20 on the annual average. So, the 675 becomes 695.

Great.

...which translates to 116,000 barrels a day in that table.

Right. Thank you very much.

Thank you. The next question is from Mohan Mandrekar from Deutsche Bank.

Yes, hi. This is actually Jay Saunders sitting in for Mohan. Sorry I've been jumping on and off the call here. I just want to get some clarity on the CapEx for Prima. I guess it was a little bit higher for six months, and of course, there is going to be some play into that. But you guys I assume are still sticking to the 50 million in '05?

Yes. That's basically -- we haven't changed our thinking on that since we made the press release. In fact we have no new information because we just closed yesterday.

Yes, ok. And how about on MacKay, the production -- the profile on the third quarter and fourth quarter of the production, do you expect most of the increase in the back part of the year or earlier?

Well we're -- if you look at where we are year-to-date and where we need to be to finish the year. To make 18,000 barrels a day, we need to produce something like about 21,000 barrels a day for the last half. And we're basically running at that today.

All right.

But you have to bear in mind that we're coming down for about a one-week shut down to do that work that I mentioned for water quality improvement. So, that will take a little bit out of it. So I think, absent that, you would expect to see this more or less ramping up through the last half of the year.

OK. Great. Thank you.

Thank you. Once again, please press "star" "one" at this time if you have a question. The next question is from Paul Cheng from Lehman Brothers. Please go ahead.

Good morning, gentlemen. Ron or maybe Gordon, pardon me because I joined you guys a bit late so you may have already discussed that. When I'm looking at your international operation, the effective tax rate is much higher - and actually it is very high even after I take into consideration that I presume the hedging laws does not have a corresponding tax benefit on that result. Can you elaborate a little bit or explain to me why it's not so high?

Paul as you well now, there's always a lot of noise in these effective tax rates, but it is -- the real difference that you see in our quarter-over-quarter is related to the tax treatment on the hedge.

And so if you remove that noise from there, the effective tax rate is up only slightly from 2003 and very much in line with the guidance that we gave earlier, which is, you know, around 65 to 75, it turns out that it's closer to 70 during the second quarter.

And Harry, should we assume 70% going forward? Or that you're still going to stick with 65% or so?

Well, I think for the balance of the year, certainly for the first six months, the effective tax rate has been just under 70%. So, I think our guidance was 65 to 75. Things are going to move around.

But I think if you were looking for a number, you could always put it right in the middle of that guidance and I think you'd cover off some of the ups and downs.

OK. And Ron, when we're looking at your new production guideline for North American gas to be about 675 for the remainder of this year and perhaps into next year, I presume, should we assume that your exploration activity or exploration expense in the North American natural gas is going to be higher going forward, comparing to the past several, say, quarters?

I would guess marginally, Paul, although I don't have any numbers in front of me but the fact that we're spending more money, and a portion of that probably pro rata is going into exploration, a reasonable assumption might be a pro rata increase in exploration expense. But f I haven't really made that projection.

Ron, do you have a target reserve replacement for the North American operation?

For this year?

Yes, on the longer-term basis. I mean is there a target that you will try to (inaudible) to replace 100% or that you think that it's not possible given the maturity of the asset? You're only looking for maybe replacing 70%, 80% and then substituted by acquisition, any kind of target rates or expectation there?

Well, I think this year, with the success that we've had so far, I suspect we'll come out very similar to where we ended last year, which was in the 80% range. And going forward, we would like to see that improve, but it's the type of thing that's very difficult to predict.

Is it fair to assume that if we continue to have difficulty to repay 100% of the production, then that means that longer term absent acquisition, the production trend would continue to be down?

Yes. I mean that's the consequence. If you're not replacing reserves. And that's what we had indicated in our Investor Day, for example.

Right. And that hasn't changed, right? Even though that you have increased your near-term outlook for the natural gas?

That's correct. Yes.

OK. Very good. Thank you.

You've got a pretty strong underlying decline trend in all of this that's running probably in excess of 20%.

Sure.

So the replacement is quite -- the replacement requirement is obviously quite significant. And so, success or lack of in the replacement can make a big difference in the production outlook down the road.

