Occidental Petroleum 10-K 2009
Documents found in this filing:
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Commission File Number 1-9210
Occidental Petroleum Corporation
(Exact name of registrant as specified in its charter)
Securities registered pursuant to Section 12(b) of the Act:
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. þ YES o NO
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. (Note: Checking the box will not relieve any registrant required to file reports pursuant to Section13 or 15(d) of the Exchange Act from their obligations under those Sections). o YES þ NO
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. þ YES o NO
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. þ
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. (See definition of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act).
Large Accelerated Filer þ Accelerated Filer o Non-Accelerated Filer o Smaller Reporting Company o
Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2). o YES þ NO
The aggregate market value of the voting common stock held by nonaffiliates of the registrant was approximately $71.9 billion, computed by reference to the closing price on the New York Stock Exchange composite tape of $89.86 per share of Common Stock on June 30, 2008. Shares of Common Stock held by each executive officer and director have been excluded from this computation in that such persons may be deemed to be affiliates. This determination of potential affiliate status is not a conclusive determination for other purposes.
At January 31, 2009, there were 810,294,560 shares of Common Stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrants definitive Proxy Statement, filed in connection with its May 1, 2009, Annual Meeting of Stockholders, are incorporated by reference into Part III.
TABLE OF CONTENTS
ITEMS 1 AND 2 BUSINESS AND PROPERTIES
In this report, "Occidental" refers to Occidental Petroleum Corporation, a Delaware corporation (OPC), and/or one or more entities in which it owns a majority voting interest (subsidiaries). Occidental conducts its operations through various oil and gas, chemical, midstream, marketing and other subsidiaries and affiliates. Occidentals executive offices are located at 10889 Wilshire Boulevard, Los Angeles, California 90024; telephone (310) 208-8800.
Occidentals principal businesses consist of three segments. The oil and gas segment explores for, develops, produces and markets crude oil, natural gas liquids (NGLs), condensate and natural gas. The chemical segment (OxyChem) manufactures and markets basic chemicals, vinyls and performance chemicals. The midstream, marketing and other segment (midstream and marketing) gathers, treats, processes, transports, stores, trades and markets crude oil, natural gas, NGLs, condensate and carbon dioxide (CO2) and generates and markets power. Unless otherwise indicated hereafter, discussion of oil or oil and liquids refers to crude oil, NGLs and condensate.
Occidental changed its alignment of operating segments at the beginning of 2008. In previous years, oil and gas and a portion of the midstream and marketing operations were reported as a single oil and gas segment and some of the corporate-directed midstream and marketing operations were reported under corporate and other. In the past two years, the Dolphin Project (Dolphin) pipeline began transporting natural gas to the United Arab Emirates (UAE) and Occidental acquired a common carrier pipeline system in the Permian Basin, various gas processing plants and the remaining ownership interest in a cogeneration facility. The addition of these operations to the existing midstream and marketing infrastructure caused management to realign its operating segments to increase its focus on these operations. All segment information for prior periods has been revised to retrospectively reflect the current segment reporting structure. The change to segment reporting had no effect on Occidental's reported consolidated earnings. Each of the reportable segments represents separate and distinct operations, is managed and receives resource allocation as a separate business unit and has its performance separately evaluated. For financial information by segment and by geographic area, see Note 16 to the Consolidated Financial Statements of Occidental (Consolidated Financial Statements).
For information regarding Occidental's current developments, see the information in the "Managements Discussion and Analysis of Financial Condition and Results of Operations" (MD&A) section of this report.
OIL AND GAS OPERATIONS
Occidentals domestic oil and gas operations are located in Texas, New Mexico, California, Kansas, Oklahoma, Utah and Colorado. International operations are located in Argentina, Bolivia, Colombia, Libya, Oman, Qatar, the UAE and Yemen. For additional information regarding Occidental's oil and gas segment, see the information under the caption "Oil and Gas Segment" in the MD&A section of this report.
