form10-q.htm
 


 


UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C.  20549

FORM 10-Q

x   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2008

OR

¨   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from _____to_____

Commission file number: 001-07964
CORPORATE LOGO
NOBLE ENERGY, INC.
(Exact name of registrant as specified in its charter)


Delaware
 
73-0785597
(State of incorporation)
 
(I.R.S. employer identification number)
     
100 Glenborough Drive, Suite 100
   
Houston, Texas
 
77067
(Address of principal executive offices)
 
(Zip Code)

(281) 872-3100
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes [X]    No [  ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer [X]
Accelerated filer [  ]
Non-accelerated filer [  ]
Smaller reporting company [  ]
 
(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes [  ]    No [X]

Number of shares of common stock outstanding as of July 15, 2008: 172,697,075.



 

 

  PART I. FINANCIAL INFORMATION  
  ITEM 1. FINANCIAL STATEMENTS  
                         
  Noble Energy, Inc. and Subsidiaries  
  Consolidated Statements of Operations  
  (in millions, except per share amounts)  
  (unaudited)  
                         
   
Three Months Ended
   
Six Months Ended
 
   
June 30,
   
June 30,
 
   
2008
   
2007
   
2008
   
2007
 
Revenues
                       
Oil, gas and NGL sales
  $ 1,130     $ 727     $ 2,074     $ 1,394  
Income from equity method investees
    56       49       118       95  
Other revenues
    19       18       38       48  
Total
    1,205       794       2,230       1,537  
Costs and Expenses
                               
Lease operating expense
    88       83       170       161  
Production and ad valorem taxes
    51       28       94       54  
Transportation expense
    16       16       29       27  
Exploration expense
    103       54       143       99  
Depreciation, depletion and amortization
    196       183       399       349  
General and administrative
    61       48       121       93  
Loss on involuntary conversion
    -       38       -       51  
Other operating expense, net
    18       16       38       32  
Total
    533       466       994       866  
Operating Income
    672       328       1,236       671  
Other (Income) Expense
                               
Loss (gain) on commodity derivative instruments
    828       (1 )     1,065       (2 )
Interest, net of amount capitalized
    17       31       34       58  
Other expense, net
    25       5       18       18  
Total
    870       35       1,117       74  
Income (Loss) Before Income Taxes
    (198 )     293       119       597  
Income Tax Provision (Benefit)
    (54 )     84       48       176  
Net Income (Loss)
  $ (144 )   $ 209     $ 71     $ 421  
                                 
Earnings (Loss) Per Share
                               
Basic
  $ (0.84 )   $ 1.22     $ 0.41     $ 2.46  
Diluted
  $ (0.84 )   $ 1.21     $ 0.41     $ 2.43  
                                 
Weighted average number of shares outstanding
                               
    Basic
    172       171       172       171  
    Diluted
    172       173       175       173  
                                 
The accompanying notes are an integral part of these financial statements.
                         

 
2

 

Noble Energy, Inc. and Subsidiaries
 
Consolidated Balance Sheets
 
(in millions, except share amounts)
 
             
   
(Unaudited)
       
   
June 30,
   
December 31,
 
   
2008
   
2007
 
ASSETS
           
Current Assets
           
Cash and cash equivalents
  $ 983     $ 660  
Accounts receivable - trade, net
    864       594  
Other current assets
    301       315  
    Total current assets
    2,148       1,569  
Property, plant and equipment
               
Oil and gas properties (successful efforts method of accounting)
    11,129       10,217  
Other property, plant and equipment
    139       112  
Total property, plant and equipment
    11,268       10,329  
Accumulated depreciation, depletion and amortization
    (2,799 )     (2,384 )
Total property, plant and equipment, net
    8,469       7,945  
Goodwill
    759       761  
Other noncurrent assets
    561       556  
Total Assets
  $ 11,937     $ 10,831  
                 
LIABILITIES AND SHAREHOLDERS’ EQUITY
               
Current Liabilities
               
Accounts payable - trade
  $ 921     $ 781  
Commodity derivative instruments
    964       540  
Other current liabilities
    320       315  
    Total current liabilities
    2,205       1,636  
Deferred income taxes
    1,999       1,984  
Asset retirement obligations
    146       131  
Commodity derivative instruments
    390       83  
Other noncurrent liabilities
    361       337  
Long-term debt
    1,851       1,851  
Total Liabilities
    6,952       6,022  
                 
Commitments and Contingencies
               
                 
Shareholders’ Equity
               
Preferred stock - par value $1.00; 4 million shares authorized, none issued
    -       -  
Common stock - par value $3.33 1/3; 250 million shares authorized;
               
192 million and 191 million shares issued, respectively
    641       636  
Capital in excess of par value
    2,170       2,106  
Accumulated other comprehensive loss
    (195 )     (284 )
Treasury stock, at cost; 19 million shares
    (613 )     (613 )
Retained earnings
    2,982       2,964  
Total Shareholders’ Equity
    4,985       4,809  
Total Liabilities and Shareholders’ Equity
  $ 11,937     $ 10,831  
                 
The accompanying notes are an integral part of these financial statements.
               
