"During the second quarter 2006, Marathon continued to benefit from strong operational performances in both our upstream and downstream businesses, while maintaining our focus on key safety and environmental goals. Our strong operational performance was complemented by substantial investments in all segments of our Company," said Clarence P. Cazalot, Jr., Marathon president and CEO. "Since January 2005, Marathon has invested more than $9 billion across all segments of the Company, which is significantly in excess of Marathon's net income of approximately $5.6 billion over this same 18-month period. During this time, we have continued to advance our major projects around the world. These projects and future investments will help Marathon meet the energy needs of our customers while adding long-term shareholder value."
In early June, Marathon completed the sale of its Russian oil exploration and production businesses in the Khanty-Mansiysk region of western Siberia to OAO Lukoil, for a total transaction value of $787 million plus working capital and other closing adjustments, netting an after-tax gain of $243 million. The activities of these businesses have been reported as discontinued operations and therefore have been excluded from segment results for all periods presented in this release.
Effective January 1, 2006, Marathon revised its measure of segment income to reflect the effects of minority interests and income taxes related to the segments. In addition, the results of activities primarily associated with the marketing of the Company's equity natural gas production, which had been presented as part of the Integrated Gas segment prior to 2006, are now included in the Exploration and Production segment. Segment information for all periods presented in this release reflect these changes.
Total segment income was $1.593 billion in the second quarter 2006, compared with $820 million in the second quarter 2005.
Exploration and Production
Upstream segment income totaled $659 million in the second quarter 2006, compared to $504 million in the second quarter 2005. The increase was primarily due to higher hydrocarbon sales prices and liquid hydrocarbon volumes. Reported sales volumes during the quarter averaged 392,000 barrels of oil equivalent per day (boepd) compared to production available for sale of 353,000 boepd. Both of these daily volumes exclude approximately 20,000 boepd from Russian operations which, as discussed above, are not reflected in segment income but in discontinued operations.
The difference between the 353,000 boepd available for sale and the 392,000 boepd of sales from continuing operations resulted primarily from the timing of international crude oil liftings. At the end of the first quarter 2006, the Company had an underlift balance from international operations of approximately 4 million barrels. During the second quarter 2006, the Company was overlifted by 3.5 million barrels, of which 1.8 million was attributed to Libya. As a result, the Company is in a relatively balanced position on liftings versus production on a worldwide basis at the end of the second quarter 2006.
Marathon estimates 2006 average daily production available for sale to be 350,000 to 370,000 boepd. This estimate excludes Russia, which has been treated as a discontinued operation, and excludes the impact of any future acquisitions or dispositions.
United States upstream income was $243 million in the second quarter 2006, compared to $258 million in the second quarter 2005. The lower income in second quarter 2006 is primarily a result of lower natural gas sales volumes and prices. The lower volumes were due largely to the watering out of the Camden Hills field in the Gulf of Mexico early in the first quarter of this year. Also contributing to the lower income was higher dry well expense in the second quarter 2006 and business interruption insurance proceeds associated with damage from Hurricane Ivan in the second quarter 2005. These income decreases were partially offset by higher liquid hydrocarbon prices.
International upstream income was $416 million in the second quarter 2006, compared to $246 million in the second quarter 2005. The increase was primarily a result of higher hydrocarbon prices and higher liquid hydrocarbon sales volumes due to the resumption of production in Libya and the benefit of a full quarter of the condensate expansion project in Equatorial Guinea. This increase was partially offset by higher international income taxes.
Marathon continues to advance its major projects. At the end of the second quarter 2006, the Alvheim project in Norway was 64 percent complete and on target to deliver first production in the first quarter of 2007. As part of this project, Alvheim development drilling commenced in the second quarter 2006. Installation of pipelines and umbilicals has been completed and additional subsea structures are currently being installed. In addition, the first phase of the module lifts onto the Alvheim floating production, storage and offloading (FPSO) vessel has been completed and integration of all FPSO components is proceeding.
The Neptune development in the Gulf of Mexico was 28 percent complete at the end of the second quarter 2006, and remains on target to deliver first production by early 2008. Development drilling began in the second quarter 2006 and will continue through first oil.
Marathon recently completed a leasehold acquisition of a long-life natural gas asset in the Piceance Basin of Colorado estimated to contain in excess of 900 billion cubic feet (bcf) of net recoverable natural gas resource. The acreage is located in Garfield County in the Greater Grand Valley Field Complex and is flanked by, and on-trend with, adjacent production. Marathon acquired this leasehold in a cash transaction valued at $354 million. The Company plans to drill approximately 700 wells over the next 10 years with the potential to add nearly 180 million net cubic feet per day of natural gas production by 2014. First production is expected in late 2007.
In the exploration program year-to-date, Marathon has four discoveries out of eight exploration wells, three in Angola and one in Norway. During the second quarter of 2006, Marathon participated in two deepwater discoveries in Block 31 offshore Angola, where Marathon holds a 10 percent interest. These two discoveries were the Urano prospect and a yet to be announced exploration well in the southeast portion of the block. Additional drilling/seismic analysis will be required to determine commerciality of these two discoveries. The other two discoveries, announced in the first quarter 2006, are the Mostarda well on Block 32 offshore Angola, where Marathon has a 30 percent interest, and the Gudrun well offshore Norway, in which Marathon has a 28.2 percent interest.
Marathon expects to participate in seven to eight additional exploration wells during 2006, bringing the total anticipated exploration wells for the year to 15 to 16. Three to four additional exploration wells originally expected to be drilled in 2006 are now expected to be carried over to 2007. Marathon is currently participating in an appraisal well at the Stones discovery in the Gulf of Mexico and three wells in deepwater Angola.
