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HES > SEC Filings for HES > Form 10-Q on 8-Nov-2012All Recent SEC Filings

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Form 10-Q for HESS CORP


8-Nov-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.

Overview

Hess Corporation (the Corporation) is a global integrated energy company that operates in two segments, Exploration and Production (E&P) and Marketing and Refining (M&R). The E&P segment explores for, develops, produces, purchases, transports and sells crude oil and natural gas. The M&R segment manufactures refined petroleum products and purchases, markets and trades refined petroleum products, natural gas and electricity.

The Corporation reported net income of $557 million in the third quarter of 2012 up from $298 million in the third quarter of 2011. See page 21 for the items affecting comparability of results between periods.

Exploration and Production

E&P reported net income of $608 million in the third quarter of 2012 compared to $422 million in the third quarter of 2011. Excluding the items affecting comparability, E&P net income was $546 million in the third quarter of 2012 and $503 million in the same period of 2011. In the third quarter of 2012, the Corporation's average worldwide crude oil selling price, including the effect of hedging, was $86.69 per barrel up from $85.81 per barrel in the third quarter of 2011. The Corporation's average worldwide natural gas selling price was $5.88 per thousand cubic feet (mcf) in the third quarter of 2012, and $5.74 per mcf in the third quarter of 2011. Worldwide crude oil and natural gas production was 402,000 barrels of oil equivalent per day (boepd) in the third quarter of 2012, up from 344,000 boepd in the same period of 2011, principally reflecting an increase in production from the Bakken oil shale play and the resumption of operations in Libya. The Corporation expects its full year production to average between 395,000 and 405,000 boepd.

The following is an update of E&P activities during the third quarter of 2012:

In North Dakota, net production from the Bakken oil shale play was 62,000 boepd for the third quarter of 2012, up from 32,000 boepd in the third quarter of 2011. The Corporation continues to expect its net production for full year 2012 to average between 54,000 and 58,000 boepd.

The Corporation will substantially complete its "held by production" drilling in the Bakken in the fourth quarter of 2012 and is transitioning to pad drilling, which involves sequentially drilling a number of wells on a pad followed by sequential fracturing of the wells. This pad drilling process is expected to lead to a temporary flattening of the Bakken production profile until mid-2013, at which point steady-state operations will allow an upward growth trajectory.

The Corporation completed the sale of its interest in the Schiehallion Field (Hess 16%) and associated assets for cash proceeds of $524 million after normal post-closing adjustments. The transaction resulted in a pre-tax gain of $376 million ($349 million after income taxes).

The Corporation recorded impairment charges of $208 million ($116 million after income taxes) due to increases in the Corporation's estimated abandonment liabilities for non-producing properties, which resulted in the book value of the properties exceeding their fair value.

The Corporation decided during the quarter to cease further development and appraisal activities in Peru. As a result, the Corporation recorded exploration expenses totaling $86 million ($56 million after income taxes) to write off its exploration assets in the country.

The Corporation reached an agreement to sell its assets in Azerbaijan consisting of its interests in the Azeri-Chirag-Guneshli (ACG) fields (Hess 3%) and the associated Baku-Tbilisi-Ceyhan (BTC) pipeline (Hess 2%) to ONGC Videsh Ltd. for $1 billion before normal post-closing adjustments. This transaction, which is expected to close in the first quarter of 2013, is subject to Indian and other government and regulatory approvals.

The Corporation signed an exchange agreement with the partners of Green Canyon Block 512, which contains the Knotty Head discovery and is adjacent to the Corporation's Pony discovery on Block 468. Under this agreement, the Corporation was appointed operator and has a 20% working interest in the blocks, now collectively referred to as Stampede.


PART I - FINANCIAL INFORMATION (CONT'D.)

