Earnings Call: Q3 2012

Oct 25, 2012

Good morning. My name is Christie and I will be your conference operator today. At this time, I would like to welcome everyone to the Occidental Third Quarter 2012 Earnings Release Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session. Thank you. Mr. Stavros, you may begin your conference. Thank you, Christy, and good morning, everyone. Welcome to Toxidil Petroleum's Q3 2012 earnings conference call. Joining us on the call this morning from Los Angeles are Stephen Chasen, Oxy's President and Chief Executive Officer Cynthia Walker, Oxy's Executive Vice President and Chief Financial Officer Bill Albright, President of Oxy's Oil and Gas Operations in the Americas and Sandy Lowe, President of our International Oil and Gas Business. In just a moment, I will turn the call over to our CFO, Cynthia Walker, who will review our financial and operating results for this year's Q3. Steve Chasen will then follow with comments on our strategy, progress, as well as providing some guidance for the remainder of this year. Our Q3 2012 earnings press release, Investor Relations, supplemental schedules and the conference call presentation slides, which refer both to Cynthia's and Steve's remarks can be downloaded off of our website at www dotoxy.com. I'll now turn the call over to Cynthia Walker. Cynthia, please go ahead. Thank you, Chris, and good morning, everyone. Income from continuing operations was $1,400,000,000 or 1.70 per diluted share in the Q3 of 2012, compared to $1,800,000,000 or $2.18 per diluted share in the Q3 of 2011 and $1,300,000,000 or $1.64 per diluted share in the Q2 of 2012. The 3rd quarter income from continuing operations improved by $0.06 per diluted share from the Q2 of this year. The improvement reflected higher margins in the marketing and trading businesses, partially offset by lower earnings in partially offset by the impact of a 3% decline in realized worldwide crude oil prices. Now let me turn to the segment breakdown for the 3rd quarter. In the oil and gas business, earnings for the Q3 of 2012 were $2,000,000,000 compared to $2,000,000,000 in the Q2 of 2012 and 2 point $6,000,000,000 in the Q3 of 2011. Overall, Q3 2012 production was 700 and 66,000 barrels per day, flat with the record set by the company in the Q2 of 2012 and up 4% from the Q3 of 2011. Our domestic production was 469,000 barrels per day, an increase of 7,000 barrels per day from the Q2 of 2012 and most notably the 8th consecutive quarter of domestic record volume growth for the company. Production was 8% higher in the Q3 of 2011 versus the Q3 of 2011. Almost all the sequential quarterly increase came from the Permian and Williston Basins. California production was higher in liquids, but flat on an overall BOE basis with the Q2, mainly due to lower gas volumes associated with initial start up issues of the new gas plant. These issues were resolved mid quarter, although the positive effect of the plant on overall Q3 production was muted as a result. Today, the plant continues to run as expected and California's current production run rate is approximately 150,000 barrels per day. In Latin America, volumes were 32,000 barrels per day. And in the Middle East, volumes were 265,000 barrels per day. I'll note meaningful sequential changes in cutter production. However, details regarding other company specific production levels are available as usual in the Investor Relations supplemental schedules that we provide. Dolphin's production was 13,000 barrels per day lower than the 2nd quarter resulting from the full cost recovery of pre startup capital as we noted to anticipate last quarter. Cutter's production was also impacted by a facility outage in August, which reduced production in the quarter by about 5,000 barrels per day. The outage was subsequently resolved. The rest of the Middle East partially offset these decreases in part due to higher spending levels, Factors affecting production sharing and similar contracts including oil prices did not significantly impact the quarter's production volumes compared to the Q3 of 2011 or the Q2 of 2012. 3rd quarter 2012 realized prices were mixed for our products compared to the Q2 of the year. Our worldwide crude oil realized price was 96 point $6.2 per barrel, a decrease of about 3%. Worldwide NGLs were $40.65 per barrel, also a decrease of about 3% from the Q2, while domestic natural gas prices were $2.48 per 1,000,000 cubic feet, an improvement of 19%. The change in worldwide crude oil realized price was primarily due to the mix of sales volumes in the quarter. 3rd quarter 2012 realized prices were lower than Q3 2011 prices for all of our products. On a year over year basis, price decreases were 1% for worldwide crude oil, 27% for worldwide NGLs and 41% for domestic natural gas. Realized oil prices for the quarter represented 105% of the average WTI price and 88% of the average Brent price. Realized NGL prices were 44% of the average WTI price and realized domestic gas prices were 90% of the average NYMEX price. At current global prices, a $1 per barrel change in oil prices affects our quarterly earnings before income taxes by approximately $36,000,000 and 8,000,000 dollars for $1 per barrel change in NGL prices. A change of $0.50 per 1,000,000 BTU in domestic gas prices affects quarterly pretax earnings by about $35,000,000 These price change sensitivities include the impact of production sharing and similar contracts volume changes on income. Oil and gas production costs were $15 per barrel for the 1st 9 months of 2012. This is compared to $12.84 per barrel for the full year of 2011. The cost increase reflects higher well maintenance activity in part reflecting our higher well count, higher workover activity and higher support and injection costs. Taxes other than on income, which are generally related to product prices were $2.43 per barrel for the 1st 9 months of 2012 compared to $2.21 per barrel for the full year of 2011. And Q3 exploration expense was $69,000,000 Now turning to the Chemicals segment. Earnings for the Q3 of 2012 were $164,000,000 compared to $194,000,000 in the Q2 of 2012 $245,000,000 for the Q3 of 2011. Both the sequential quarterly and year over year declines were due to lower Asian market demand that drove export prices lower, partially offset by lower ethylene costs. In the Midstream segment, earnings were $156,000,000 for the Q3 of 2012 compared to $77,000,000 in the Q2 of 2012 and as well in the Q3 of 2011. The 2012 quarterly increase in earnings was in the marketing and trading business primarily and power generation, partially offset by lower margins in the gas plants reflecting lower NGL prices. Our worldwide effective tax rate was 38% for the Q3 of 2012. The lower rate compared to our guidance was attributable to a shift in the mix of income towards more domestic. Our 3rd quarter U. S. And foreign tax rates are included in the Investor Relations supplemental schedules. In the 2012, we generated $9,200,000,000 of cash flow from operations before working capital changes. Working capital reduced our 9 month cash flow from operations by approximately $660,000,000 to $8,500,000,000 