Excellent. Actually, Harry, I'm wondering if I can have one final question. On the Edmonton refinery, the one month shut down on the cracker, and also the two week total shut down of the facility, is there any rough estimate what's the opportunity cost for you guys?

That's a hard number to really come up with.

Sure.

So, we don't really have that at our fingertips here.

OK. All right. Thank you.

Thank you. The next question is from Robert Plexman from CIBC World Markets. Please go ahead.

Well, good morning. One thing I was wondering about, Ron, is that now that you've made a couple of significant acquisitions, you know, the Intrepid and the Prima, and that certainly changes the production file going forward, are you satisfied with the way the production profile looks now or do you feel the requirement to do more, especially in your comments about the high natural decline rate?

Are you talking about natural gas?

Talking overall.

Overall. We've got a lot of things going on aside from the two acquisitions that we mentioned. We've got projects in virtually all parts of our business that are part of our growth profile. And so, our first priority is obviously to make sure that we execute those effectively and bring those that are still hanging out there to some extent, like Middle Area gas, for example, to fruition.

We have our exploration program that I have referenced on several occasions, which we're building up, and we anticipate some success from over time. So, when you put all that into the forward picture, I have to say that today, in addition, when you're including the acquisitions that we've done, our picture certainly looks a lot more healthy than it did even a year ago.

And we just continue to look to building that going forward. I mean, to say that we're ever satisfied would be to sell ourselves short. We're always looking for good opportunities. We've got the financial capacity as Harry mentioned to pursue good opportunities.

We've got lots of ideas that we're chasing. I mentioned LNG, for example, which is further down the road, but still, can be a very significant addition to our portfolio. I think if you look at that chart that we put into our Investor Relations package, we usually end up with the growth profile chart with all the projects, so you get a sense of what we're working on and the quality of investments that we see being able to invest in over time. So, the answer is no, we're not satisfied, we're always looking for more.

And can I ask you just to pursue that a little further to relate it to the share buyback that program -- that's a tender way. It just started in June, so you haven't had a chance to really buy much. But given your more positive perspective on the commodity price environment, in terms of -- I know this is difficult to answer, but -- and I guess depends on the economics of a project you may be looking at, but in terms of the priorities, can you give us some idea of, you know, what your preference would be -- would it be to make another acquisition or, I guess, what I'm getting at is how serious your intention is buyback stock over the next few months?

Robert, I think we're in the fortunate business of not having to choose one or the other. In fact, we have the capacity to not only continue with our share buyback when we see that being the right opportunity from a value creation point of view, but also if we saw some attractive acquisitions come along, we wouldn't hesitate to take those on as well.

We've got that kind of capacity in our balance sheet. So, it's not like we've stacked up priority one and priority two. We'll look at each opportunity as it comes along and then weigh them against each other. But, the share buyback, I think as Harry mentioned, from our perspective is another tool in the tool kit. I think it's a very -- from our perspective, today certainly, a very attractive way for us to add shareholder value.

Thanks Ron.

The next question is from Amir Arif from Friedman, Billings. Please go ahead.

Good morning guys. I just wanted some clarification on the decline rate you were talking about for North Africa, you know, you mentioned 12 to 14% net, is that just on the oil or is that total BOE declining rate you're talking about?

That's really on the oil in Syria.

Is that just Syria?

That's what I was describing there. The question was related to Syria, I believe.

OK. So then overall for the -- I mean Libyan production isn't declining for you, is it?

Well, Libyan production is actually one of our long life assets because it has such a tremendous resource base behind it that it really has no decline rate in effect. There's lots of undeveloped potential there that is easily tapped into. So no, that doesn't apply to Libya.

OK. I just wanted to clarify that point. The second question on MacKay River, I know you're going to be doing the turnaround, do you still expect to ramp this up to the peak capacity or peak production profile by the end of this year?

Yes. That's correct.

OK. And going forward on the Oil Sands, you mentioned that you are still doing some work on Meadow Creek in terms of drilling. Have you decided to develop that lease next?