Also in the second quarter, Marathon was awarded a 70 percent interest and will be the operator in the highly sought after Pasangkayu Block offshore Indonesia. This 1.2 million acre block is located mostly in deepwater. It is anticipated that a production sharing contract will be signed during the third quarter 2006. Seismic activity is expected to commence in 2007, followed by drilling in 2008 and 2009.
Refining, Marketing and Transportation
Downstream segment income was $917 million in the second quarter 2006, compared to $316 million in the second quarter 2005. Downstream segment income for the second quarter 2006 benefited from the June 30, 2005, minority interest acquisition.
A key driver of the increase in segment income was the Company's refining and wholesale marketing gross margin which averaged 29.78 cents per gallon in the second quarter 2006 versus 15.92 cents in the comparable 2005 quarter. This margin improvement was consistent with the improvement in the Midwest (Chicago) and the U.S. Gulf Coast crack spreads in the second quarter 2006 compared to the same quarter last year. Crude oil refined during the second quarter 2006 averaged a record 1,038,000 bpd, 26,100 bpd higher than during the second quarter 2005. In addition, total refinery throughputs totaled a record 1,244,800 bpd for the second quarter 2006, approximately 5 percent higher than the 1,186,500 bpd during the second quarter 2005. Marathon was able to achieve both of these throughput records primarily as a result of the expansion of its Detroit refinery from 74,000 to 100,000 bpd that was completed during the fourth quarter 2005.
Speedway SuperAmerica's (SSA) gasoline and distillate gross margin averaged 10.19 cents per gallon during the second quarter of 2006, down from the 12.11 cents per gallon realized in the second quarter 2005. SSA increased same store merchandise sales by 8.7 percent during the same period.
Marathon completed its ultra-low sulfur diesel fuel modifications on time and under budget during the second quarter 2006 and began producing ultra-low sulfur diesel fuel prior to the June 1, 2006 deadline. These modifications substantially complete the approximately $875 million in capital projects the Company began in 2002 to comply with the Tier II gasoline and on-road diesel requirements of the Clean Air Act that became effective on June 1, 2006.
In addition, Marathon and The Andersons, Inc. recently announced that the companies have signed a letter of intent which could lead to the formation of a joint venture that would construct and operate a number of ethanol plants. The formation of the joint venture and other related activities are subject to the negotiation and execution of definitive agreements.
Marathon is approximately 40 percent complete with the FEED of the proposed 180,000 barrel per day expansion of its Garyville, La. refinery, with process design scope complete. The FEED estimate is expected to be completed in the fourth quarter 2006. The applications for all the necessary environmental permits have been submitted and approval is expected by year- end. Marathon's expenditure commitments for the Garyville expansion project in 2006 total approximately $170 million, including both FEED costs and the procurement of certain long-lead time process unit components.
The estimated cost of the expansion has been revised to approximately $3 billion. The primary reason for the cost increase from the previous $2.2 billion estimate is due to an increase in the processing unit capacities and tankage to help optimize the overall profitability of the project. Additional tanks have been added to the scope of the project to provide increased crude supply options, along with added gasoline and diesel grade segregation, to better serve water-bound cargoes, to support on-going product quality and to better position the refinery for market opportunities. Engineering and construction costs account for the majority of the remaining increase as both labor and material costs have continued to increase significantly over the last year.
Marathon believes the proposed Garyville expansion is a leading major refinery expansion project in the U.S. due to capital efficiency, integration synergies, proximity to both supply and product distribution infrastructure, and low operating costs. If this project is approved by Marathon's Board of Directors, and the necessary permits are received by year-end, construction could commence around mid-2007.
Integrated gas segment income was $17 million in second quarter 2006, compared to breakeven results in second quarter 2005. Income from domestic LNG activities increased in the second quarter 2006, due largely to revenues associated with our re-gas facility at Elba Island.
The Equatorial Guinea LNG train 1 project moved further ahead of schedule with LNG shipments now expected to start in mid-2007. At the end of the second quarter 2006, the project was approximately 87 percent complete on an engineering, procurement and construction (EPC) basis. Marathon holds a 60 percent interest in Equatorial Guinea LNG Holdings Limited.
In January 2006, Marathon announced a $2 billion share repurchase plan. Through the second quarter of 2006, Marathon has repurchased approximately 7.3 million of its common shares at a cost of $554 million. Marathon recently announced an acceleration of this plan and currently anticipates repurchasing $1.5 billion of its common stock by December 31, 2006, with the balance of the $2 billion authorized program to be completed in 2007. This program may be changed based on the Company's financial condition or changes in market conditions and is subject to termination prior to completion.
Annually, the Corporation determines its income tax provision by aggregating income taxes arising from each jurisdiction in which it operates. In interim periods, the income tax provision is determined by applying an estimate of the Corporation's annual effective tax rate to quarterly pre-tax earnings. This tax accounting method can result in volatility in segment income quarter over quarter.
Marathon has two long-term natural gas sales contracts in the United Kingdom that are accounted for as derivative instruments. Mark-to-market changes in the valuation of these contracts must be recognized in current period income. During the second quarter 2006, the non-cash after-tax mark-to- market loss on these two long-term gas sales contracts related to Marathon's Brae gas production totaled $10 million. Due to the volatility in the fair value of these contracts, Marathon consistently excludes these non-cash gains and losses from "net income adjusted for special items."
As previously discussed in this release, in June 2006, Marathon sold its Russian oil exploration and production businesses for $787 million plus working capital and other closing adjustments. An after-tax gain of $243 million on the sale was included in discontinued operations for the second quarter 2006. This gain has been excluded from "net income adjusted for special items."
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