Approximately $510,000,000 of the working capital use occurred in the 3rd quarter. Capital expenditures for the 1st 9 months of 2012 were $7,700,000,000 of which $2,600,000,000 was spent in the 3rd quarter. Year to date capital expenditures by segment were 82% in the oil and gas business, 14% in midstream and the remainder in the chemicals business. Acquisitions for the 1st 9 months of 2012 were $1,200,000,000 of which $100,000,000 was spent in the 3rd quarter. Financing activities, which include dividends paid, stock buybacks and a $1,740,000,000 borrowing earlier this year provided a $300,000,000 net cash inflow for the 1st 9 months of the year. These and other net cash flows resulted in a $3,800,000,000 cash balance at September 30. The weighted average basic shares outstanding for the 1st 9 months of 2012 were 810,100,000 and the weighted average diluted shares outstanding were 810,800,000. Diluted shares outstanding at the end of the quarter were approximately 810,100,000. Dollars And lastly, our debt to capitalization ratio was 16%. Copies of the press release announcing our 3rd quarter earnings and the Investor Relations supplemental schedules are available on our website at www.oxy.com or through the SEC's EDGAR system. At this time, I'll turn the call over to Steve Jayson to discuss an update on our strategy, our operations and also provide guidance for the Q4 of the year. Thank you, Cynthia. Oxy's domestic oil and gas segment produced record volumes for the 8th consecutive quarter and continued to execute in our liquids production growth strategy. In the 3rd quarter, domestic production of 469,000 barrel equivalents per day consisting of 334,000 barrels of liquids and 812,000,000 cubic feet of gas per day was an increase of 7,000 barrel equivalents per day compared with the Q2 of 2012. Domestic production over the Q2 of 2012 was almost entirely in oil, which grew from 249,000 barrels a day to 260,000. Gas production declined 28,000,000 cubic feet of gas per day on a sequential quarterly basis, mainly in California, some of which was due to the initial startup issues of new gas plant that Cynthia mentioned. Compared with the Q3 of 2011, our domestic production grew by 8% or 33,000 barrels a day, of which 30,000 a day was oil production growth. Our annualized return on equity for the 1st 9 months of 2012 was 15% and return on capital employed was 13. As we near the end of 2012, I want to take this opportunity to reflect on our strategy, our progress and our future. As a company, we continue to have 3 main objectives: generate rates of return on invested capital significantly in excess of our cost of capital achieve moderate growth of the business and deliver continued dividend growth. With regards to returns, we don't believe that a depleting or shrinking business or selling profitable future opportunities to fund high decline production can yield high rates of return. One can reduce spending to achieve short term higher returns, but these returns would not be sustainable as the company would deplete. Our business model is to balance the need for growth of the business while maintaining attractive returns. We are currently in investing phase in many of our businesses where higher than normal portion of our capital is spent on longer term projects. This year, we expect to spend approximately 25% of our total capital expenditures on future growth projects that will contribute to our operations over the next several years. These expenditures include capital for the Alhos and Shaw gas project, which we expect to start production in the late 2014 capital for gas and CO2 processing plants and pipelines to maintain or expand the capacity of these facilities to handle future production increases part of the capital for the Chemicals segment and other items. In our Oil and Gas business, we have built a portfolio of assets that allow us to execute this strategy. Domestically and internationally, we have a mix of both higher return assets and higher growth assets. Importantly, many of our higher growth assets are relatively early in their development, although we have already experienced meaningful success. In the U. S, our Permian CO2 operations continues to be our most profitable business, generating the highest free cash flow after capital among our entire portfolio of assets. In contrast, our Permian non CO2 business is one of the fastest growing assets in our entire portfolio. Since we began significant delineation and development efforts in late 2010, we have grown production by over 25 percent. As a result of significant activity by us and our partners, our Permian acreage where we believe resource development is likely has grown from our estimate about 3,000,000 gross acres earlier in the year to about 4,800,000 acres in October. Oxy's share of this acreage grew from about 1,000,000 acres to about 1,700,000 acres during the same period. The attached conference call presentation slide shows our current acreage position in the Permian. In California, we have a very large acreage position with diverse geological characteristics in numerous reservoir targets. As a result, development opportunities range from conventional steam floods to water floods and shale drilling. Drilling costs and expected ultimate recoveries also vary for each area. In mid-twenty 10, we shifted our development program to conventional and unconventional opportunities outside the traditional and more mature Elk Hills areas. As a result, we've experienced strong production growth in these new areas, although traditional Elk Hills have experienced some decline. As you can see on the attached conference call presentation slide, traditional Elk Hills production dropped from 41,000 barrels per day in the Q4 of 2010 to 37,000 in the Q3 of 2012. Liquids production growth California more than offset this decline during the same period growing from 49,000 barrels a day to 69,000. Traditional Elk Hills gas production declined from 22,000 equivalent barrels per day to 19,000 during the same period, which is mostly offset by the increase in gas production in the rest of California from 21,000 equivalent barrels a day to 23,000. Recently, we further modified our programs to emphasize oil production in light of depressed gas prices and associated liquids. As a result, gas production in all of California declined in the Q3 of this year. Total California growth on a BOE basis is slower than we thought it would be, in part due to higher than expected declines at Elk Hills, permitting issues and more recently low gas prices. On a positive note, overall performance resources has been consistent with expectations, including our unconventional opportunities for which well performance is similar to the type of curves we showed you a couple of years ago. I would also note that over the last several years we spent $370,000,000 on the new Elk Hills gas plant. The plant went into operation early July, notwithstanding initial startup issues, is possibly affecting our operational efficiency and production, including higher liquids yields. The plant operated optimally for about 1 month in the last quarter and And as I mentioned, this is