Overview (continued)

Status of Libyan Operations

In response to civil unrest in Libya and the resulting imposition of sanctions, production at the Waha fields was suspended in the first quarter of 2011. During the fourth quarter of 2011, the sanctions were lifted, force majeure was withdrawn and production resumed. The Corporation's Libyan production averaged 23,000 boepd in the third quarter of 2012. The force majeure covering the Corporation's offshore exploration interests was withdrawn in March 2012.

Marketing and Refining

M&R generated income of $53 million in the third quarter of 2012, compared to a loss of $23 million in the third quarter of 2011. The increase in earnings was primarily due to improved refining and trading results, partially offset by lower marketing earnings. In the first quarter of 2012, HOVENSA L.L.C. (HOVENSA) shut down its refinery in St. Croix, U.S. Virgin Islands, and started the transition to operating the complex as an oil storage terminal.

Hurricane Sandy

In the last week of October 2012, Hurricane Sandy hit the Northeast Coast of the United States and caused significant damage, particularly to the coastal areas of New Jersey and New York. In advance of the hurricane, the Corporation arranged to have available 85 electrical generators to allow its retail gasoline stations to continue to serve customers in the event of lost power. Within two days of the storm, 177 of the 186 stations in the area were open; however, many of these stations have been operating intermittently due to shortages of supply. The Port Reading refining facility in New Jersey is currently shut down and it is expected that operations will restart approximately one week after power is restored. The Bayonne Energy Center (Hess 50%), a 512-megawatt natural gas fueled electric generating station that provides power to New York City, is expected to restart by mid-November 2012.

Results of Operations

The after-tax results by major operating activity are summarized below:




                                                      Three Months Ended                      Nine Months Ended
                                                        September 30,                           September 30,
                                                   2012                2011                2012                2011
                                                               (In millions, except per share amounts)
Exploration and Production                    $          608      $          422      $        1,887      $        2,148
Marketing and Refining                                    53                 (23 )                72                 (23 )
Corporate                                                (38 )               (44 )              (115 )              (114 )
Interest expense                                         (66 )               (57 )              (193 )              (177 )

Net income attributable to Hess Corporation   $          557      $          298      $        1,651      $        1,834

Net income per share (diluted)                $         1.64      $          .88      $         4.85      $         5.40

Items Affecting Comparability Between Periods

The following table summarizes, on an after-tax basis, items of income (expense)
that are included in net income and affect comparability between periods. The
items in the table below are explained and the pre-tax amounts are shown on
pages 25 and 26.




                                                    Three Months Ended                      Nine Months Ended
                                                      September 30,                           September 30,
                                                 2012                2011                2012                2011
                                                                          (In millions)
Exploration and Production
Gains on asset sales                        $          349      $          103      $          385      $          413
Asset impairments                                     (116 )              (140 )              (152 )              (140 )
Dry hole and other expenses                            (56 )                 -                 (56 )                 -
United Kingdom tax adjustments                        (115 )               (44 )              (115 )               (29 )

Total Exploration and Production            $           62      $          (81 )    $           62      $          244


PART I - FINANCIAL INFORMATION (CONT'D.)

Results of Operations (continued)

In the following discussion and elsewhere in this report, the financial effects of certain transactions are disclosed on an after-tax basis. Management reviews segment earnings on an after-tax basis and uses after-tax amounts in its review of variances in segment earnings. Management believes that after-tax amounts are preferable for explaining variances in earnings, since these after-tax amounts show the entire effect of a transaction rather than only the pre-tax amount. After-tax amounts are determined by applying the income tax rate in each tax jurisdiction to pre-tax amounts.