                 
 

 
3

 
 
Noble Energy, Inc. and Subsidiaries
 
Consolidated Statements of Cash Flows
 
(in millions)
 
(unaudited)
 
   
Six Months Ended
 
   
June 30,
 
   
2008
   
2007
 
Cash Flows From Operating Activities
           
Net income
  $ 71     $ 421  
Adjustments to reconcile net income to net cash provided by operating activities:
               
Depreciation, depletion and amortization
    399       349  
Dry hole expense
    69       31  
Deferred income taxes
    10       104  
Income from equity method investees
    (118 )     (95 )
Dividends received from equity method investees
    121       97  
Unrealized loss (gain) on commodity derivative instruments
    934       (2 )
Settlement of previously recognized hedge losses
    (101 )     (91 )
Loss on involuntary conversion
    -       51  
Other
    59       98  
Changes in operating assets and liabilities, net of acquisition:
               
(Increase) in accounts receivable
    (276 )     (22 )
(Increase) decrease in other current assets
    (28 )     37  
Increase in accounts payable
    64       30  
(Decrease) in other current liabilities
    (50 )     (235 )
Net Cash Provided by Operating Activities
    1,154       773  
                 
Cash Flows From Investing Activities
               
Additions to property, plant and equipment
    (932 )     (695 )
Proceeds from property sales
    109       -  
Net Cash Used in Investing Activities
    (823 )     (695 )
                 
Cash Flows From Financing Activities
               
Exercise of stock options
    24       16  
Excess tax benefits from stock-based awards
    23       10  
Cash dividends paid
    (53 )     (33 )
Purchases of treasury stock
    (2 )     (102 )
Proceeds from credit facility
    450       280  
Repayment of credit facility
    (425 )     (115 )
Repayment of installment notes
    (25 )     -  
Proceeds from short term borrowings
    -       15  
Net Cash (Used in) Provided by Financing Activities
    (8 )     71  
Increase in Cash and Cash Equivalents
    323       149  
Cash and Cash Equivalents at Beginning of Period
    660       153  
Cash and Cash Equivalents at End of Period
  $ 983     $ 302  
                 
The accompanying notes are an integral part of these financial statements.
               


 
 
4

 

Noble Energy, Inc. and Subsidiaries
 
Consolidated Statements of Shareholders' Equity
 
(in millions)
 
(unaudited)
 
                                                   
                           
Accumulated
                     
   
Shares of Stock
         
Capital in
   
Other
     
 Treasury
 
   
Total
 
   
Common
   
Treasury
   
Common
   
Excess of
   
Comprehensive
     
 Stock
   
Retained
   
Shareholders'
 
   
Stock
   
Stock
   
Stock
   
Par Value
   
Loss
     
 at Cost
   
Earnings
   
Equity
 
December 31, 2007
    191       19     $ 636     $ 2,106     $ (284 )   $ 
 (613
)   $ 2,964     $ 4,809  
Net income
    -       -       -       -       -      
-
      71       71  
Stock-based compensation expense
    -       -       -       20       -      
-
      -       20  
Exercise of stock options
    1       -       4       20       -      
-
      -       24  
Tax benefits related to exercise of stock options
    -       -       -       23       -      
-
      -       23  
Restricted stock awards, net
    -       -       1       (1 )     -      
-
      -       -  
Dividends ($0.30 per share)
    -       -       -       -       -      
-
      (53 )     (53 )
Changes in treasury stock, net
    -       -       -       2       -      
-
      -       2  
Oil and gas cash flow hedges:
                                                                
  Realized amounts reclassified into earnings
    -       -       -       -       97      
-
      -       97  
Interest rate cash flow hedges:
                                                               
  Unrealized change in fair value
    -       -       -       -       (7 )    
-
      -       (7 )
Net change in other
    -       -       -       -       (1 )     -       -       (1 )
June 30, 2008
    192       19     $ 641     $ 2,170     $ (195 )  
 (613
)   $ 2,982     $ 4,985  
                                                                 