a very diverse opportunity set. For example, one of the projects we haven't talked about much in the past is a major steamflood project in Lost Hills. We expect to achieve significant production growth about 15,000 barrels a day in several years from the current 4,000 barrel a day rate. Total oil in place is estimated to be about 500,000,000 barrels. Using reasonable assumptions, we expect to recover over 50,000,000 barrels net to Oxy. Our drilling costs in this area averaged in the low $200,000 per well and we expect to bring this average cost down over time. In the Williston Basin in North Dakota, we currently have over 310,000 net acres of significant resource potential, which we estimate to be about 250,000,000 net barrels. Our production in the basin has tripled since we entered the area over 1.5 years ago. We have recently slowed our drilling activity and significantly reduced our rig count in the basin as a result of cost pressures. While well costs have subsequently declined modestly, we will only increase our rig count when costs come down enough to make returns competitive with the rest of our portfolio. We believe that over the long term, our resource base in the Williston Basin represents a significant opportunity for the company. In the Mid Continent, including our assets in South Texas, we have significantly reduced our gas drilling. However, we could ramp up our gas production rapidly and meaningfully in their current level on a sustained basis. Internationally, our most significant businesses are in the Middle East region where our operations are characterized by limited duration contracts with high rates of return on invested capital during the contract term. Our primary focus in the Middle East is United Arab Emirates, Oman and Qatar which includes Dolphin. Most of our international capital is allocated to these countries and we derive a very substantial portion of our international earnings and free cash flow after capital from Qatar and Oman. Going forward, the UAE where we are developing the Elhosin gas project is also expected to make significant contribution to earnings and free cash flow. The Elhos and Gas project is approximately 61% complete and is progressing as planned. The project made up about 11% of our total capital program for the 1st 9 months of this year. While capital spending is running higher for 2012 than our initially anticipated levels, total development capital for the project is expected to be in line with previous estimates. Currently, the Elhosin project is consuming sizable amounts of capital during its development phase. We expect to see a significant shift in late 2014 when the project changes from being a cash consumer to a cash generator. Once the project becomes operational, early free cash flow should generate should be approximately $600,000,000 annually at roughly current oil prices and conservative sulfur prices. The project has the potential for additional production in later years, which would significantly increase its cash flow. We're going to spend approximately $1,200,000,000 on the Hossein project this year. While once the project becomes operational, our free cash flow should increase by the difference between the capital consumption and generation. Based on our 2012 capital spend for the project, this would equate to a $1,800,000,000 increase in our annual cash flow. Lastly, we are focusing on proving our returns through a comprehensive effort to reduce operating expenses and improve capital efficiency. As we indicated in the past, our operating costs have been increasing for some time for a variety of reasons including industry inflation, our desire to take advantage of high product prices by accelerating production through workovers which pay for themselves over a short period of time and our recent rapid growth which has caused some short term inefficiencies. We are embarking on an aggressive plan to improve our operational efficiencies overall cost categories including capital, with our to view to achieve an appreciable reduction in our operating expenses and our drilling costs to at least last year's levels. We believe that we will start seeing the benefit of this plan clearly in the Q1 of 2013 achieve last year's cost levels by the end of the next year on a run rate basis. Several initiatives have already begun and we are seeing good early results. For example, during the Q3, we reduced our drilling cost by over 15 percent in parts of Elk Hills. Our goal next year is to reduce U. S. Well costs by about this amount. I will now turn to guidance for the Q4. Our 4th quarter capital spending will slow from the 3rd quarter level to a run rate that we believe will be in line with next year's total capital program. Our intention was to reduce capital spending meaningfully starting in the 3rd quarter. However, this would have resulted in efficiency in areas where we were seeing positive results as the Permian parts of California and Oman. As we discussed in prior quarters, we are sharply reducing our pure gas drilling and have more recently cut back our drilling in certain liquids rich areas as well. We are also in the process of eliminating our less productive rigs to improve our returns. Our focus on much higher return oil drilling will result in decline in our gas and to a much lesser extent NGL production in the future. Turning to production expectations in the 4th quarter. Over the last year, we achieved our goal of increasing domestic production by 6,000 to 8,000 barrels equivalent per day quarter over quarter. We expect our 4th quarter oil production to grow by about this much. However, the expected decline in gas production resulting the change in our capital program focus I discussed earlier may offset some of the increased oil production on an equivalent barrels per day basis. Internationally at current prices, we expect production to be approximately flat with the Q3, while sales volumes will increase slightly. We expect 4th quarter exploration expense to be about $100,000,000 for seismic and drilling in our exploration program. The 4th quarter is typically the Chemical segment's weakest 4th quarter earnings will be about $140,000,000 or slightly lower than the 3rd quarter, along with seasonal factors, weak global demand for the European and Asian economies and rising natural gas costs keep pressure on the margins. The worldwide tax rate for the Q4 in 2012 to increase to about 40% to 41%. In closing, we believe that we have a deep portfolio of development opportunities that will allow us to continue to deliver returns that are 5 to 6 points above our cost of capital. Total return to our shareholders is a combination of appreciation, stock price and dividends. We have long believed that the job of management is to convert earnings that are retained into stock market value. For example, if we retain $1,000,000,000 we should be able to give the shareholders at least $1,000,000,000 increase in the market value of the company. Historically, we have generated close to $1.5 in value for each dollar kept. This is a challenging proposition over time as the company continues to grow. An old Wall Street maxim is that