Producers Show 3Q Earnings Gains from Commodity Prices

Royal Dutch/Shell Group was the only major to report third quarter earnings last week, but its performance, while strong, did not match analysts' high expectations. A few of the largest Houston-based independents -- Burlington Resources Inc., Apache Corp. and Marathon Oil Corp. -- also released their 3Q numbers, with Burlington easily surpassing Wall Street's expectations with a 238% increase in net income and a 3% overall boost in natural gas, natural gas liquids (NGLs) and crude oil production.

On Friday, Lehman Brothers analyst Thomas Driscoll released his estimated North American 3Q production numbers, which have only begun to be released. For the full year, the analyst is forecasting gas volumes to drop 2% in the United States and 3% in Canada.

Once all of the producers have released quarterly numbers, Driscoll estimates that North American gas production will show a 1.5-2% sequential decline, forcing industrial and some utility customers to reduce gas consumption this year. The Lehman survey accounts for about 70% of North American volumes. Among those reporting quarterly earnings this coming week will be Anadarko Petroleum Corp., BP plc, ConocoPhillips, ChevronTexaco, Kerr-McGee Corp., Unocal and Exxon Mobil Corp.

A number of exceptional charges offset production gains by Royal Dutch/Shell Group in the third quarter, and despite a double-digit earnings gain, the Anglo-Dutch energy giant fell short of Wall Street's 41% increase in earnings expectations. Shell, the world's third largest publicly traded oil and gas producer behind BP and Exxon Mobil., reported its net income rose 16% to $2.6 billion, compared with $2.24 billion in 3Q02. Analysts had forecast quarterly earnings to jump much higher, to $3.16 billion. Shell measures its profit on an adjusted current costs of supplies basis, which removes the fluctuating value of oil inventory. The third quarter charges totaled $330 million.

Shell's "numbers aren't as bad as they look at first glance, but they're still below expectations," said Citigroup Smith Barney analyst Jonathan Wright. With the special charges added into the figures, Wright said Shell's unit earnings still were 3-4% below expectations.

Shell also warned it will probably miss its year-end oil and gas production target of 4.1 MMboe/d by 1% because of asset sales and a change in the terms of a major production contract. In addition, Shell said it may fall short as much as 2% on a 2004 target of 13%-15% for return on average capital employed, or ROACE, because of accounting changes and currency fluctuations. ROACE is a key measurement of how efficiently a company uses its money.

Most of Shell's $239 million in third quarter special charges came from the impact of a declining power market for InterGen, its power generation business, in both the United States and Brazil, it said. Shell co-owns the InterGen power company with Bechtel Group in the United States. Net income at Shell's gas and power unit dropped 49% to $65 million on an adjusted basis from $127 million. The earnings, said Shell, also reflected strong market demand for liquefied natural gas (LNG) and continued high LNG prices.

"The power market is depressed; that is the essence of why we took an impairment," said Judy Boynton, Shell's CFO, during a conference call. She said Shell is working to improve its generation business to either prepare for a market upturn or to eventually sell the business.

Meanwhile, Shell's exploration and production operations reported a 22% earnings hike to $2.06 billion, reflecting significantly higher commodity prices, which were partly offset by lower production volumes. Production averaged 3.9 MMboe/d in the quarter, which was below analysts' expectations.

"Volume performance in the upstream is disappointing, and operating profit still looks a little light," said Commerzbank Securities said in a note. "Not as big a miss as it looks but still a miss," it added.

Production gains also proved no problem for Apache, which had a 34% overall gain and a 19% jump in natural gas production. The independent produced 449,034 boe/d in the quarter, which was 5% higher than in the second quarter. Natural gas production averaged 1.26 Bcf/d, up 19% from 1.06 Bcf/d in 3Q02. Natural gas liquids (NGL) production averaged 9,686 bbl/d, up from 8,081 bbl/d last year. Oil production rose 51% to 228,698 bbl/d, compared with 151,143 bbl/d in 3Q02.

Apache reported earnings of $276 million ($1.69/diluted share), compared with $145 million (95 cents) in 3Q02. Absent the impact of non-cash foreign currency fluctuations on deferred taxes, Apache would have earned $1.81 per share. Cash was a record $730 million, up 81% from the year-earlier period and a 14% sequential increase.