I know you're not going to bring anything on until '07 or so, but I know -- in the previous couple of quarters you mentioned you weren't sure if you were going to do expansion with MacKay River or with Meadow Creek. Have you made that decision yet?

No. We're still evaluating our winter drilling results that basically just finished in March and early April sometime. So -- and the two possibilities that we're looking at is a sweet spot in the Meadow Creek area, and also an expansion at MacKay River. There is a very attractive sand body that runs south of our existing production operation that could also make a very good project for us. So the choice is between those two areas principally.

OK. And just one final question on the share buybacks, can you tell us how many shares you have bought back since the end of the second quarter and after the second quarter?

This is Harry. We've been in a blackout because of the second quarter results.

OK.

So the number I gave you was all of the shares that we've bought back. We should be able to start trading again or potentially, if you will, on the 3rd of August.

OK. And you do, I guess, from the previous comments sounds like you're going to be active in your buybacks?

I think as Ron was talking, you could view us as being opportunistic.

OK.

Thank you. The next question is from Louis Felicita (ph) from Harold Brown. Please go ahead.

Hi guys. I'm curious. Do you have any update on the Canadian government's plan to dispose of Petro-Canada's shares and your intentions to participate?

We don't have any news other than what you've read in the newspaper, Louis. The last comment, I think was by Goodale, when you indicated subsequent to the election that they intended to proceed and that's about all we know.

And, as far as our intention to participate our thinking really hasn't changed on that either. We will certainly look at the opportunity at the time and see whether that makes sense for us, but we're not committed one way or the other.

Thank you.

Thank you. The next question is from Martin Molyneaux from FirstEnergy Capital. Please go ahead.

Ron, what are your thoughts going forward here in terms of refining and marketing? Obviously, we've seen international margins increase substantially, seems like a lot of that has been reflected back in the Canada. What does your crystal ball tell you for the balance of the year?

I've got a plastic water bottle is about as close as I can come to a crystal ball here. I think there's a couple of things going on here. First of all, we saw some very strong cracks through the second quarter, and that might also persist through the third quarter.

And I think what you have to recognize is that virtually all of North American refining is facing the same situation that we are in Canada, and that is the need to meet these low sulfur gasoline requirements starting January 1st of next year, so that my guess is virtually every refinery in North America has to shut down sometime this year to tie in that new equipment.

And so, I think, part of what you're seeing is the effect in this Q2, Q3 period -- is the effect of refineries shutting down and that boosting the cracks in the short term. But having said that, my own view is that we're going to see stronger cracks going forward, simply because of the supply/demand situation in North America for petroleum products. I mean demand is increasing quite considerably. There is no new substantial refining capacity coming on the market. There are increasing regulations in the United States that are compartmentalizing through product specifications individual markets.

I mean they're essentially creating a whole series of Californias, if you like, by having regional specific specifications, and that limits the ability to move product from one refining region to another.

And that creates local shortages that in turn affects the crack. So, I think that going forward we will probably see stronger cracks than we have historically.

OK. There is no mention in the press release about your Lubes operation. How are they doing?

Lubes doing extremely well. In fact our lube -- our total lube sales are up this year over last year. I forgot the number but it's 5% or 6%, something like that.

And the sales of our -- the sales into the high margin major markets are continuing to increase. So we're very much meeting our objectives there. And I would say that those sales are increasing despite the fact that the overall market for premium lubricants into the manufacturing sector of the United States is down about 5%.

And that's because you're seeing a migration of a lot of this manufacturing capacity out of the United States and into places like China. So, in fact, one of the things that we're looking at is, I think I've mentioned this previously, if you bottleneck the lubricant facility, which we could see possibly extending our market into the Chinese market. So there are lots of good things going on in the lubricants business for us right now.

Great. Thank you.

Thank you. There are no further questions registered at this time.

I would now like to turn the meeting back over to you, Mr. Richie.

Thank you operator. And thank you everyone for joining us today. As always, if there's any follow-up questions, Derek and I will be here all day, and we look forward to taking your calls and questions. Thank you and have a good day.

Thank you.

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