market is a voting machine over the short term, but a weighing machine over time. We hope that this is true as we firmly believe that our program investing in a longer than usual for us time frame will reap rewards for our shareholders. If for some reason our investment plans do not generate acceptable stock market results over the next few months, we will return more of our retained earnings to our shareholders. We have increased our dividends at a compounded rate of 15.8% over the last 10 years through 11 dividend increases. We expect to increase our dividends again next year and in the future at a rate that would maximize return to our shareholders. I think we're now ready to take your questions. Thank you. And your first question comes from Doug Tarson of ISI. Hi, Steve. Hi. Your emphasis on returns on capital was pretty clear from today's comments. And on this point, I wanted to better understand the point about achieving 2011 cost levels by the end of 2013. But first, is that the correct interpretation? And if so, does that imply the pre tax cost savings will be above $1,000,000,000 maybe $2,500,000,000 And if so, are there some specific compartments from which those cost savings will emanate that you can highlight to us today? Yes. There's 2 elements of the cost saving. One is operating costs. And I think it's fairly straightforward to take the current $15 rate and subtract from last year's number and multiply it by 275,000,000 barrels, which is roughly the annual production. I don't give you an idea sort of the savings. I hope to beat that frankly. We should be able to, but I think that's what we're going to say for now. There may be some G and A savings too, but we haven't really baked that in. On the capital, I think it's fairly straightforward to say that the capital program for the U. S. Business will If we save 15% on wells, the capital for the U. S. Business will decline sort of by that amount. Okay. So the cash flow savings, you're right about where that will be. We may decline the U. S. Business by more than that frankly. But it just depends on how well they're converting dollars into returns. We can delay drilling where the returns aren't as good as we would like And we're I'm going to be more aggressive in the capital program than I've been in the last year. So a lot more negative feedback to the unit. So I think you should look to lower capital levels next year for the U. S. Business. The international business is a little more complicated because a lot of that's really not in our control, but similar levels. About the only increased area I see is in the midstream where we're going to build a pipeline from our gathering system and pipelines in West Texas to the Houston area now cost us about $400,000,000 and we hope to capture a fair amount of the differential and improve our returns that way. But we're going to focus a lot more starting this quarter, but in the quarters ahead on improving the returns and translating more of the volume growth into profits. Right. Thanks a lot, Steve. Thank you. Thank you. Your next question comes from Doug Leggate of Bank of America Merrill Lynch. Thanks. Good morning, everybody. Steve, I've got a couple if I may. The first one is really on your very last comment about I don't want to paraphrase you too badly here, but if your current strategy doesn't translate to shareholder returns or better shareholder returns of share price, I guess, you're going to take a different track. Could I just ask you to elaborate on that a little bit? Because obviously there has been, as you're well aware material on the performance of the stock. I'm just wondering how tolerant you're going to be of that on a go forward basis before you Not too tolerant. I think this is the hard answer. I don't know whether I don't know the form that it will take, but dividends are the easiest form because that way everybody knows they actually get the check. If the stock is trading at crummy levels, there'll be more emphasis on share repurchase than we done historically. But my tolerance level is modest. If we don't see if I don't see real improvements in the returns in the next couple of quarters strategy will change. Got it. My follow-up is really, as you're well aware, there's been a fair amount of I'm not going to call it misinformation, but there's been a lot of questions and specifically around the California assets given perhaps your the fact that you haven't given a lot of disclosure. I'm curious when you talk about reallocating capital. If your type curves are still per your presentation in 2010 and your liquids mix as per your presentation and of course your costs evenly are down. And now you've got the gas plant. I could go on and on and on about all the things that have lined up here. It would seem to us anyway that those have got to be some of the more compelling returns in the portfolio. So I just asked you to explain why are you not getting after that a little more aggressively now that you've got the gas plant in place, the cost down and so on and seeing where the permits in place? And I'll leave it at that. Yes. The permitting process while it's working pretty well in the fields that is existing fields, Extending beyond the fields is still slow. And so and some of the plants some air quality permits that are slow and coming. The permitting process well is a lot better say in Elk Hills field or Buena Vista field or some of the other fields outside of the field. It's still slower than it used to be. The only way I can assure that there's getting the squeal out of every dollar that they spend is to tighten their capital rather than give them more money. And so they have probably suffered less in the capital tightening, but they can still take their costs down considerably. And the more capital, I don't know how to say it, but discourages prudent spending. So I think their capital program will not be as effective as some others, but will still be affected some. And there are clearly some efficiencies that are needed there. I think their operating costs are way too high and they need to bring their operating costs by a whole bunch. And I understand that to some extent I'm pushed and pulled. I got half the shareholders think I should spend $2,000,000,000 a year on capital and the other half think I should spend $20,000,000,000 a year. So I'm trying to maybe probably unsuccessfully sort of weave our way through this. But I think that as a if this thing doesn't if they don't get their operating costs down, which is what I'm most focused on, because that translates immediately to profits. Then I'm going to continue to tighten there and there'll be some other changes there in the business unit. Same thing frankly in the Permian where their operating costs are still too high. And the operating costs affect the profits right away and affects our cash flow right away. The capital affects it over time. And our drilling, we're simplifying our program. We'll be drilling fewer different types of wells next year and that should make us more efficient. I think we can improve the capital efficiency a fair amount. But where I'm looking for it is in the operating