December 31, 2006
    188       17     $ 629     $ 2,041     $ (140 )  
(511
)   $ 2,095     $ 4,114  
Net income
    -       -       -       -       -      
 -
      421       421  
Stock-based compensation expense
    -       -       -       12       -      
 -
      -       12  
Exercise of stock options
    1       -       3       13       -      
 -
      -       16  
Tax benefits related to exercise of stock options
    -       -       -       10       -        -       -       10  
Restricted stock awards, net
    1       -       2       (2 )     -      
 -
      -       -  
Dividends ($0.195 per share)
    -       -       -       -       -      
 -
      (33 )     (33 )
Purchases of treasury stock
    -       2       -       -       -      
 (102
)     -       (102 )
Oil and gas cash flow hedges:
                                                               
  Realized amounts reclassified into earnings
    -       -       -       -       (3 )    
 -
      -       (3 )
  Unrealized change in fair value
    -       -       -       -       (51 )    
 -
      -       (51 )
Net change in other
    -       -       -       -       2      
 -
      -       2  
June 30, 2007
    190       19     $ 634     $ 2,074     $ (192 )  
 (613
)   $ 2,483     $ 4,386  
                                                                 
The accompanying notes are an integral part of these financial statements.
                                 
 


 
5

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 (unaudited)

Note 1 – Organization and Nature of Operations
Noble Energy, Inc. (Noble Energy, we or us) is an independent energy company engaged in the acquisition, exploration, development, production and marketing of crude oil, natural gas and natural gas liquids (NGLs). We have exploration, exploitation and production operations in the US and internationally. We operate throughout major basins in the US including Colorado’s Wattenberg field and Piceance basin, the Mid-continent region of western Oklahoma and the Texas Panhandle, the San Juan Basin in New Mexico, the Gulf Coast and the Gulf of Mexico. In addition, we conduct business internationally in China, Ecuador, the Mediterranean Sea, the North Sea, West Africa (Equatorial Guinea and Cameroon) and in other areas.

Note 2 – Basis of Presentation
Presentation – The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the US for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required by US generally accepted accounting principles (GAAP) for complete financial statements. The accompanying consolidated financial statements at June 30, 2008 (unaudited) and December 31, 2007 and for the three months and six months ended June 30, 2008 and 2007 contain all normally recurring adjustments considered necessary for a fair presentation of our financial position, results of operations and cash flows for such periods. Operating results for the six-month period ended June 30, 2008 are not necessarily indicative of the results that may be expected for the year ended December 31, 2008. Certain reclassifications of amounts previously reported have been made to conform to current year presentations.  These consolidated financial statements should be read in conjunction with the consolidated financial statements and accompanying notes included in our annual report on Form 10-K, as amended, for the year ended December 31, 2007.

Mid-continent Acquisition – In July 2008, we acquired producing properties in western Oklahoma for $291 million in cash, subject to customary adjustments. Properties acquired cover approximately 15,500 net acres and are currently producing 25 MMcfepd.

Statements of Operations Information – Other statements of operations information is as follows:

   
Three Months Ended
   
Six Months Ended
 
   
June 30,
   
June 30,
 
   
2008
   
2007
   
2008
   
2007
 
   
(in millions)
 
Other Revenues
                       
Electricity sales
  $ 14     $ 14     $ 29     $ 37  
Gathering, marketing and processing revenues
    5       4       9       11  
Total
  $ 19     $ 18     $ 38     $ 48  
Other Operating Expense, net
                               
Electricity generation expense
  $ 13     $ 12     $ 28     $ 28  
Gathering, marketing and processing expense
    4       4       8       9  
Other operating (income) expense, net
    1       -       2       (5 )
Total
  $ 18     $ 16     $ 38     $ 32  
Other Expense, net
                               
Deferred compensation expense
  $ 29     $ 3     $ 22     $ 15  
Interest income
    (6 )     (3 )     (12 )     (6 )
Other (income) expense, net
    2       5       8       9  
Total
  $ 25     $ 5     $ 18     $ 18  
 

 
6

 


Balance Sheet Information – Other balance sheet information is as follows:
 
 
June 30,
 
December 31,
 
 
2008
 
2007
 
    (in millions)  
Other Current Assets
       
Inventories
$ 92   $ 60  
Commodity derivative instruments
  52     15  
Prepaid expenses and other current assets
  24     27  
Deferred income taxes
  133     131  
Assets held for sale
  -     82  
Total
$ 301   $ 315  
Other Noncurrent Assets
           
Equity method investments
$ 355   $ 357  
Mutual fund investments
  117     124  
Probable insurance claims
  37     37  
Commodity derivative instruments
  22     5  
Other noncurrent assets
  30     33  
Total
$ 561   $ 556  
Other Current Liabilities
           