Proved Reserves and Sales Volumes
The table below shows Occidentals total oil and natural gas proved reserves and sales volumes in 2008, 2007 and 2006. See "MD&A Oil and Gas Segment," Note 17 to the Consolidated Financial Statements and the information under the caption "Supplemental Oil and Gas Information" for certain details regarding Occidentals oil and gas proved reserves, the estimation process and sales volumes by country. On May 1, 2008, Occidental reported to the United States Department of Energy on Form EIA-28 proved oil and gas reserves at December 31, 2007. The amounts reported were the same as those reported in Occidentals 2007 Annual Report.
Comparative Oil and Gas Proved Reserves and Sales Volumes
Oil in millions of barrels; natural gas in billions of cubic feet; BOE in millions of barrels of oil equivalent
Competition and Sales and Marketing
As a producer of oil and natural gas, Occidental competes with numerous other domestic and foreign private and government producers. Oil and natural gas are commodities that are sensitive to prevailing global and, in certain cases, local conditions of supply and demand and are sold at "spot" or contract prices or through the futures markets to refiners and other market participants. Occidental competes by developing and producing its worldwide oil and gas reserves cost-effectively and acquiring rights to explore and develop in areas with known oil and gas deposits. Occidental also competes by increasing production through enhanced oil recovery projects in mature and underdeveloped fields and making strategic acquisitions.
OxyChem manufactures and markets basic chemicals, vinyls and performance chemicals.
OxyChem owns and operates manufacturing plants at 21 domestic sites in Alabama, Georgia, Illinois, Kansas, Louisiana, New Jersey, New York, Ohio, Pennsylvania and Texas and at three international sites in Brazil, Canada and Chile. OxyChem produces the following products:
MIDSTREAM, MARKETING AND OTHER OPERATIONS
The midstream and marketing operations gather, treat, process, transport, store, trade and market crude oil, natural gas, NGLs, condensate and CO2 and generate and market power.
Below is a description of midstream and marketing operations:
For information on capital expenditures, see the information under the heading "Liquidity and Capital Resources Capital Expenditures" in the MD&A section of this report.
Occidental employed approximately 10,400 people at December 31, 2008, 6,900 of whom were located in the United States. Occidental employed approximately 6,200 people in the oil and gas and midstream and marketing segments and 3,100 people in the chemical segment. An additional 1,100 people were employed in administrative and headquarters functions. Approximately 800 United States-based employees and 200 foreign-based employees are represented by labor unions.
Occidental has a long-standing strict policy to provide fair and equal employment opportunities to all applicants and employees.
For environmental regulation information, including associated costs, see the information under the heading "Environmental Liabilities and Expenditures" in the MD&A section of this report.
Occidental makes the following information available free of charge through its web site at www.oxy.com:
Information contained on Occidental's web site is not part of this annual report.
ITEM 1A RISK FACTORS
Volatile global and local commodity pricing strongly affects Occidentals results of operations.
Occidentals financial results typically correlate closely to the prices it obtains for its products. Changes in consumption patterns, global and local economic conditions, inventory levels, production disruptions, the actions of OPEC, currency exchange rates, speculation, worldwide drilling and exploration activities, weather, geophysical and technical limitations and other matters may affect the supply and demand dynamics of oil and gas, contributing to price volatility.
Demand and, consequently, the price obtained for Occidentals chemical products correlate strongly to the health of the United States and global economy, as well as chemical industry expansion and contraction cycles. Occidental also depends on feedstocks and energy to produce chemicals, which are commodities subject to significant price fluctuations.
Recent global economic conditions have driven oil and gas prices down to levels last seen in 2004. These conditions may continue for an extended period.
Occidentals oil and gas business operates in highly competitive environments, which affect, among other things, its results of operations and its ability to grow production and replace reserves.
Occidentals oil and gas production and results of operations depend, in part, on its ability to profitably acquire, develop or find additional reserves. Occidental replaces significant amounts of its reserves through acquisitions and large development projects. Occidental has many competitors (including national oil companies), some of which are larger and better funded, may be willing to accept greater risks or have special competencies. Competition for reserves may make it more difficult to find attractive investment opportunities or require delay of expected reserve replacement efforts. Cash conservation considerations during periods of low product prices may delay production growth and reserve replacement efforts.