costs because there I can affect it more quickly. And if they don't do it soon there's going to be wide spread changes in the operation. Steve, let me ask you a very quick follow-up. There seems to be a perception that you've got something pardon me for being direct, but you've got something to hide in California with your failure to be more transparent. Would you care to address that? And then I'll leave it at that. Thanks. Yes, sure. I think the way I've tried to think about how to show this. We're effectively the only one drilling in California. So you can't look at somebody else which is what you can do in the Permian or something like that. We show you the actual again this quarter, we take out old Elk Hills and we show you the growth in the other business. That's really the best way to look at the total business. The acquisition program doesn't add much in California because there really isn't any volumes to buy. And so that's growing at a very high rate. And if that were a standalone business, you would think it was terrific. This is the best way to show what's going on. There's really nothing to hide. We aren't drilling as many shale wells as somebody would like. And the reason is and it goes back to this capital efficiency question, if I could bore you for a second. Shale well has a very high decline rate, maybe 30%, 40% 1st year, maybe more. Okay. So I can boost this year's production by drilling a bunch of shale wells. But in order to keep the production flat next year, my capital program has to go up because I got to drill more wells. I mean and so that goes against the capital efficiency that people are looking for in the free cash flow. And so I'm trying to do more conventional drilling, which has a lesser decline rate to keep the capital from bloating in California and I don't want it to bloat. There's really nothing to hide and we show you this number with excluding Elk Hill. The disappointment has been at Elk Hills where the decline rate has been worse than we thought. And maybe the gas plant will make it better, maybe it won't. It's doing fine now and we'll just have to see. But there's really nothing to hide. I disclosed the Lost Hills numbers for a reason. In some report somebody sent me, I don't know where it came from, guy estimated that the well that the Lost Hills wells were costing $3,000,000 each. They cost roughly $200,000 each. So either the guy doesn't know anything about California or it was deliberately designed to make the numbers for the total of California look worse. Did somebody think we would drill 120 wells that had a $2.50 breakeven? So we disclose that. And if you either take Lost Hills out of the numbers or put the right numbers in there, it doesn't really look so bad. While we could track the number of wells that were in that report, we couldn't track the other numbers that he used. So I don't think there's anything to hide. We've shown you what an aggregate is going on which is all you really should care about. Thanks for answering it, Steve. Appreciate it. Thank you. Thank you. Your next question comes from Ed Westlake of Credit Suisse. Hey, good morning, Steve. Good morning. I guess I'll try another one on California. And I know that's just because obviously there have been a lot of research reports that may or may not have been correct. So you say that you have to reduce costs before you want to put more assets to work. I mean is that a concern that you have that the average IPs are not as good as you were hoping? I mean is there any statistical well data you could share with us this morning? It isn't really the IP rates. The IP rates have actually gotten better. The operating costs has reduced the margins to a point where if they're going to overspend on operating costs and doesn't make sense to encourage that. And so we're not going to with the reductions in the capital program, in the cost of the wells that they say they can achieve and that they will achieve. They'll be able to drill more wells for the same money, which is the true objective. Although leases aren't going anywhere. So that's where I'm a steward for this money, Not the goal is not volume growth per se, but profit growth. And we focused on volume growth and the profit growth sort of went away. So that's not and California is a big piece of the total and you can't change the company without proving California. So for the near term, there oil guys, I think I tell people this all the time only half jokingly, can only work on one thing at a time. So if you tell them you want volume growth, they'll give you volume growth, but some of the other stuff doesn't show up. And if you say, well, what I want is something else, it's only one thing at a time. So I guess I'm going to have to be more agile in their giving them objectives, maybe to give quarterly objectives not annual ones. But if the operating costs that they're running in California doesn't make any sense to me, they were running a lot less half 2 years ago. And they need to be back to that. If they do that, they'll have plenty of capital to drill the wells. Great. And then a follow-up which on the CapEx side. I mean, this is focused more on the midstream. Dollars 1,400,000,000 I guess this year which has obviously ramped up some of that sharp some of it's integrity in the domestic business. But as you look at your plans and I think you said that CapEx will go up next year because you want to build this additional pipe. But is there a year at which that as you look at the forward plans that you've done enough of that spend and it will fall to bring up some free cash as well? Yeah. I would once we're through this pipeline and the Alhosin project the spending on the plant will basically end in 2014 and then it will fall next year because you shift from a plant phase to a drilling phase. So the actual spending on Elhosin will decline some next year and more the following year as you go from drilling to building out the plant. I think Chris showed you a picture of the plant in the presentation there. This is not a small plant. So it's going to take but so spending will decline some on the plant next year and by the following year it will be down considerably. And we should we'll be through the pipeline next year. It's a 1 year program really. So that will fall off pretty sharply. Unless there turns out to be you should understand that if this arbitrage continues where you can buy oil in our pipeline system at $85 and sell it on the Gulf Coast at $100 we'll probably spend more gathering other people's oil and shipping it through our lines. And that's until we do enough of it that the arbitrage goes away. Thanks very much. Thank you. Thank you. Your next question comes from the line of Paul Sankey of Deutsche Bank. Hi, good morning everyone and welcome to Cynthia. Steve that was very interesting and your words were interesting about quite specifically if things don't change within the next few months, which came not long after you had said how the market is a voting and weighing machine depending on your time frames. Are you saying that if the stock price doesn't improve over the next relative performance doesn't improve