Accrued and other current liabilities
$ 233   $ 206  
Current income taxes payable
  -     52  
Current installment of long-term debt
  25     25  
Asset retirement obligations
  15     13  
Interest payable
  11     18  
Interest rate lock derivative instrument
  12     1  
Deferred gain on asset sale
  24     -  
Total
$ 320   $ 315  
Other Noncurrent Liabilities
           
Deferred compensation liability
$ 243   $ 225  
Accrued benefit costs
  59     51  
Other noncurrent liabilities
  59     61  
Total
$ 361   $ 337  
 
Adoption of SFAS 157 – We adopted Statement of Financial Accounting Standards No. 157, “Fair Value Measurements” (SFAS 157), as of January 1, 2008 as related to our financial assets and liabilities. SFAS 157 establishes a single authoritative definition of fair value based upon the assumptions market participants would use when pricing an asset or liability and creates a fair value hierarchy that prioritizes the information used to develop those assumptions. Under the standard, additional disclosures are required, including disclosures of fair value measurements by level within the fair value hierarchy. As a result of adoption, we have begun incorporating our own credit standing into the measurement of certain liabilities. Adoption of SFAS 157 did not have a significant impact on our consolidated financial statements. See Note 3 – Fair Value Measurements. On January 1, 2009, we will adopt SFAS 157 as it relates to non-financial assets and liabilities, including nonfinancial assets and liabilities measured at fair value in a business combination; impaired properties, plants and equipment; goodwill; and initial recognition of asset retirement obligations. We do not expect any significant impact to our consolidated financial statements when we implement SFAS 157 for these assets and liabilities.
 
Adoption of FSP FIN 39-1 – We adopted FASB Staff Position FIN 39-1, “An Amendment of FASB Interpretation No. 39” (FSP FIN 39-1), as of January 1, 2008. FSP FIN 39-1 addresses certain modifications to FIN 39, “Offsetting of Amounts Related to Certain Contracts.” FIN 39-1 allows companies to offset fair value amounts recognized for derivative instruments and the fair value amounts recognized for the right to reclaim cash collateral or the obligation to return cash collateral. The cash collateral (commonly referred to as a “margin”) must arise from derivative instruments recognized at fair value that are executed with the same counterparty under a master netting arrangement. Upon adoption, we elected to offset the right to reclaim cash collateral or the obligation to return cash collateral against our net derivative positions for which master netting agreements exist. As of June 30, 2008 and December 31, 2007, we had no significant cash collateral obligations.

 
7

 

Note 3 – Fair Value Measurements
Measurement information for financial assets and liabilities reported at fair value at June 30, 2008, includes the following:
 
 
Fair Value Measurements Using
               
 
Quoted Prices in
Active Markets(Level 1)
 
Significant Other
Observable Inputs
(Level 2)
 
Significant
Unobservable Inputs
(Level 3)
   
Netting
Adjustment (1)
   
 Fair
Value
Measurement
 
   (in millions)  
Financial assets:
                         
Mutual fund investments
$ 117   $ -   $ -     $ -      $
 117
 
Commodity derivative instruments
  -     130     -       (56 )    
 74
 
Financial liabilities:
                                 
Commodity derivative instruments
  -     (1,410 )   -       56      
 (1,354
Interest rate lock derivative instruments
  -     (12 )   -       -        (12
) 
 
(1)  
Amount represents the impact of master netting agreements that allow us to settle asset and liability positions with the same counterparty.

SFAS 157, which we adopted as of January 1, 2008, establishes a fair value hierarchy which prioritizes the inputs to valuation techniques used to measure fair value into three levels. The fair value hierarchy gives the highest priority to quoted market prices (unadjusted) in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). Level 2 inputs are inputs, other than quoted prices included within Level 1, that are observable for the asset or liability, either directly or indirectly. We use Level 1 inputs when available as Level 1 inputs generally provide the most reliable evidence of fair value. We use the following methods and assumptions to estimate the fair values of the assets and liabilities in the table above:

Mutual Fund Investments Our mutual fund investments consist of various publicly-traded mutual funds that include investments ranging from equities to money market instruments. The fair values are based on quoted market prices.

Commodity Derivative Instruments – Our commodity derivative instruments consist of variable to fixed price swaps, costless collars and basis swaps. We estimate the fair values of these instruments based on published forward commodity price curves for the underlying commodities as of the date of the estimate. The discount rate used in the discounted cash flow projections includes a measure of nonperformance risk. In addition, for costless collars, we estimate the option value of the contract floors and ceilings using an option pricing model which takes into account market volatility, market prices and contract parameters. See Note 4 – Derivative Instruments and Hedging Activities.