"Since the beginning of the year, Apache's production has increased by one-third, largely as a result of strategic acquisitions in the North Sea and the Gulf of Mexico, but also as a result of our very successful drilling program," said CEO G. Steven Farris. "Exploration success in Egypt and Australia has added future production potential in both of those core areas." Even with the acquisitions, Apache still ended the period with a debt-to-capitalization ratio of 28.5%, he said.

At Houston-based Marathon, CEO Clarence P. Cazalot Jr. attributed its upbeat third quarter to the "strong exploration performance of five discoveries," which he said "underscores our commitment to achieve profitable growth in existing and new core areas." Marathon's 3Q exploration program was marked by discoveries in Angola, Equatorial Guinea, the Gulf of Mexico and Norway, and year-to-date, Marathon has announced eight discoveries out of 12 significant exploratory wells.

Marathon reported quarterly net income of $281 million (90 cents/share), compared with $87 million (28 cents) in 3Q02. A year ago, Marathon had net income adjusted for special items that totaled $149 million (48 cents).

In the United States, Marathon's net natural gas production for the quarter was 704.4 MMcf/d, down from 709.6 MMcf/d in 3Q02. However, U.S. gas volumes for the quarter made a huge jump, totaling 718 Mcf/d, compared with 3Q02's reported 494.2 Mcf/d. Canadian gas volumes also were higher for the quarter, with a reported 319.5 Mcf/d, compared with 316.3 Mcf/d a year ago.

Marathon also reported progress in selling off non-core assets during the quarter. To date, Marathon's total 2003 non-core asset sales are nearing $1 billion. Taking into consideration the acquisitions and dispositions made to date, but excluding the impact of any additional sales, Marathon estimates its fourth quarter production will average approximately 375,000 boe/d. Full-year production now is forecast to average 390,000 boe/d, a reduction from July's forecast of 395,000 boe/d.

Houston-based Burlington had exceptional third quarter, which also was boosted by progress in the company's cost containment efforts. Burlington reported net income of $267 million ($1.33 per share) in the quarter, beating the Street's estimate of $1.01 a share. In the third quarter a year ago, the company reported earnings of $79 million (39 cents). Total production was 2,551 MMcfe/d, compared with last year's 2,465 MMcfe/d, an increase of 3% on a reported basis and 11% when adjusted for asset sales during 2002.

Burlington also achieved unit cost improvements during the quarter, with combined production and processing and administrative costs declining slightly to $0.66/Mcfe.

"This was yet another outstanding quarter for our company in terms of performance," said CEO Bobby S. Shackouls. "Further, we believe that we are in the early stages of an exceptional period of production growth for Burlington, which, in combination with our focus on cost efficiency and capital discipline, positions us to perform differentially throughout price cycles."

Natural gas production averaged 1,889 MMcf/d, up 3% from 3Q02's average of 1,839 MMcf/d. NGL production increased 6% to 63,000 bbl/d, compared with 59,600 bbl/d in 3Q02. Oil production also increased 6% to 47,300 bbl/d from 44,700 bbl/d a year ago.

Burlington's natural gas and NGL volumes were up in Canada, and significantly higher oil volumes internationally came from its MLN Field in Algeria, which it operates. Subsequent to the quarter, oil production began from the partner-operated Panyu Field offshore China, and gas volumes were rising in the Madden Field in Wyoming as a result of progress on the gathering line repairs.

Natural gas price realizations averaged $4.68/Mcf in the quarter, almost double from the $2.77/Mcf recorded in 3Q02. The company said increased pipeline capacity in the Rocky Mountains reduced basis differentials and increased prices realized for Burlington's gas production there. NGL price realizations of $20.42/bbl also were up from $15.22/bbl a year ago. And oil price realizations were $27.16/bbl, compared with $25.90 a year ago. Exploration expenses were higher in the quarter, standing at $55 million in the quarter, compared with $53 million in 3Q03.

Burlington is keeping its prior volume guidance in a target range of 2,500-2,640 MMcfe/d for the year. Next year, the company expects to hit the higher range of its targeted 3-8% volume growth.

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