Comparison of Results

Exploration and Production

Following is a summarized income statement of the Corporation's E&P operations:




                                                    Three Months Ended                      Nine Months Ended
                                                       September 30,                          September 30,
                                                  2012               2011                2012               2011
                                                                          (In millions)
Sales and other operating revenues (*)       $        2,707     $        2,137      $        8,316     $        7,448
Gains on asset sales                                    376                103                 412                446
Other, net                                               44                 (6 )                72                (10 )

Total revenues and non-operating income               3,127              2,234               8,800              7,884

Costs and expenses
Production expenses, including related
taxes                                                   712                609               2,062              1,739
Exploration expenses, including dry holes
and lease impairment                                    259                199                 708                769
General, administrative and other expenses               79                 71                 223                231
Depreciation, depletion and amortization                725                564               2,127              1,654
Asset impairments                                       208                358                 267                358

Total costs and expenses                              1,983              1,801               5,387              4,751

Results of operations before income taxes             1,144                433               3,413              3,133
Provision for income taxes                              536                 11               1,526                985

Results of operations attributable to Hess
Corporation                                  $          608     $          422      $        1,887     $        2,148

(*) Amounts differ from E&P operating revenues in Note 14, Segment Information, primarily due to the exclusion of sales of hydrocarbons purchased from third parties.

The changes in E&P earnings are primarily attributable to changes in selling prices, sales volumes, costs and expenses and items affecting comparability between periods as described below:

Selling prices: Lower average overall realized selling prices decreased E&P revenues by approximately $15 million in the third quarter of 2012 compared to the same period of 2011. Lower average realized selling prices, primarily of crude oil including the effects of hedging, decreased E&P revenues by approximately $225 million in the first nine months in 2012, compared to the corresponding period of 2011.

The Corporation's average selling prices were as follows:

                                                     Three Months Ended                     Nine Months Ended
                                                        September 30,                         September 30,
                                                   2012               2011               2012               2011
Crude oil - per barrel (including hedging)
United States                                 $        90.17     $        95.12     $        92.53     $        97.71
Europe                                                 75.08              65.92              77.13              81.19
Africa                                                 90.78              89.41              89.56              89.85
Asia                                                  102.85             112.31             107.88             112.03
Worldwide                                              86.69              85.81              87.71              90.22


                    PART I - FINANCIAL INFORMATION (CONT'D.)



Results of Operations (continued)




                                                     Three Months Ended                     Nine Months Ended
                                                        September 30,                         September 30,
                                                   2012               2011               2012               2011

Crude oil - per barrel (excluding hedging)
United States                                 $        90.87     $        95.12     $        94.46     $        97.71
Europe                                                 75.36              65.92              78.18              81.19
Africa                                                110.33             113.03             111.28             111.20
Asia                                                  103.20             112.31             109.92             112.03
Worldwide                                              92.35              92.33              94.58              95.89

Natural gas liquids - per barrel
United States                                 $        38.35     $        57.72     $        42.60     $        58.86
Europe                                                 56.82              82.18              75.67              78.09
Asia                                                   64.67              71.30              75.95              74.18
Worldwide                                              41.71              63.64              49.05              63.70

Natural gas - per mcf
United States                                 $         2.18     $         3.43     $         1.83     $         3.66
Europe                                                  9.15               8.93               9.56               8.64
Asia and other                                          6.56               5.86               6.64               5.85
Worldwide                                               5.88               5.74               6.01               5.84

During 2008, the Corporation closed Brent crude oil cash flow hedges covering 24,000 barrels per day through 2012, by entering into offsetting contracts with the same counterparty. As a result, the valuation of those contracts is no longer subject to change due to price fluctuations. The deferred hedge losses as of the date that the hedges were closed are being recorded in earnings as the hedged transactions occur. For 2012, the Corporation has entered into Brent crude oil hedges using fixed-price swap contracts to hedge the variability of forecasted future cash flows from 120,000 barrels per day of crude oil sales volumes for the full year. The average price for these hedges is $107.70 per barrel.

Realized losses from E&P hedging activities reduced Sales and other operating revenues by $148 million in the third quarter and $533 million for the nine months ended September 30, 2012 ($94 million and $334 million after-taxes, respectively) and $131 million and $387 million in the third quarter and first nine months of 2011, respectively ($82 million and $244 million after-taxes, respectively). At September 30, 2012, the after-tax deferred losses in Accumulated other comprehensive income (loss) related to Brent crude oil hedges were $115 million, which will be reclassified into earnings in the fourth quarter of 2012 as the hedged crude oil sales are recognized in earnings.