Governmental actions, political instability and labor unrest may affect Occidentals results of operations.
Occidentals businesses are subject to the decisions of many governments and political interests. As a result, Occidental faces risks of:
Occidental may experience adverse consequences, such as risk of loss or production limitations, because certain of its foreign operations are located in countries occasionally affected by political instability, armed conflict, terrorism, insurgency, civil unrest, security problems, labor unrest, OPEC production restrictions, equipment import restrictions and sanctions. Exposure to such risks may increase if a greater percentage of Occidentals future oil and gas production comes from foreign sources.
Occidental faces risks associated with its mergers, acquisitions and divestitures.
Occidentals merger, acquisition and divestiture activities carry risks that it may: not fully realize anticipated benefits due to less than expected reserves or production or changed circumstances, such as prices; bear unexpected integration costs or experience other integration difficulties; experience share price declines based on the markets evaluation of the activity; assume or retain liabilities that are greater than anticipated; or be unable to resell acquired assets as planned or at planned prices.
Occidentals oil and gas reserves are based on professional judgments and may be subject to revision.
Calculations of oil and gas reserves depend on estimates concerning reservoir characteristics and recoverability, as well as oil and gas prices, capital costs and operating costs. If Occidental were required to make unanticipated significant negative reserve revisions, its results of operations and stock price could be adversely affected.
Occidental may incur significant losses in exploration activities or delays or cost overruns in development efforts.
Exploration is inherently risky. Exploration and development activities are subject to misinterpretation of geologic or engineering data, unexpected geologic conditions or finding reserves of disappointing quality or quantity, which may result in significant losses. Occidental bears the risks of project delays and cost overruns due to equipment failures, approval delays, construction delays, escalating costs for materials and labor, border disputes and other associated risks in its development efforts.
Concerns about climate change or energy dependence may affect Occidentals operations or results of operations.
There is an ongoing scientific effort to assess and quantify the effects of climate change and the potential human influences on climate, and related efforts by certain U.S. and foreign jurisdictions to propose or adopt legislation, regulations or policies seeking to control or reduce emissions of greenhouse gases or consumption of fossil fuels. As a result of these efforts, Occidental faces risks of delays in new or expanded development projects and increases in taxes. Occidental also faces risks of increases in the costs to produce, reductions in the demand for, and restrictions on the use of, its products.
Occidentals businesses may experience catastrophic events.
The occurrence of natural disasters, such as earthquakes, hurricanes and floods, and events such as well blowouts, oilfield fires, industrial accidents and other events that cause operations to cease, may affect Occidentals businesses. Third-party insurance may not provide adequate coverage or Occidental may be self-insured with respect to the related losses.
Other risk factors.
Additional discussion of risks related to oil and gas reserve estimation processes, price and demand, litigation, environmental matters, foreign operations, impairments, derivatives and market risks appears under the headings: " MD&A Oil & Gas Segment Proved Reserves" and " Industry Outlook," "Chemical Segment Industry Outlook," "Midstream, Marketing and Other Segment Industry Outlook," "Lawsuits, Claims, Commitments, Contingencies and Related Matters," "Environmental Liabilities and Expenditures," "Foreign Investments," "Critical Accounting Policies and Estimates," and "Derivative Activities and Market Risk."
ITEM 1B UNRESOLVED STAFF COMMENTS
ITEM 3 LEGAL PROCEEDINGS
For information regarding legal proceedings, see the information under the caption, "Lawsuits, Claims, Commitments, Contingencies and Related Matters" in the MD&A section of this report and in Note 9 to the Consolidated Financial Statements.
ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of Occidentals security holders during the fourth quarter of 2008.