Interest Rate Lock Derivative Instruments – At June 30, 2008, we had interest rate locks of $1 billion notional value, based on US Treasury rates. We estimate the fair values of the locks based on published interest rate yield curves as of the date of the estimate. We settled the locks in July 2008. See Note 4 – Derivative Instruments and Hedging Activities.

Note 4 – Derivative Instruments and Hedging Activities
Commodity Derivative Instruments – We use various derivative instruments in connection with forecasted crude oil and natural gas sales to minimize the impact of commodity price fluctuations. Such instruments include variable to fixed price swaps, costless collars and basis swaps.

We account for derivative instruments and hedging activities in accordance with SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended (SFAS 133), and all derivative instruments are reflected at fair value on our consolidated balance sheets. We elected to designate certain of our commodity derivative instruments as cash flow hedges through December 31, 2007. However, effective January 1, 2008, we voluntarily discontinued cash flow hedge accounting on all existing commodity derivative instruments. We made this change to provide greater flexibility in our use of derivative instruments. From January 1, 2008 forward, we recognize all gains and losses on such instruments in earnings during the period in which they occur. Net derivative losses that were deferred in accumulated other comprehensive income (loss) (AOCL) as of December 31, 2007, as a result of previous cash flow hedge accounting, will be reclassified to earnings in future periods as the original hedged transactions occur. The discontinuance of cash flow hedge accounting for commodity derivative instruments did not affect our net assets or cash flows at December 31, 2007 and does not require adjustments to our previously reported financial statements.

 
8

 

The components of loss (gain) on commodity derivative instruments included in the consolidated statements of operations are as follows:

   
Three Months Ended
   
Six Months Ended
 
   
June 30,
   
June 30,
 
   
2008
   
2007
   
2008
   
2007
 
   
(in millions)
 
Unrealized loss on commodity derivative instruments
  $ 716     $ -     $ 934     $ -  
Realized loss on commodity derivative instruments
    112       -       131       -  
Ineffectiveness gain
    -       (1 )     -       (2 )
Loss (gain) on commodity derivative instruments
  $ 828     $ (1 )   $ 1,065     $ (2 )
 
Crude oil and natural gas sales include amounts reclassified from AOCL as follows:

   
Three Months Ended
   
Six Months Ended
 
   
June 30,
   
June 30,
 
   
2008
   
2007
   
2008
   
2007
 
   
(in millions)
 
Decrease in crude oil sales
  $ (93 )   $ (40 )   $ (190 )   $ (68 )
(Decrease) increase in natural gas sales
    (2 )     29       35       72  
Total (decrease) increase in oil and gas sales
  $ (95 )   $ (11 )   $ (155 )   $ 4  
 

 
9

 

As of June 30, 2008, we had entered into the following crude oil derivative instruments:

     Variable to Fixed Price Swaps      Costless Collars
             
Weighted
           
Weighted
   
Weighted
 
Production
     
Bbls
   
Average
     
Bbls
   
Average
   
Average
 
Period
 
Index
 
Per Day
   
Fixed Price
 
Index
 
Per Day
   
Floor Price
   
Ceiling Price
 
3rd Qtr 2008
 
NYMEX WTI
    16,500     $ 38.11  
NYMEX WTI
    3,100     $ 60.00     $ 72.40  
4th Qtr 2008
 
NYMEX WTI
    16,500       37.92  
NYMEX WTI
    3,100       60.00       72.40  
3rd Qtr 2008
 
Dated Brent
    2,000       88.18  
Dated Brent
    3,848       45.00       66.19  
4th Qtr 2008
 
Dated Brent
    2,000       88.18  
Dated Brent
    3,587       45.00       65.90  
                                               
2009
 
NYMEX WTI
    9,000       88.43  
NYMEX WTI
    6,700       79.70       90.60  
2009
 
Dated Brent
    2,000       87.98  
Dated Brent
    5,074       70.62       87.93  
                                               
2010
                   
NYMEX WTI
    5,500       69.00       85.65  
 
As of June 30, 2008, we had entered into the following natural gas derivative instruments:

   
Variable to Fixed Price Swaps (1)
 
Costless Collars
 
             
Weighted
           
Weighted
   
Weighted
 
Production
     
MMBtu
   
Average
     
MMBtu
   
Average
   
Average
 
Period
 
Index
 
Per Day
   
Fixed Price
 
Index
 
Per Day
   
Floor Price
   
Ceiling Price
 
3rd Qtr 2008
 
NYMEX HH
    170,000     $ 5.33  
 IFERC CIG
    14,000     $ 6.75     $ 8.70  
4th Qtr 2008
 
NYMEX HH
    170,000       5.63  
 IFERC CIG
    14,000       6.75       8.70  
                                               
2009
                   
NYMEX HH
    170,000       9.15       10.81  
2009
                   
 IFERC CIG
    15,000       6.00       9.90  
                                               
2010
                   
 IFERC CIG
    15,000       6.25       8.10  
 
(1)
In addition to the NYMEX HH variable to fixed price swaps shown above for 2008, we have 100,000 MMBtu per day of IFERC CIG basis swaps with an average differential to NYMEX HH of $(1.66) per MMBtu, 40,000 MMBtu per day of IFERC ANR-OK basis swaps with an average differential to NYMEX HH of $(1.01) per MMBtu, and 10,000 MMBtu per day of  IFERC PEPL basis swaps with an average differential to NYMEX HH of $(0.98) per MMBtu.