Production and sales volumes: The Corporation's crude oil and natural gas production was 402,000 boepd in the third quarter and 409,000 boepd in the first nine months of 2012, up from 344,000 boepd and 371,000 boepd for the same periods in 2011. The increase in production in 2012 was mainly due to higher production from the Bakken oil shale play and the resumption of operations in Libya. The Corporation expects its full year 2012 production to average between 395,000 and 405,000 boepd.


                    PART I - FINANCIAL INFORMATION (CONT'D.)



Results of Operations (continued)



The Corporation's net daily worldwide production by region was as follows:




                                                      Three Months Ended                     Nine Months Ended
                                                         September 30,                         September 30,
                                                    2012               2011               2012               2011
                                                                           (In thousands)
Crude oil - barrels per day
United States                                             109                 82                104                 78
Europe                                                     80                 68                 91                 86
Africa                                                     75                 59                 75                 70
Asia                                                       17                 15                 17                 14

Total                                                     281                224                287                248


Natural gas liquids - barrels per day
United States                                              16                 13                 15                 13
Europe                                                      2                  3                  3                  3
Asia                                                        1                  1                  1                  1

Total                                                      19                 17                 19                 17


Natural gas - mcf per day
United States                                             116                102                112                103
Europe                                                     36                 55                 50                 78
Asia and other                                            462                458                459                453

Total                                                     614                615                621                634


Barrels of oil equivalent per day (*)                     402                344                409                371

(*) Reflects natural gas production converted on the basis of relative energy content (six mcf equals one barrel). Barrel of oil equivalence does not necessarily result in price equivalence as the equivalent price of natural gas on a barrel of oil equivalent basis has been substantially lower than the corresponding price for crude oil over the recent past. See the average selling prices in the table that begins on page 22.

United States: Production in the United States was higher in the third quarter and first nine months of 2012 compared to the corresponding periods in 2011, primarily due to increased production from the Bakken oil shale play.

Europe: Crude oil production in the third quarter and first nine months of 2012 was higher than the same periods in 2011, largely due to new wells in Russia and improved operating performance at the Schiehallion Field in the United Kingdom North Sea, which more than offset lower production from the Valhall Field, offshore Norway, resulting from planned downtime. The Schiehallion Field was sold at the end of the third quarter of 2012.

Natural gas production in the third quarter of 2012 was lower than the corresponding period in 2011, principally due to the sale in January 2012 of the Snohvit Field located offshore Norway, natural decline at the Beryl Field, and planned downtime at the Valhall Field. Natural gas production was lower in the first nine months of 2012 compared to the same period in 2011, mainly due to the sale in January 2012 of the Snohvit Field, the sale in February 2011 of certain natural gas producing assets in the United Kingdom North Sea and planned downtime of the Valhall Field.

Africa: Crude oil production in Africa was higher in the third quarter and first nine months of 2012 compared to the corresponding periods in 2011, mainly due to the resumption of operations in Libya following the civil unrest, partially offset by natural field declines in the Okume Complex in Equatorial Guinea.

Asia: Crude oil production in the third quarter and first nine months of 2012 was higher than the corresponding periods in 2011 due to new wells at the Pangkah Field in Indonesia.

Sales volumes: Higher sales volumes, primarily relating to crude oil, increased revenue by approximately $585 million and $1,095 million in the third quarter and first nine months of 2012, respectively, compared with the corresponding periods of 2011.


PART I - FINANCIAL INFORMATION (CONT'D.)