The current term of employment of each executive officer of Occidental will expire at the May 1, 2009 organizational meeting of the Board of Directors or when a successor is selected. The following table sets forth the executive officers and significant employees of Occidental:
TRADING PRICE RANGE AND DIVIDENDS
This section incorporates by reference the quarterly financial data appearing under the caption "Quarterly Financial Data (Unaudited)" after the Notes to the Consolidated Financial Statements and the information appearing under the caption "Liquidity and Capital Resources" in the MD&A section of this report. Occidentals common stock was held by 38,791 stockholders of record at December 31, 2008, and by approximately 410,000 additional stockholders whose shares were held for them in street name or nominee accounts. The common stock is listed and traded principally on the New York Stock Exchange. The quarterly financial data, which are included in this report after the Notes to the Consolidated Financial Statements, set forth the range of trading prices for the common stock as reported on the composite tape of the New York Stock Exchange and quarterly dividend information.
In May 2006, Occidental amended its Restated Certificate of Incorporation to increase the number of authorized shares of common stock to 1.1 billion. The par value per share remained unchanged.
On August 1, 2006, Occidental effected a two-for-one stock split in the form of a stock dividend to stockholders of record as of that date with distribution of the shares on August 15, 2006. The total number of authorized shares of common stock authorized for issuance and associated par value per share were unchanged by this action. All share and per-share amounts have been adjusted to reflect this stock split.
The quarterly dividends declared on the common stock were $0.25 per share for the first quarter of 2008 and $0.32 for the last three quarters of 2008 ($1.21 for the year). On February 5, 2009, a quarterly dividend of $0.32 per share ($1.28 on an annualized basis) was declared on the common stock, payable on April 15, 2009 to stockholders of record on March 10, 2009. The declaration of future cash dividends is a business decision made by the Board of Directors from time to time, and will depend on Occidentals financial condition and other factors deemed relevant by the Board.
SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS
All of Occidental's equity compensation plans for its employees and non-employee directors, pursuant to which options, rights or warrants or other equity awards may be granted, have been approved by the stockholders. See Note 12 to the Consolidated Financial Statements for further information on the material terms of these plans.
The following is a summary of the shares reserved for issuance as of December 31, 2008, pursuant to outstanding options, rights or warrants or other equity awards granted under Occidentals equity compensation plans:
SHARE REPURCHASE ACTIVITIES
Occidentals share repurchase activities for the year ended December 31, 2008 were as follows:
The following graph compares the yearly percentage change in Occidentals cumulative total return on its common stock with the cumulative total return of the Standard & Poor's 500 Stock Index and with that of Occidentals peer group over the five-year period ended on December 31, 2008. The graph assumes that $100 was invested in Occidental common stock, in the stock of the companies in the Standard & Poor's 500 Index and in a portfolio of the peer group companies weighted by their relative market values each year and that all dividends were reinvested.
Occidental's peer group consists of Anadarko Petroleum Corporation, Apache Corporation, BP p.l.c. (BP), Chevron Corporation, ConocoPhillips, Devon Energy Corporation, ExxonMobil Corporation, Royal Dutch Shell plc and Occidental. Analysis for the peer group includes five years of historical performance data as noted above for the common stock of each of the companies.
ITEM 6 SELECTED FINANCIAL DATA
Five-Year Summary of Selected Financial Data
Dollar amounts in millions, except per-share amounts
ITEM 7 AND 7A
Managements Discussion and Analysis of Financial Condition and Results of Operations (MD&A)
In this report, "Occidental" refers to Occidental Petroleum Corporation (OPC), and/or one or more entities in which it owns a majority voting interest (subsidiaries). Occidental's principal businesses consist of three industry segments operated by OPC's subsidiaries and affiliates. The oil and gas segment explores for, develops, produces and markets crude oil, natural gas liquids (NGLs), condensate and natural gas. The chemical segment (OxyChem) manufactures and markets basic chemicals, vinyls and performance chemicals. The midstream, marketing and other segment (midstream and marketing) gathers, treats, processes, transports, stores, trades and markets crude oil, natural gas, NGLs, condensate and carbon dioxide (CO2) and generates and markets power. Unless otherwise indicated hereafter, discussion of oil or oil and liquids refers to crude oil, NGLs and condensate. In addition, discussions of oil and gas production or volumes, in general, refer to sales volumes unless context requires or it is indicated otherwise.