over the next few months, you would essentially radically change the strategy, if you like the long term strategy? Or are you saying that if you don't get the cost improvements over the next few months you would radically change the strategy? Thanks. Well, I think we're saying some of each. If the relative performance doesn't improve, then we'll return more money to the shareholders one way or another. Relative stock performance. Relative stock performance. I think it's also useful to note that we have a I don't know 75% or so correlation to WTI as a stock, which is a lot more than other people. So to some extent some of it's caused by a decline in WTI I think. But putting that aside, the costs are how I intend to make the performance of the stock do better. So you got to say what's the tool to make it. So the tool is bringing the costs under control and improving the profitability. If that doesn't work that is to say the profitability improves and the stock continues to be a dog then we'll have to rethink the whole thing. To use the words that the stock has been a dog over the past year, I'm not sure why you haven't for example, book where A changed the dividend most recently, but B why there's been so little buyback in the recent months? The buyback is basically when we know what the earnings are, we stop buying back. And so a lot of the declines for whatever reason shows up in the month before the earnings call. But buybacks are as far as raising the dividend, we raise it once a year. And it's whatever 16% compounded growth in the dividend over a decade, starting not from 0 like some companies. So I don't know what the complaint would be, but if go to the Board, we set the program, we figure out how much we're going to spend and we figure out how much go to the Board, we set the program, we figure out how much we're going to spend and we figure out how much the dividends go with it. So it's all done together. I think doing the dividends in a vacuum doesn't give the Board the kind of oversight that it should have. No. I guess my point was that your balance sheet would suggest you could do both. I mean you could be buying back stock aggressively as well as pursuing the cost. We could. Now in the past you've talked about I guess this is going to be a pretty obvious answer, but in the past you said you have a vision of the value of the stock on any given day. And I think what you're saying obviously is that you feel it's poorly valued relative to what you think it's really worth. But again, I still don't understand why the buyback has been so muted given that? The buyback is done on a formula basis. And if and at the current levels or current levels this morning anyway when I woke up, You get one set of numbers at higher levels. You basically buy less back. If you look at the we don't look at relative performance when we do the share buyback. The share buyback is against absolute value. And so the lower the stock falls the more shares are bought back. Right. And then finally for me, it sounds like the action you would take would be a radical let's say radical, I don't know if that's the right word financial approach probably cutting CapEx aggressively, probably significantly raising the dividend, possibly buying back stock. Is there an alternate strategy that would be for example to split the company, sell the company anything in the other direction? I don't know if anybody's got enough money to buy it. So No. I'll ask you about splitting. Splitting, you got to be if you split it, you really have to have assets that would be valued materially differently than the overall. And it's very difficult right now to see and I don't know what an international business would trade for or so I think that before you go down the splitting the company route, you got to see whether you can bring your costs under control. And the last very last one for me. Would you consider special dividends? Or do you want to make those a regular? Regular dividends work better. Yes. Thank you. Thank you. Your next question comes from Arjun Murti of Goldman Sachs. Yes. Steve, just kind of following up on that last point there. So if there's a possibility, if the underperformance continues that you cut CapEx and raise the cash return to shareholders, I mean the Al Hosian project that CapEx is going to be what it's going to be. You've added acreage in the Permian. You've added acreage in the Bakken. You've got a huge acreage position in California. Presumably, it doesn't make sense to just sit on these assets, asset sales, joint ventures, bringing in others to drill this stuff. Is that part of the plan? Or practically speaking, what does it really mean to cut CapEx when you've been building up these big acreage positions over the years? Thank you. Yes. In the poor performing or the lower opportunity areas you might think of doing something like that In the stuff that's got long term very strong potential, you don't really want to sell your futures. So but you could cut the cap for example, you could cut the capital. We haven't really added much acreage in the Permian. All we're showing you here is that the areas that we think of that have resource potential have grown. We haven't really bought the acreage. That's just recharacterizing what we own. The you don't know, but you don't really want I don't if you have stuff that has long term potential, you don't really want to sell your futures if you can avoid it. But if you looked and you said well okay for the next you could cut the U. S. Business mostly long term leases or ownership outright. You could cut the capital and then as the Ahosin project comes on in a couple of years, suddenly you got a one $800,000,000 swing and so you could bring your capital, you could use some of that then. So I view it as sort of a deferral mechanism rather than just sort of cutting it. But if they can't generate the returns and some of the assets we might farm some out to people who might operate more efficiently. Absolutely. So I know you've worked on the organization over the years. And I think it was a couple of years ago you were pretty honest about classically you guys are an EOR company not a shale drilling company. You're now kind of again going after that same operational execution ability. You have to acquire a company that can do this stuff for you? I mean we No, I don't think so. It's 2 years ago we had this exact conversation in New York. Yes. And I said that we were shifting the business from a for want of a better word an EOR Acquisition Companyacquisition company to something that was more operational and more traditional. And I said that was not going to be easy. And I was right. And we've lowered I don't know how to say it, the average experience level, I guess is the politically correct way of saying it, of the people. And so some more mistakes have been made than might otherwise have been made. But I think we're getting there. I hope we're getting there. I'm just in a hurry because I'm older than the average. So it's taken longer and more been more difficult to change the organization to operational efficiency. One of the issues we have is outside the United