Results of Operations (continued)

Operating costs and depreciation, depletion and amortization: Cash operating costs, consisting of production expenses and general and administrative expenses, increased by approximately $110 million and $315 million in the third quarter and first nine months of 2012 compared with the same periods in 2011. The increase in third quarter expenses principally reflects higher operating and maintenance expenses, higher general and administrative expenses, together with increased production taxes. The increase in the costs for the first nine months of 2012 and 2011 was due to the cost drivers described above and higher workover expenses.

Depreciation, depletion and amortization expenses were higher in the third quarter and first nine months of 2012 compared to the same periods in 2011, principally reflecting increased production volumes from the Bakken and Eagle Ford fields and a higher average per barrel rate.

For the third quarter of 2012, E&P total production unit costs were $40.98 per barrel, consisting of cash operating costs of $21.37 per barrel and depreciation, depletion and amortization expenses of $19.61 per barrel. For the first nine months of 2012, E&P total production unit costs were $39.32 per barrel, consisting of cash operating costs of $20.36 per barrel and depreciation, depletion and amortization expenses of $18.96 per barrel.

E&P total production unit costs are expected to be in the range of $39.00 to $41.00 per barrel for the full year of 2012. E&P cash operating costs are expected to be in the range of $20.00 to $21.00 per barrel and depreciation, depletion and amortization expenses are expected to be in the range of $19.00 to $20.00 per barrel.

Asset impairments: In the third quarter of 2012, the Corporation recorded impairment charges of $208 million ($116 million after income taxes) due to increases in the Corporation's estimated abandonment liabilities for non-producing properties, which resulted in the book value of the properties exceeding their fair value. See Note 7, Asset Retirement Obligations. In the second quarter of 2012, the Corporation recorded a charge of $59 million ($36 million after-tax) to reduce the carrying value of certain properties in the Eagle Ford shale in Texas to their fair value. These properties were part of an asset exchange with a joint venture partner that was completed in the third quarter of 2012.

In the third quarter of 2011, the Corporation recorded impairment charges of $358 million ($140 million after income taxes) related to increases in the Corporation's estimated abandonment liabilities primarily for non-producing properties. These charges are all included in the table of items affecting comparability between periods on page 21.

Exploration expenses: Exploration expenses in the third quarter of 2012 were higher than the third quarter of 2011, due to the write off of the Corporation's assets in Peru following the decision in the quarter by the operator and the Corporation to cease future appraisal and development activities. Exploration expenses in the first nine months of 2012 were lower than the corresponding period in 2011, primarily due to lower lease impairment expenses. The amounts for the write off of assets in Peru are included as an item affecting comparability of earnings between periods shown on page 21.

Income taxes: Excluding items affecting comparability of earnings between periods, the effective income tax rate for E&P operations was 49% in the third quarter of 2012 compared to 27% for the third quarter of 2011, and was 46% for the first nine months of 2012 compared to 37% for the first nine months in 2011. These increases reflect the resumption of operations in Libya in 2012, following the civil unrest in 2011. For the full year of 2012, the Corporation expects the E&P effective tax rate, excluding items affecting comparability, to be in the range of 44% to 48%.

In July 2012, the government of the United Kingdom changed the supplementary income tax rate applicable to deductions for dismantlement expenditures to 20% from 32%. As a result, the Corporation recorded a one-time charge in the third quarter of 2012 of approximately $115 million for deferred taxes related to asset retirement obligations in the United Kingdom. In July 2011, the United Kingdom increased the supplementary tax rate on petroleum operations to 32% from 20% with an effective date of March 24, 2011. As a result, the Corporation recorded a charge of approximately $44 million in the third quarter. This charge consisted of a provision of $15 million representing the incremental tax on earnings from the effective date to the end of the second quarter and a charge of $29 million to increase the deferred tax liability in the United Kingdom. Both of these charges are reflected in the table of items affecting comparability on page 21.


                    PART I - FINANCIAL INFORMATION (CONT'D.)



Results of Operations (continued)



Foreign exchange: The following currency gains (losses) related to E&P
activities amounted to the following:



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