Approximately $130 million of deferred losses (net of tax) related to the fair values of the commodity derivative instruments previously designated as cash flow hedges and remaining in AOCL at June 30, 2008 will be reclassified to earnings during the next 12 months as the forecasted transactions occur, and will be recorded as a reduction in oil and gas sales.

Interest Rate Lock Derivative Instruments We entered into two interest rate swaps, or interest rate “locks”, each in the notional amount of $500 million. The locks were based on five and ten year US Treasury rates of 3.55% and 4.15%, respectively, and were scheduled to expire in September 2008. We designated these locks as cash flow hedges and a related deferred loss of $8 million, net of tax, was included in AOCL at June 30, 2008. We settled the locks in July 2008 at a total cost of $0.2 million.


 
10

 

Note 5 – Capitalized Exploratory Well Costs
Changes in capitalized exploratory well costs during the period were as follows:
 
   
Six Months Ended
 
   
June 30, 2008 (1)
 
   
(in millions)
 
       
Capitalized exploratory well costs at beginning of period
  $ 249  
Additions to capitalized exploratory well costs pending determination of proved reserves
    137  
Reclassed to proved oil and gas properties based on determination of proved reserves
    -  
Capitalized exploratory well costs charged to expense
    -  
Capitalized exploratory well costs at end of period
  $ 386  
 
(1) 
Changes in capitalized exploratory well costs exclude amounts that were capitalized and subsequently expensed in the same period.

The following table provides an aging of capitalized exploratory well costs (suspended well costs) based on the date the drilling was completed and the number of projects for which exploratory well costs have been capitalized for a period greater than one year since the completion of drilling:
 
   
June 30,
 
December 31,
 
   
2008
 
2007
 
   
(in millions, except
number of projects)
 
Capitalized exploratory well costs that have been capitalized for a period of one year or less
  $ 277     $ 187  
Capitalized exploratory well costs that have been capitalized for a period greater than one year after completion of drilling
    109       62  
Balance at end of period
  $ 386     $ 249  
Number of projects that have exploratory well costs that have been capitalized for a period greater than one year after completion of drilling
    6       5  
 
The following table provides a further aging of those exploratory well costs that have been capitalized for a period greater than one year since the completion of drilling as of June 30, 2008:
 
         
Suspended Since
 
   
Total
   
2007
   
2006
   
2005
 
   
(in millions)
 
Project
                       
Raton South (deepwater Gulf of Mexico)
  $ 27     $ 4     $ 23     $ -  
Redrock (deepwater Gulf of Mexico)
    17       -       17       -  
Blocks O and I (West Africa)
    47       27       1       19  
Flyndre (North Sea)
    15       12       3       -  
Other
    3       -       3       -  
Total capitalized exploratory well costs that have been capitalized for a period greater than one year since completion of drilling
  $ 109     $ 43     $ 47     $ 19  

 
 
11

 


Exploratory well costs capitalized for more than one year at June 30, 2008 include six projects, two of which include activity in the deepwater Gulf of Mexico.  One project relates to Raton South (Mississippi Canyon Block 292) and includes $27 million of suspended exploratory well costs. We currently have a rig on location to drill a sidetrack-appraisal well and further test this prospect. The other project relates to Redrock (Mississippi Canyon Block 204) and includes $17 million of suspended exploratory well costs. Redrock is currently considered a co-development candidate to the planned sidetrack-appraisal well at Raton South. In addition, we are currently evaluating options to tie back to subsea pipelines and other facilities.

We also incurred exploratory well costs of $47 million for the Blocks O and I project in West Africa. Since drilling the initial well for the project, additional seismic work has been completed and exploration and appraisal wells have been drilled to further evaluate our discoveries. The West Africa development team is proceeding with a program to further define the resources in this area such that an optimal development program may be designed. In addition to the amount of exploratory well costs that have been capitalized for a period greater than one year for the Blocks O and I project, we have incurred $187 million in suspended costs related to additional drilling activity in West Africa through June 30, 2008.