Occidental aims to generate superior total returns to stockholders using the following strategies:
Occidental prefers to own large, long-lived "legacy" oil and gas assets, like those in California and the Permian Basin that tend to have enhanced secondary and tertiary recovery opportunities and economies of scale that lead to cost-effective production. Management expects such assets to contribute substantially to earnings and cash flow after invested capital.
At Occidental, maintaining financial discipline means investing capital in projects that management expects will generate above-cost-of-capital returns through their life cycle. Occidental expects to use most of any excess cash flow after capital expenditures to enhance stockholders' returns by continuing its program for evaluating dividend increases, potential stock repurchases and acquisition opportunities.
The chemical business is not managed with a growth strategy. Capital is expended to operate the chemical business in a safe and environmentally sound way, to sustain production capacity and to focus on projects designed to improve the competitiveness of these assets. Asset acquisitions may be pursued when they are expected to enhance the existing core chlor-alkali and polyvinyl chloride (PVC) businesses. Historically, the chemical segment has generated cash flow exceeding its normal capital expenditure requirements.
The midstream and marketing segment is managed to generate returns on capital invested in excess of Occidental's cost of capital. In order to generate these returns, the segment operates in and around Occidental's asset base and provides low cost services to other segments as well as to third parties, and operates gas plants, oil, gas and CO2 pipeline systems, storage facilities and a trading and marketing business. Capital is expended to operate those facilities in a safe and environmentally sound way, to sustain or, where appropriate, increase operational capacity and to improve the competitiveness of Occidental's assets.
Oil and Gas
The oil and gas business seeks to add new oil and natural gas reserves at a pace ahead of production while minimizing costs incurred for finding and development. The oil and gas business implements this strategy within the limits of the overall corporate strategy primarily by:
Over the past several years, Occidental has strengthened its asset base within each of the core areas. Occidental has invested in, and disposed of, assets with the goal of raising the average performance and potential of its assets.
In addition, Occidental has continued to make capital contributions and investments in the Dolphin Project in Qatar and the United Arab Emirates (UAE) and the Mukhaizna project in Oman for continued growth opportunities.
Occidentals overall performance during the past several years reflects the successful implementation of its strategy to enhance the development of mature fields, beginning with the acquisition of the Elk Hills oil and gas field in California in 1998, followed by a series of purchases in the Permian Basin in west Texas and New Mexico, the integration of Vintage Petroleum, Inc. (Vintage) operations acquired in 2006, and Plains Exploration & Production Company (Plains) assets acquired in 2006 and 2008, as well as the investment in the Dolphin Project, which began operations in 2007.
At the end of 2008, the Elk Hills and Permian assets made up 60 percent of Occidentals consolidated proved oil reserves and 37 percent of its consolidated proved gas reserves. On a barrels of oil equivalent (BOE) basis, these assets accounted for 54 percent of Occidentals consolidated proved reserves. In 2008, the combined production from these assets was approximately 282,000 BOE per day.
OxyChems strategy is to be a low-cost producer in order to maximize its cash flow generation. OxyChem concentrates on the chlorovinyls chain beginning with chlorine, which is co-produced with caustic soda, both of which are marketed to third parties. In addition, chlorine, together with ethylene, is converted through a series of intermediate products into PVC. OxyChem's focus on chlorovinyls permits it to maximize the benefits of integration and allows it to take advantage of economies of scale.
Midstream, Marketing and Other
The midstream and marketing segment is managed to generate returns on capital invested in excess of Occidental's cost of capital. In order to generate these returns, the segment operates in and around Occidental's asset base and provides low cost services to other segments as well as to third parties, and operates gas plants, oil, gas and CO2 pipeline systems, storage facilities and a trading and marketing business. Capital is expended to operate those facilities in a safe and environmentally sound way, to sustain, or, where appropriate, increase operational capacity and to improve the competitiveness of Occidental's assets.
Key Performance Indicators
Occidental seeks to ensure that it meets its strategic goals by continuously measuring its success in maintaining below average debt levels and top quartile performance compared to its peers in:
During the three-year period from 2006 to 2008, Occidental increased its annual dividend by 78 percent while its stock price increased by 50 percent.
