Second Quarter Highlights:
- Cash flow of $946 million ($1.78/share) for the second quarter of 2008
- Net income of $380 million ($0.72/share)
- Quarterly production before royalties of 254,000 boe/d-on track to meet annual production guidance
- Encouraging exploration results in the UK North Sea
- At Long Lake, bitumen production rates are approximately 13,000 bbls/d (6,500 bbls/d net to us); upgrader start up on track for late third quarter
- Approval for Normal Course Issuer Bid to be sought from Toronto Stock Exchange to allow for share repurchases
- 2008 capital program increased by between $600 and $800 million to accelerate various projects
Nexen delivered solid second quarter results generating cash flow from operations of $946 million and net income of $380 million. We also generated the highest quarterly cash netbacks in our history. Our production is unhedged and we remain well positioned to capture all upside from high commodity prices.
Production averaged 254,000 boe/d (211,000 boe/d after royalties) for the second quarter. The shut down of the Forties pipeline by a two-day labour strike at the Grangemouth refinery in Scotland caused us to temporarily shut in our North Sea production. Consequently, our production volumes for the second quarter were lower than our first quarter volumes. We remain on track to meet our annual production guidance.
At the end of the quarter, we were carrying approximately 850,000 barrels of crude oil inventory from our North Sea operations. This moved approximately $50 million of cash flow into early July, when the inventory was sold.
Net income includes a charge of approximately $330 million ($240 million after tax) for stock-based compensation resulting from a 33% increase in our stock price since the end of the first quarter.
Our marketing division reported a cash flow loss of $164 million in the second quarter compared to a contribution of $13 million in the first quarter. The loss primarily relates to significant increases in NYMEX natural gas prices in North America which resulted in widening location spreads between western supply regions and eastern consuming regions at a time when we were positioned to take advantage of traditional seasonal narrowing. By way of offset, we have $207 million of unrecognized gains on our marketing inventories and transportation assets that have increased in value. These gains can only be booked in the future when the inventories are sold and the transportation assets are used.
Comparing our second quarter results year over year, additional current taxes primarily in the UK and the impact of a weaker US dollar reduced our cash flow in 2008 by more than $500 million.
For the first six months of 2008, our cash flow exceeded our capital investment by over $500 million and we expect this excess to grow over the balance of the year. These net cash inflows can be used to fund additional capital investment programs, reduce net debt, increase dividends and repurchase shares. Earlier this year, we doubled our quarterly dividend and repaid maturing long term debt. We now intend to seek approval from the Toronto Stock Exchange (TSX) for a Normal Course Issuer Bid. Subject to approval by the TSX, this Normal Course Issuer Bid will allow us to repurchase for cancellation up to 10% of our public float of common shares. 10% of our public float amounts to approximately 53 million common shares.
We have also increased our capital investment by between $600 and $800 million, depending on program timing. This additional investment allows us to accelerate various projects such as shale gas, coalbed methane (CBM) and Medicine Hat shallow gas and provides Usan with funding for the remainder of 2008. In our shale gas program, encouraging results have led us to increase our investment plans by almost $150 million. Modifications to the royalty regime for CBM have restored development economics and we have reinstated our investment program accordingly. In the Medicine Hat area of Alberta and Saskatchewan, we plan to drill, complete and tie-in approximately 190 shallow gas wells. At Usan, we expect to invest a total of $300 million this year now that development of the project is underway. We have also allocated additional capital to the Masila field in Yemen where we plan to drill more development wells. We expect these wells will increase our 2008 exit rate and 2009 production volumes.
At Ettrick, additional drilling is required later this year to maximize reserves recoveries, bringing our share of total full-cycle development costs to approximately $620 million. Capital allocated to Long Lake brings the total Phase 1 investment to the upper end of our previously announced range.
For the full year, we expect to generate approximately $4 billion of cash flow assuming WTI oil price of US$90 per barrel and NYMEX gas price of US$8.50 for the second half of the year. This will fund our revised capital investment program of between $3.0 and $3.2 billion and other working capital requirements. Each US$1 increase in benchmark oil and gas prices adds about $20 million and $25 million, respectively, to our after tax cash flow for the balance of the year.
"We continue to review the best opportunities we have to deploy our excess cash to generate value for our shareholders," stated Charlie Fischer, Nexen's President and Chief Executive Officer. "The additional capital investment will add between 4,000 and 6,000 boe/d to our 2008 exit volumes and increase our production in 2009."
Our second quarter production volumes averaged 254,000 boe/d (211,000 boe/d after royalties). North Sea production was disrupted by a strike at the Grangemouth refinery which reduced quarterly volumes by approximately 3,000 boe/d.
