Nexen Inc., Canada’s fourth largest oil and gas producer, saw its profit nearly halved in the second quarter on lower-than-expected production results and charges on stock option plan changes. The independent, which focuses on oil and gas production in the Gulf of Mexico (GOM), Canada, Yemen and Nigeria, as well as oil sands in Canada, also took an earnings hit from new accounting rules that govern natural gas in storage.

The Calgary-based producer reported earnings totaled C$143 million (C$1.09/diluted share) for the three months, down 46% from 2Q2003’s C$263 million (C$2.04). By converting Nexen’s stock option plan to a tandem option plan — allowing employees to take cash instead of shares — the company also reduced its earnings by C$54 million after tax.

And while Nexen had unrealized gains of C$21 million on 20 Bcf of natural gas it had in storage at the end of the second quarter, it had to expense-related costs under new accounting rules. Cash flow also fell 5% to C$428 million (C$3.32/share), from C$452 million (C$3.53) reported a year ago.

Higher commodity prices helped, but worldwide, unexpected maintenance problems and natural declines sent Nexen’s production down 14% over a year ago. Production averaged 167,000 boe after royalties, down from 195,000 in 2Q2003, and nearly all of its operating areas reported lower production than a year ago. Lower output had been expected in some areas, including Canada, where Nexen had sold assets since 2Q2003.

In the quarter, GOM production fell 5,300 boe/d mostly because of higher water content from natural gas pumped at its Vermilion 76, located on the Outer Continental Shelf. Nexen also had to shut off a well at its new Gunnison project earlier than expected so that it could be re-completed. And in Yemen, output fell nearly 5,000 boe/d because of field maintenance and natural production declines.

CEO Charlie Fischer said Nexen’s business plan in the GOM “is to exploit mature assets. Historically, we have offset base declines through drilling. The timing of our shelf drilling program prevented this until late in the second quarter.” Nexen expects production in the Gulf to exit the year producing at approximately 75,000 boe/d.

Fischer told analysts during a conference call Thursday that production already is on the increase in the second half of this year. He said for the year, output will be at the low end of Nexen’s target range. The company had budgeted output after royalties of 180,000-195,000 boe/d.

“We expect to drill a number of high-potential exploration wells in the Gulf of Mexico in the second half of the year,” said Fischer. “These include prospects at Crested Butte, three miles northwest of our Aspen field; Anduin in the Mississippi Canyon; and a deep-shelf test at Main Pass 240. We are finalizing our technical evaluation of a number of additional deep-shelf gas prospects and expect to begin drilling four or more of these before year-end. All of these prospects are exciting opportunities, featuring relatively short-cycle times from discovery to production.”

Fischer said, “If oil prices average US$30/bbl and natural gas prices average US$4.25/MMBtu during the second half of the year, we expect cash flow for the year of approximately C$1.7 billion, and a modest increase in our net debt. At current prices, we expect to further reduce our debt this year. This is important as we continue to develop our Long Lake [Canada] Synthetic Crude Oil project.”

Lehman Brothers called the earnings and production numbers “disappointing,” and lowered 2004 and 2005 production estimates by 3% each. “We feel key drivers of stock price performance over the next 12 months will be associated with progress on its Long Lake oil sands project as a cost overrun/delay could negatively impact share price,” said Thomas Driscoll and Philip R. Skolnick. “We also feel a high potential exploration program will be a catalyst.”

Lehman now estimates production (gross of royalties) in 2004 will decline 6% to 253 Mboe/d, versus a previous estimate of 261 Mboe/d “and rise about 5% to 265 Mboe/d next year (versus our previous 275 Mboe/d estimate).”

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