Nexen delivered strong financial results with cash flow of $488 million and net income of $615 million in the third quarter of 2005. Strong oil and gas commodity prices, improving product price differentials and gains on dispositions helped generate these results.
We accomplished these results even after our marketing division recorded a loss of $162 million in the third quarter. As a marketer of natural gas, we actively hold natural gas in storage and pipeline capacity to transport gas from Alberta to eastern markets. We use financial instruments to preserve the economic value of these physical assets. During the quarter, Hurricanes Katrina and Rita caused unprecedented volatility in the market. This resulted in a significant increase in the value of these physical assets. At the same time, the value of the financial instruments protecting the value of these assets decreased. While accounting rules require us to recognize the loss on the financial instruments, they do not allow us to recognize the gain on the offsetting physical assets until the gas is delivered and sold. Had we been able to recognize the economic value of these offsetting assets, marketing would have reported income of $33 million rather than a loss of $162 million for the quarter. We expect to recognize this difference of $195 million in income over the next two quarters as the gas is delivered and sold in eastern markets.
Income was further reduced by $260 million related to stock-based compensation. We have a broad stock-based compensation plan to attract and retain quality employees in a highly-competitive environment and have recognized stock-based compensation expense since 2003. Our common shares appreciated 49% during the quarter, adding approximately $5 billion in shareholder value. Cash flow was reduced by $33 million as a result of this charge.
Income was increased by $418 million as a result of gains on dispositions. We sold Canadian conventional oil and gas properties for proceeds of $946 million (before closing adjustments) during the quarter. The properties contributed approximately 18,300 boe/d and $56 million of cash flow in the second quarter and 6,500 boe/d and $23 million of cash flow in the third quarter. We recognized gains totaling approximately $225 million from these sales. During the quarter, we also raised $500 million from the sale of approximately 39% of our chemical business to Canexus Income Fund. We recognized a gain of $193 million on this disposition.
Third-quarter production improved modestly from the second quarter after considering asset dispositions in Canada and weather-related disruptions in the Gulf of Mexico. The dispositions reduced third-quarter production by 12,000 boe/d and Gulf production was reduced by approximately 10,000 boe/d as a result of hurricanes.
Production before Production after Royalties Royalties Crude Oil, NGLs and -------------------- -------------------- Natural Gas (mboe/d) Q3 2005 Q2 2005 Q3 2005 Q2 2005 --------------------------------------------------- -------------------- Yemen 114 115 61 64 North Sea 12 12 12 12 Canada 45 58 36 45 United States 39 43 33 37 Other Countries 5 6 5 5 Syncrude 17 17 17 17 -------------------- -------------------- Total 232 251 164 180 -------------------- --------------------
In Yemen, production before royalties from East Al Hajr (Block 51) increased approximately 6,000 bbls/d to average just over 30,000 bbls/d in the third quarter. The final stage of our production facilities are expected to be completed in the fourth quarter.In the North Sea, the Scott platform underwent a significant maintenance turnaround and facilities upgrade during the second and third quarters to improve reliability and facility capacity. The facilities upgrades included significant improvements to the electric, produced water injection, drilling and metering systems. The overhaul was completed in August.
In the Gulf of Mexico, Hurricane Rita resulted in significant damage to our facilities at Vermillion 321 and 340. These fields were producing approximately 3,900 boe/d prior to Rita. While we expect these facilities to be repaired in late 2005, resumption of production will be dependent on third-party infrastructure being repaired. Our current production is approximately 31,000 boe/d and we expect this to increase to approximately 42,000 boe/d by early November and to sustain this through the remainder of the year. We carry insurance that, subject to certain deductibles, should cover property damage and business interruption from this hurricane.
"Production in Yemen and Canada was strong over the first nine months of the year," said Charlie Fischer, Nexen's President and CEO. "We expect our average production for the year to be near the mid-point of our guidance of between 235,000 and 245,000 boe/d, even after our asset dispositions and the impact of storms in the Gulf."
Long Lake Project - Long-Term Growth Plans Solidified
Long Lake continues on schedule and on budget. With detailed engineering largely completed, approximately 60% of the project's total costs committed, and approximately 45% of these costs incurred, our experience remains in line with our original estimates. The major remaining cost uncertainty is related to labour access and productivity. We are monitoring these factors as field construction progresses. Long Lake is scheduled to begin steam injection in late-2006 and synthetic crude oil production in 2007.
Nexen and joint venture partner, OPTI Canada, are currently planning three future phases to increase production to 240,000 bbls/d by 2016 (120,000 bbls/d net to Nexen). Phase 2 will develop the southern portion of the Long Lake lease, known as Kinosis. Phases 3 and 4 are planned to develop jointly held lands at Cottonwood and Leismer. Detailed planning for Phase 2 has commenced. In 2006, we will invest in additional drilling and seismic to further evaluate our leases. We are moving forward with environmental and regulatory applications to support these staged developments.
Phase 2 steam-assisted gravity drainage (SAGD) production could be on- stream by late 2010 with upgrader start up by the second half of 2011. Each subsequent phase will leverage the significant knowledge and experience gained in the successful development of previous phases. Future phases will be of similar size and design as Long Lake, and consist of SAGD and an integrated upgrader. By keeping the core team in place and repeating and improving upon existing designs and execution plans, we expect to gain efficiencies in engineering, module fabrication and on-site construction.
"Long Lake and future phases represent an exciting opportunity for our company," said Fischer. "These projects have the potential to provide annual reserve additions approximating our current corporate production each year for the next decade and beyond."