Buzzard performed well and contributed 86,500 boe/d (200,200 boe/d gross) to our second quarter volumes. In early July, Buzzard was shutdown for two days for a planned rig move and returned to full rates soon after. The shutdown corresponded with maintenance downtime on the Frigg gas pipeline. In August, we have one week of scheduled downtime to move the rig back and carry out platform maintenance.
Syncrude volumes matched levels seen in the first quarter as a result of a coker turnaround which took longer than expected. The turnaround has since been completed and production volumes are now back to 26,000 bbls/d net to us. Another coker turnaround is planned for later in the quarter.
"We remain on track to meet our annual guidance range of 260,000 boe/d to 280,000 boe/d," commented Fischer. "Our Long Lake volumes are continuing to ramp up and we are seeing improved reliability at Syncrude."
Long Lake Project Update
Commissioning of the upgrader is approximately 80% complete and we remain on track for start up late in the third quarter.
We continue to inject steam into the reservoir and currently have 35 of 81 well pairs converted to SAGD operation. While the reservoir is performing well, we have been limited at surface by facility start up issues that have restricted our ability to generate our full complement of steam. Reliability of surface facilities has been impacted by third-party power outages, the recalibration of burner tips on the once-through steam generators and downtime associated with the heat exchangers. These issues have all been resolved and steam generation is ramping up to planned rates.
In late June, there was a failure of the main third-party transformer at Kinosis which required us to shutdown our SAGD facilities. As a result, bitumen production and steam circulation was temporarily suspended. Production volumes subsequently ramped back up to pre-shutdown levels but this slowed our near-term bitumen ramp up profile.
At this stage of the ramp up process and considering our past steaming constraints, production is meeting expectations with oil rates increasing and steam-oil-ratios (SOR) decreasing. The well pairs that have been converted to SAGD operation are currently producing, in aggregate, approximately 13,000 bbls/d or 6,500 bbls/d net to us, at a combined SOR of about 3.0. The overall SOR of the well pairs on SAGD together with those still circulating steam is currently ranging between 5.0 and 6.0. This is expected to decrease to our long-term expectation of approximately 3.0 when peak rates are achieved in 2009.
We continue to expect to have sufficient bitumen feedstock to start up the upgrader later this summer. SAGD volumes are expected to continue ramping up through the remainder of 2008 and reach the full design rate of 72,000 bbls/d (36,000 bbls/d net to us) in late 2009.
Excellent progress has been made on upgrader commissioning. Synthetic crude and pentane have been loaded into the OrCrude(TM) unit and testing in this unit is advancing well. Catalyst loading is complete in the hydrocracker and the sulphur recovery units, with these units moving into the final commissioning steps required before start up activities commence. In the gasification unit, automation testing activities are progressing with our licensor, Shell Global Solutions.
As previously announced, a holding tank used to balance liquid oxygen flow between the air separation plant and the gasifier was damaged in the commissioning process. Damage to the tank was limited to the upper section of the tank and we have since replaced this section. Hydrotesting, reinsulation and commissioning of the tank will be completed early in the third quarter. We remain on track to start up the upgrader later this summer. Our start up schedule forecasts production of synthetic crude to ramp up to full rates over a 12 to 18 month period following initial upgrader start up. The upgrader is designed to produce approximately 60,000 bbls/d (30,000 bbls/d net to us) of premium synthetic crude.
"We are very pleased with the reservoir performance at Long Lake," said Fischer. "We expect to see our bitumen production ramp up as the reliability of our surface SAGD facilities improves and are looking forward to start up of the upgrader shortly."
Phase 1 of Long Lake will develop approximately 10% of our oil sands inventory. Work continues on Phase 2 and our goal is to sanction this phase late this year. However, ultimate timing depends on accumulating sufficient operating history from Phase 1 and receiving clarity on proposed regulatory changes such as climate change. Proposed federal climate change regulations indicate a move towards carbon capture and sequestration of greenhouse gas emissions. With the addition of shift reactors to future phases, our unique process allows for the pre-combustion capture of these emissions for future sequestration.
North Sea Update
During the quarter, we drilled exploration wells in the North Sea at Blackbird and Pink. Blackbird is located 6 km south of Ettrick and if successful, this prospect could be fast tracked for development given the short distance to the Ettrick floating production, storage and offloading vessel (FPSO). We operate both Ettrick and Blackbird and have an 80% working interest in each.
Pink has been sidetracked and we are currently evaluating the results of this discovery. The Pink well is a candidate for co-development with Golden Eagle. We have a 46% operated working interest in this field.