Another project, Flyndre, is located in the UK sector of the North Sea and incurred exploratory well costs of $15 million.  We successfully completed an exploratory appraisal well in 2007 and we are working with the operator to formulate a development plan.

The remaining two projects, which total $3 million in suspended exploratory well costs, continue to be evaluated by various means including additional seismic work, drilling additional wells and evaluating the potential of the exploration wells.

Note 6 – Asset Retirement Obligations
Asset retirement obligations consist primarily of estimated costs of dismantlement, removal, site reclamation and similar activities associated with our oil and gas properties. Changes in asset retirement obligations were as follows:
 
   
Six Months Ended
 
   
June 30, 2008
 
   
(in millions)
 
Asset retirement obligations at beginning of period
  $ 144  
Liabilities incurred in current period
    14  
Liabilities settled in current period
    (7 )
Revisions
    6  
Accretion expense
    4  
Asset retirement obligations at end of period
  $ 161  

Accretion expense is included in depreciation, depletion and amortization expense in the consolidated statements of operations.

 
12

 

Note 7 – Employee Benefit Plans
We have a noncontributory, tax-qualified defined benefit pension plan covering employees who were hired prior to May 1, 2006. We also have an unfunded, nonqualified restoration plan that provides the pension plan formula benefits that cannot be provided by the tax-qualified pension plan because of pay deferrals and the compensation and benefit limitations imposed on the pension plan by the Internal Revenue Code of 1986, as amended. Net periodic benefit cost related to the pension and restoration plans is as follows:
 
   
Three Months Ended
   
Six Months Ended
 
   
June 30,
   
June 30,
 
   
2008
   
2007
   
2008
   
2007
 
   
(in millions)
 
Service cost
  $ 3     $ 3     $ 6     $ 6  
Interest cost
    3       2       6       5  
Expected return on plan assets
    (3 )     (2 )     (6 )     (5 )
Other
    1       1       1       2  
Net periodic benefit cost
  $ 4     $ 4     $ 7     $ 8  
 
Note 8 – Stock-Based Compensation
We recognized stock-based compensation expense as follows:
 
   
Three Months Ended
   
Six Months Ended
 
   
June 30,
   
June 30,
 
   
2008
   
2007
   
2008
   
2007
 
   
(in millions)
 
Stock-based compensation expense
  $ 11     $ 7     $ 20     $ 12  
Tax benefit recognized
  $ (4 )   $ (3 )   $ (8 )   $ (5 )
 
During the six months ended June 30, 2008, we granted 1.1 million stock options with a weighted-average grant-date fair value of $20.65 per share and awarded 0.5 million shares of restricted stock subject to service conditions with a weighted-average grant-date fair value of $73.63 per share.

Note 9 – Basic and Diluted Earnings (Loss) Per Share
Basic earnings (loss) per share of common stock is computed using the weighted average number of shares of common stock outstanding during each period. The diluted earnings per share of common stock include the effect of outstanding stock options and restricted stock, except in periods in which there is a net loss. The following table summarizes the calculation of basic and diluted earnings (loss) per share:

         
Weighted
         
Weighted
 
   
Net
   
Average
   
Net
   
Average
 
   
Income (Loss)
   
Shares
   
Income
   
Shares
 
   
2008
   
2007
 
   
(in millions, except per share amounts)
 
Three Months Ended June 30:
                       
Net income (loss)
  $ (144 )     172     $ 209       171  
Basic Earnings (Loss) Per Share
  $ (0.84 )           $ 1.22          
                                 
Net income (loss)
  $ (144 )     172     $ 209       171  
Effect of dilutive stock options and restricted stock
    -       -       -       2  
Net income (loss) available to common shareholders
  $ (144 )     172     $ 209       173  
Diluted Earnings (Loss) Per Share
  $ (0.84 )           $ 1.21          
                                 
Six Months Ended June 30:
                               
Net income
  $ 71       172     $ 421       171  
Basic Earnings Per Share
  $ 0.41             $ 2.46          
                                 
Net income
  $ 71       172     $ 421       171  
Effect of dilutive stock options and restricted stock
    -       3       -       2  
Net income available to common shareholders
  $ 71       175     $ 421       173  
Diluted Earnings Per Share
  $ 0.41             $ 2.43          
 
A total of 1.1 million weighted average shares of our common stock held in a rabbi trust and weighted average stock options were antidilutive for both the second quarter and the first six months of 2008 and were excluded from the calculation of diluted earnings per share.  A total of 2.8 million and 2.6 million weighted average shares of our common stock held in a rabbi trust and weighted average stock options were antidilutive for second quarter and the first six months of 2007, respectively, and were excluded from the calculation of diluted earnings per share.