States, our competitors have names like Shell and Exxon and BP and they operate differently than a small company might operate. We spend a sizable percentage of our capital on environmental health and safety issues, similar probably to the percentages that Exxon or somebody like that would in both the U. S. And internationally. The smaller producers simply probably doesn't do that. I mean and so we're never going to be the absolute best because of the fact we're more environmentally focused than some small producer can be. On the other hand, we can be a lot better than we are. And it's been more difficult. There's no question about it. And it's come I knew it would be difficult. And we've made a number of changes in the people that are running the assets brought more aggressive people in and if DP will make more changes. Yes. Just the final one on this point Steve. I think for any larger company, there's really no great examples of being able to grow at a fast rate and generating good returns. Sometimes over a few years, luck happens and it can happen. But you've had a 5% to 8% growth objective. You've historically had top quartile returns on capital. Is this really just an acknowledgment that having both of those goals is just not possible and you are picking returns right now? Well, pretty much a lot of the growth is baked in for the next few years with the capital we've invested. So but we need to do it with returns. It isn't just about volume growth. At some point in size, the need for capital comes. So a typical E and P today whatever they say, I mean they may sell assets to fund it is spending, I don't know, 150% of its cash flow on capital. We obviously aren't spending anywhere near that nor would we. So you can't grow as quickly as they do. We spend more on capital as a percentage than large integrated. So it's an attempt to do both. I don't know where you come out in the percentages. Obviously, if we said, well, we're going to grow 15% a year that wouldn't be something we could do. But we need to grow at a moderate rate, because I think the business if you don't grow at least some And on a regular basis, I don't mean by saying well in 20.40 in 2017, we're on track for our 2017 program and we're going to grow in 2017. Meanwhile, we're going to deplete 5% a year. That's not what I call growth. But regular growth, you have a hard time attracting people. Investors tend not to like it. They tend to compare you to basically depleting businesses. So you got to have a fair amount of growth. I don't know what the right percentage is. Right now, it's 5% to 8%. We're running really about 5% currently. And there'll be a boost in 20 15 from the Elhosin project, which will bring the growth rate up. Over a long term, we're not going to just make the if you continue to drill high decline wells, your capital will soar because if your wells are declining 30%, 40%, you need huge amounts of cash to keep to replace the 40% and grow. And so we're shifting the program to more stable things, so we can keep the capital under control. And that's really what we're doing underneath the hood, if you were to look at it that way. Instead of drilling as many high decline wells, we're drilling more or doing more stuff that has a lesser decline rate, which is what we historically did. Was that all too long an answer? That's terrific. Thank you so much, Steve. Thanks. Your next question comes from Matthew Portillo of Tudor, Pickering, Holt. Good morning, guys. Good morning. Few quick questions for me. You mentioned that on the release, the Q4 CapEx and I was just curious if you could give us a specific number that you're looking at for Q4 CapEx? Since my reliability on this has been crummy, what the only thing I'll give you is that in September, we ran about $785,000,000 and we're coming that's a monthly number. And it's coming down from that as the wells come as it comes down. So that will give you sort of a feel for it. And I think that's a but I don't I've missed it so many quarters. I just assume not missing one more. Sure. And then just on the M and A front, could you talk a little bit about the M and A market today and kind of your interest level? It sounds like kind of what the packages in the market today, there may not be that much interest, but just curious on your views. We always look at stuff in our core areas. Core area really right now the only area I call core right now is the Permian. There's a rush to do by private people to do something by the end of the year, unless the tax rates go up. There might be some things, but they would be oily and basically in the Permian if there was anything. There's some other stuff going around that's pretty gassy and I'm not sure we would do that. The market is not good for sellers particularly. It may not be good for buyers either, but it's definitely not good for sellers. So especially for larger packages, I think you can do a $100,000,000 deal and get 25 people to bid. At $500,000,000 you're lucky you track 1. And I think that's really where the market is today where there's money for small deals and really no money for large deals larger being $500,000,000 deals. We don't have any appetite for large scale M and A. We've said that for several quarters. Perfect. That is. Thank you. And just the last question for me. Could we get just I guess a quick update on maybe where your rig count is roughly in the Permian going around that's pretty gassy. And I'm not sure we would do that. The market is not good for sellers particularly. It may not be good for buyers either, but it's definitely not good for sellers. So especially for larger packages, I think you can do $100,000,000 deal and get 25 people to bid. At $500,000,000 you're lucky you track 1. And I think that's really where the market going around. That's pretty gassy. And I'm not sure we would do that. The market is not good for sellers particularly. It may not be good for buyers either, but it's definitely not good for sellers. So especially for larger packages, I think you can do $100,000,000 deal and get 25 people to bid. At $500,000,000 you're lucky you track 1. And I think that's really where the market is today where there's money for small deals and really no money for large deals or larger being $500,000,000 deals. We don't have any appetite for large scale M and A. We've said that for several quarters. Perfect. That is. Thank you. And just the last question for me. Could we get just I guess a quick update on maybe where your rig count is roughly in the Permian, California and Mid Con Bakken? And then as we think about that 2013 program, could you give us just a rough direction on maybe where those are heading either up or down just directionally trying to get a better sense of that capital allocation? Thank you. I don't as far as next year goes, we've sent the team back several times as you could probably tell the tone of my voice. So I'd hate to talk about what next year is going to look like at this point. We've cut back materially. I think in the Williston Bill in the Williston how many rigs you're running? We have 4 running right now Steve. And so and we peaked at We peaked at 14. 