At Ettrick, delivery of the leased FPSO has taken longer than expected due to third-party labour shortages in the Singapore construction yard. The FPSO is designed to handle 30,000 bbls/d of oil and 35 mmcf/d of gas. We expect first production to commence in the fourth quarter with a modest contribution to our annual production volumes.
"We are encouraged with the results of our exploration program in the North Sea," commented Fischer. "The prospects we have drilled are near existing infrastructure and can be tied back quickly upon success, providing incremental production growth to complement our outstanding Buzzard asset."
Shale Gas Update
The Horn River basin in northeast British Columbia has the potential to become one of the most significant shale gas plays in North America and the recoverable contingent resource identified on our Dilly Creek lands here could double our total proved reserves. As previously announced, we currently estimate our Dilly Creek lands contain between 3 and 6 trillion cubic feet (0.5 to 1.0 billion barrels of oil equivalent) of recoverable contingent resources. Further appraisal activity is required before these estimates can be finalized and commerciality established. We have increased our holdings to approximately 88,000 acres in the Dilly Creek area with a 100% working interest. This shale gas play has been compared to the Barnett Shale in Texas by other operators in the area as it displays similar rock properties and play characteristics.
Following the success of last winter's drilling program, we have accelerated the drilling of two horizontal wells which will be fraced and tested this summer. This winter, we are planning an 8 to 16 well drilling and completion program. We have secured access to 70 mmcf/d of pipeline and processing capacity for our shale gas production for a five year period with a renewal option.
"We have been able to secure a strong land position in the heart of this exciting play," said Fischer. "The potential resource size here is significant and development of our shale gas acreage will provide us with short cycle-time production growth."
CBM Development Continues
In Canada, we have reinstated the investment program for our Mannville CBM development project following modifications to the royalty regime by the Government of Alberta which restored the economics associated with this play. Our CBM production averaged 40 mmcf/d for the quarter. This is a significant increase from last quarter and primarily reflects improved well pumping reliability. We expect to exit the year around 46 mmcf/d as our existing wells dewater and production increases.
Gulf of Mexico Update
In the Eastern Gulf of Mexico, we recently spud the Fredericksburg exploration well. This is the third prospect to be drilled in this area following earlier success at Vicksburg and Shiloh. We have a 20% interest in Fredericksburg and Shiloh, and a 25% interest in Vicksburg, with Shell operating all three. When we combine the discoveries at Shiloh and Vicksburg with several prospects we see on our land holdings, this area has the potential to become a significant part of our Gulf of Mexico business.
Development of the Longhorn discovery is progressing well and first production is expected in 2009 with a peak production rate of approximately 200 mmcf/d gross (50 mmcf/d net to us). We have a 25% non-operated working interest and ENI is the operator.
At Knotty Head, we plan to drill an appraisal well in mid 2009 when the first of our two new deep-water drilling rigs arrives. We have a 25% operated interest in the field.
Offshore West Africa Update
Development of the Usan field, offshore Nigeria has recently commenced. The field development plan includes a FPSO vessel with a storage capacity of two million barrels of oil. All major contracts for deep-water facilities have been awarded and contractors are mobilizing for detailed engineering and project execution. Development of the Usan field commenced earlier this year than we expected and we recently allocated additional capital accordingly. Our investment is expected to be within the range of US$1.6 to US$2.0 billion over the development period. The Usan field is expected to come on stream in early 2012 and will ramp up to a peak production rate of 180,000 bbls/d (36,000 bbls/d net to us).
The Usan field development is located in OML 138 and is covered by the original production sharing contract for OPL 222 issued in 1993, with the Nigerian National Petroleum Corporation as concessionaire. The contract conveys the right to develop and produce crude oil and continue with exploration activity. We are currently processing three-dimensional seismic in anticipation of further exploratory drilling in the area in 2009. The Usan field was discovered in 2002 and is located approximately 100 km offshore in water depths ranging from 750 to 850 meters. Drilling of the development wells is expected to commence next year. Nexen has a 20% interest in exploration and development along with Elf Petroleum Nigeria Limited (20% and Operator), Chevron Petroleum Nigeria Limited (30%) and Esso Exploration and Production Nigeria (Offshore East) Limited (30%).
Middle East Opportunity
We have recently been advised that we have successfully pre-qualified to participate in future oil and gas opportunities that may present themselves in Iraq.
"We were the only Canadian company to successfully pre-qualify in a group that contains a number of the world's major oil and gas companies," stated Fischer. "This builds on our strength in the Middle East and could present us with long term opportunities in one of the world's richest resource basins."
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