13

Note 10 Income Taxes
The income tax (benefit) provision consists of the following:
 
   
Three Months Ended
   
Six Months Ended
 
   
June 30,
   
June 30,
 
   
2008
   
2007
   
2008
   
2007
 
   
(in millions)
 
Current
  $ (28 )   $ 28     $ 38     $ 72  
Deferred
    (26 )     56       10       104  
Total income tax (benefit) provision
  $ (54 )   $ 84     $ 48     $ 176  
 
The deferred tax assets associated with the foreign loss carryforwards of certain controlled foreign corporations, primarily Suriname, have increased during 2008.  In addition, because management currently does not believe it is more likely than not that the deferred tax assets related to these foreign loss carryforwards will be realized, the valuation allowance has been increased.

In 2007, China’s legislature, the National People’s Congress, enacted the China Corporate Income Tax Law.  This new legislation decreased our tax rate in China from 33% to 25% starting in 2008.

Unrecognized Tax Positions  We do not have significant unrecognized tax benefits as of June 30, 2008. Our policy is to recognize any interest and penalties related to unrecognized tax benefits in income tax expense. We did not accrue interest or penalties at June 30, 2008, because the jurisdiction in which we have unrecognized tax benefits does not currently impose interest on underpayments of tax, and we believe that we are below the minimum statutory threshold for imposition of penalties.
 
In our major tax jurisdictions, the earliest years remaining open to examination are as follows: US - 2004, Equatorial Guinea - 2006, China - 2006, Israel - 2000, UK - 2006 and the Netherlands - 2005.

Note 11 – Comprehensive Income (Loss)
Comprehensive income (loss) includes net income (loss) and certain items recorded directly to shareholders’ equity and classified as AOCL. Comprehensive income (loss) was calculated as follows:
 
   
Three Months Ended
   
Six Months Ended
 
   
June 30,
   
June 30,
 
   
2008
   
2007
   
2008
   
2007
 
   
(in millions)
 
Net income (loss)
  $ (144 )   $ 209     $ 71     $ 421  
Other items of comprehensive income (loss)
                               
Oil and gas cash flow hedges:
                               
Realized amounts reclassified into earnings
    95       11       155       (4 )
Less tax provision
    (36 )     (4 )     (58 )     1  
Unrealized change in fair value:
    -       18       -       (82 )
Less tax provision
    -       (7 )     -       31  
Interest rate cash flow hedges:
                               
Unrealized change in fair value
    32       -       (11 )     -  
Less tax provision
    (12 )     -       4       -  
Net change in other:
    -       1       (1 )     2  
Other comprehensive income (loss)
    79       19       89       (52 )
                                 
                                 
Comprehensive income (loss)
  $ (65 )   $ 228     $ 160     $ 369  
 
14

Note 12 – Segment Information
We have operations throughout the world and manage our operations by country. The following information is grouped into five components that are all primarily in the business of natural gas and crude oil acquisition, exploration and production:  the US, West Africa, the North Sea, Israel, and Other International, Corporate and Marketing. Other International includes Argentina (through February 2008), China, Ecuador and Suriname.

In February 2008, we closed on the sale of our interest in Argentina for a sales price of $117.5 million, effective July 1, 2007. The gain on sale has been deferred, as the sale is contingent upon approval of the Argentine government. We are currently unable to predict when government approval will be obtained. The Argentina operations, financial position and cash flows are not material for the current or prior periods and have not been segregated as discontinued operations.

The following data was prepared on the same basis as our consolidated financial statements and excludes the effects of income taxes.
 
                               
Other Int'l
 
         
United
   
West
   
North
       
Corporate &
 
   
Consolidated
   
States
   
Africa
   
Sea
   
Israel
 
Marketing
 
   
(in millions)
 
Three Months Ended June 30, 2008
                                 
Revenues from third parties
  $ 1,244     $ 752     $ 163     $ 99     $ 30   $ 200  
Amount reclassified from AOCL (1)
    (95 )     (84 )     (11 )     -       -     -  
Intersegment revenue
    -       144       -       -       -     (144 )
Income from equity method investees
    56       -       56       -       -     -  
Total Revenues
    1,205       812       208       99       30     56  
                                               
DD&A
    196       165       9       12       5     5  
Loss on commodity derivative instruments
    828       677       151       -       -     -  
Income (loss) before taxes
    (198 )     (214 )     38       72       23     (117 )
                                               
Three Months Ended June 30, 2007
                                             
Revenues from third parties
  $ 756     $ 426     $ 122     $ 62     $ 24   $ 122  
Amount reclassified from AOCL (1)
    (11 )     (11 )     -       -       -     -  
Intersegment revenue