14. That give you a feel for the Williston. California it varies a lot because we might drop and the type of rigs run. And so running about 20 in California. About 20 in California. Permian also there's been some rigs dropped and we peaked at Teated around 32. And we're sort of half that. We're at 21 now. 21. Okay. And is that just a function of kind of where we are in the capital spend for this year? Or is that really as we think about your program and I know you said you continue to go back to the drawing board, but just trying to get a sense of is that activity going to accelerate a little bit into next year? Or you're pretty happy with those levels? I think the way I'm thinking about it at this point is that more or less going into next year it's going to look like this. My current plan would be to withhold a fair amount of capital and from the units that is drilling at these levels until I can see which units are doing well and which ones are not. And those that do well will get some more rigs to run and those that don't won't. And so I think going into the Q1 you'll see sort of this level because that's the way we sort of managed at this point. Beyond that, we'll just see. Thank you very much. Thank you. Your next question comes from Faisal Khan of Citigroup. Thanks. Good morning. Good morning. I'm just trying to reconcile some of the comments you made on California. So I mean my understanding is the opportunity in California for you is supposed to have amongst the lowest breakeven sort of oil prices in those sort of projects or those sort of wells that you're drilling. But I'm just trying to reconcile some of wells that you're drilling. But CapEx is running about $2,000,000,000 a year. You seem to say you're having higher declines in Elk Hills and costs in California are higher and it seems like you're trying to rate in some of those costs. So what is it that's if this is such a great opportunity, what is it now what you thought it was 2 years ago when you first started out on the program? The operating costs have doubled. Okay. So is the resource opportunity not the same also? No, the resource opportunity is the same. It's the cost to extract it. And if you thought that was fundamental that's one thing. And then you say, well, okay. But it's not I think it's fixable. Does that mean the F and D cost that you kind of talked about maybe a couple of years ago of $5 a barrel, dollars 10 a barrel more like closer to $20 right now in the current quarter? They're below $20 but they've come up with the well costs. And so they need to bring those down closer to where we were and they need to bring their operating costs down. And the only way to do that is not to give more money to drill wells even though the wells are economic more than economic, because gas prices here are a little higher than the rest of the country and oil prices are higher. Throw more money at it is simply the wrong solution. Sure. No, I understand that. In the RIG County, California is 20 rigs now? Was it weren't you at 35 kind of a little bit earlier in the year? So it sounds like you've done like an about face on that program? It was around 30. Around 30. Okay. So within a short period of time you've cut 10 rigs out of the operation? Because we didn't like what that was at the cost of the wells. Okay. And once again the type of wells that you're drilling this is all kind of the same depth homogeneous sort of opportunities? Or is it kind of different opportunities spread across It's different opportunities. And again, as I said earlier, we shifted the program to lower decline wells. Okay. So I mean the shale program that you guys had outlined before has kind of been pulled back? Some, not a lot. And the exploration program that you guys were running in California? The exploration program has been slowed by the permitting process. Okay. We're well behind on the exploration program a 13% sort of number for 2012. How would that split between international and domestic? Oh, I don't know. International generates higher returns on capital employed. And that's really that's how the company is structured. When we said I said it from the beginning. The high returns on invested capital come out of the international business the highest. And then domestic business because the leases are forever and then the oil in the international business are basically cut off by the life of the contract. So the upside if you will in the reservoirs over time and the long term product price goes largely to the country, but you generate good returns meanwhile. Domestically, you get to keep all that. So you generate more money domestically, but the returns are less. And that's the balance in the company and how you generate the above average returns compared to an E and P which are well into the mid single digits. Okay. Fair enough. And then last question for me. So going into next year given this focus on returns and given the where the rig count is, do you still think you can grow production year over year? Yes. Okay. Fair enough. Thank you. We have time for one last question. And your final question comes from He has a mouse in his pocket on the Wii, I think. Go ahead. Your final question comes from John Herrlin of Societe Generale. Yeah. Hi, Steve. Just quick ones. You've been complaining about returns now for several quarters. Why weren't you more proactive with the organization? Or why do you and it just takes them that long to react? I don't know. I mean, I don't know why I wasn't more it wasn't that I didn't try. It just didn't apparently didn't translate. Okay. That's fine. And I've made some changes in the management structure. Yes. Regarding the Permian, you had about a 36% working interest. Given the potential there, why not higher? Because it seems like it's probably kind of your historic level. Sorry? With the Permian acreage, the working interest was about 36 percent. Oh, I see the gross in that using the play acreage. Correct. Yes. Okay. Why not higher or because it seems like it's probably more your historic level? Yes. It would be nice if it were higher. And we acquired some properties in the last couple of years in the areas that we historically hadn't been active and those tended to be smaller interest, so you wind up with a lower average working interest in the new plays. And that's really it's just a result. We'd like to have higher interest. And in the end when you drill a well, you might wind up with a higher interest. Sure. Okay. Last one for me is on the Bakken. You've also kind of complained about those operations as well. Is that really critical to you going forward long term? I think in the remarks I pointed out the large amount of resource base there. I believe that product prices on a relative basis have improved recently. One of the issues is at least partially on its way to resolution. The other issue is that the wells cost too much. And we need large scale reductions in the cost. If we can get the large scale reductions then the assets clearly an asset we could that will be fine. If you can't achieve the large scale reductions in costs that are required then it's something for study. Okay. Thank you. Thanks.