Buzzard Update - Installation of Field Facilities Underway, Development
Drilling to Begin
The Buzzard development in the North Sea is over 80% complete and remains on schedule and on budget. We have installed the platform jackets and wellhead deck. Export and water injection pipelines have been installed and final tie-in of these pipelines is ongoing. We are mobilizing the Galaxy 3 drilling rig and will commence drilling the eight initial development wells shortly. Buzzard is scheduled to come on-stream late 2006. At its peak, Buzzard is expected to add approximately 85,000 boe/d of net production and between $1.6 and $1.7 billion of annual cash flow, assuming US$50/bbl WTI.
Our Farragon field development remains on schedule to begin producing late this year at between 3,000 and 4,000 boe/d, net to Nexen.
"With Buzzard, Long Lake and our other development projects on schedule, in two years we expect our net production to be approximately 50% higher than it is today," said Fischer. "This translates into cash flow of more than $4 billion in 2007, assuming oil prices of US$50."
Coal Bed Methane - Commercial Development of Mannville Coals
Nexen and its partners plan to invest approximately $400 million over the next 18 months to develop coal bed methane (CBM) from Upper Mannville coals in the Fort Assiniboine area of Alberta. This capital will be used to drill wells, construct production and water handling facilities, and expand existing facilities in the Corbett area. We are currently finalizing our drilling program and expect to have four drilling rigs active in the Corbett area during the fourth quarter.
"We are focused primarily on Upper Mannville coals which have high gas-in-place and large aerial extent," said Fischer. "We currently have over 500 net sections of CBM lands containing an estimated 3 tcf of gas-in-place. We are targeting 150 million cubic feet of daily CBM production by 2011."
Exploration Update - Continued Drilling Success
We had two small exploration successes in the North Sea during the quarter. The Polecat-1 well on Block 20/4a encountered 30 feet of net oil pay. The Yeoman-1 well on Block 15/18b found 32 feet of net gas and 52 feet of net oil pay. We have a 40% interest in Polecat and a 50% interest in Yeoman and operate both discoveries. We are currently drilling the Black Horse prospect on Block 15/22 and expect to drill one or two additional exploration wells in the North Sea this year.
One of our core strategies in the deep-water Gulf of Mexico is to explore for Miocene-aged, subsalt prospects in the Green Canyon, Walker Ridge, and Garden Banks areas. This strategy produced encouraging results during the second quarter at Knotty Head where we confirmed approximately 400 feet of high-quality net oil pay in shallower, secondary objectives.
Knotty Head is a large, four-way dip closure, approximately 15 miles northeast of the Tahiti discovery. The well is continuing to drill towards the primary objective in the lower Miocene, to a total depth of 32,500 feet. We have a 25% working interest in Knotty Head.
Elsewhere in the Gulf, Castleton, on Garden Banks 668, has reached its target depth and is being evaluated. This is a potential tie-back to the Gunnison facilities where we have available production capacity. We have a 30% non-operated interest in this well.
Drilling activity at the Pathfinder and Ringo Shallow prospects have been delayed due to hurricane damage to drilling rigs. Pathfinder, on Green Canyon 390, is expected to resume drilling late this year. Ringo, on Mississippi Canyon 546, is expected to spud early next year.
On Block 51 in Yemen, the BAK-I-2 well was abandoned. The BAK-U-1 is currently testing a basement target north of the BAK-A field. At BAK-J, we expect to re-enter the well and commence testing and drilling early in the fourth quarter.
Offshore West Africa, the Usan-7 and Usan-8 appraisal wells were successfully drilled during the quarter. The Field Development Plan for Usan on Block 222 has been approved by the Nigerian National Petroleum Corporation, the concessionaire of the licence. We are currently seeking approval from the Department of Petroleum Resources. The plan features development of Usan through 35 subsea wells connected to a two-million-barrel floating production and storage facility by subsea lines and risers. The processing capacity will be around 160,000 bbls/d. The operator has taken initial steps in the tendering process by publishing pre-qualification notices for contractors. A final investment decision is expected in 2006, with first oil planned by 2010.
"Looking back on the nine months of the year, I am very pleased with our results," said Fischer. "Even with the storm disruptions, our production has been strong, our major projects are on time and on budget, and our exploration program is delivering results. I would also emphasize that we have no fixed price hedges in place, and are benefiting fully from high commodity prices. We are on track for a great year."
The Board of Directors has declared the regular quarterly dividend of $0.05 per common share payable January 1, 2006, to shareholders of record on December 9, 2005.
Three Months Ended Nine Months Ended September 30 September 30 -------------------- -------------------- (Cdn$ millions) 2005 2004 2005 2004 ------------------------------------------------------------------------- Production (mboe/d)(1) Before Royalties 232 244 247 247 After Royalties 164 170 176 171 Net Sales 1,121 837 3,013 2,359 Cash Flow from Operations(2) 488 508 1,631 1,350 Per Common Share ($/share)(2) 1.87 1.97 6.27 5.26 Net Income 615 220 852 547 Per Common Share ($/share) 2.36 0.85 3.28 2.13 Capital Expenditures 648 380 1,923 1,046 ------------------------------------------------------------------------- (1) Production includes our share of Syncrude oil sands. US investors should read the Cautionary Note to US Investors at the end of this release. (2) For reconciliation of this non-GAAP measure, see Cash Flow from Operations on pg. 7.
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