Occidental focuses on achieving top quartile ROE and ROCE. Occidental has delivered such returns even after considering that during 2008 and the three-year period from 2006 to 2008, Occidental increased its stockholders equity by 20 percent and 81 percent, respectively.
Occidentals year-end 2008 total debt-to-capitalization ratio declined to 9 percent from 27 percent at the end of 2004. During that time, Occidental has reduced its debt over 29 percent while increasing its stockholders' equity by 158 percent.
Since 2007, Occidentals long-term senior unsecured debt has been rated A by Fitch Ratings. In 2008, Occidental's long-term senior unsecured debt was upgraded from A- to A by Standard and Poor's Ratings Services, from A3 to A2 by Moody's Investors Service and from A(low) to A by Dominion Bond Rating Service. A security rating is not a recommendation to buy, sell or hold securities, may be subject to revision or withdrawal at any time by the assigning rating organization and should be evaluated independently of any other rating.
OIL AND GAS SEGMENT
Oil and gas prices are the major variables that drive the industrys short and intermediate term financial performance. Average oil prices were stronger in 2008 over 2007, as a result of steadily increasing prices during the first half of the year followed by a steep price decline in the second half, and ended the year lower than the 2007 year-end levels. West Texas Intermediate (WTI) settled at $145.31 per barrel on July 3, 2008, up from $95.98 per barrel as of December 31, 2007, and then dropped to $44.60 per barrel at the end of 2008. The average WTI market price for 2008 was $99.65 per barrel compared with $72.32 per barrel in 2007. Occidentals realized price for crude oil as a percentage of average WTI prices was approximately 89 percent and 90 percent for 2008 and 2007, respectively. Prices and differentials can vary significantly, even on a short-term basis, making it impossible to predict realized prices with a reliable degree of certainty.
The average New York Mercantile Exchange (NYMEX) domestic natural gas price in 2008 increased approximately 27 percent from 2007. For 2008, NYMEX gas prices averaged $9.01 per Mcf compared with $7.12 per Mcf for 2007, but was $5.62 per Mcf as of December 31, 2008.
All sales, production and reserves volumes are net to Occidental unless otherwise specified.
Worldwide Sales Volumes
In February 2008, Occidental purchased from Plains a 50-percent interest in oil and gas properties in the Permian Basin and western Colorado for approximately $1.5 billion. In December 2008, Occidental purchased the remainder of Plains' interests in the same assets for approximately $1.2 billion.
In June 2008, Occidental and its partner signed 30-year agreements (including a potential 5-year extension) with the Libyan National Oil Company (NOC) to upgrade its existing petroleum contracts in Libya. The new agreements increased Occidental's after-tax economic returns while allowing NOC and Occidental to design and implement major field redevelopment and exploration programs in the Sirte Basin. Occidental will contribute 37.5 percent of the development capital. Under these contracts, Occidental will pay $750 million as its share of a signature bonus. Occidental made its first payment in the amount of $450 million in June 2008. Occidental's remaining annual payments of $150 million each, are due in each of the next two years.
Production-Sharing Contracts (PSC)
Occidental conducts its operations in Qatar, Oman, Libya and Yemen and the Dolphin Project under PSCs. Under such contracts, Occidental receives a share of production and reserves to recover its costs and generally an additional share for profit. In addition, Occidental's share of production and reserves from THUMS, Tidelands and certain contracts in Colombia are subject to contractual arrangements similar to a PSC. These contracts do not transfer any right of ownership to Occidental and reserves reported from these arrangements are based on Occidentals economic interest as defined in the contracts. Occidentals share of production and reserves from these contracts decreases when product prices rise and increases when prices decline. Overall, Occidentals net economic benefit from these contracts is greater when product prices are higher.
1. Elk Hills and other interests
2. Long Beach
3. Midcontinent / Rockies
4. Permian Basin
The Permian Basin extends throughout southwest Texas and southeast New Mexico and is one of the largest and most active oil basins in the United States, with the entire basin accounting for approximately 19 percent of the total United States crude oil production. Occidental is the largest producer of crude oil in the Permian Basin with an approximate 16-percent net share of the total production. Occidental also produces and processes natural gas and NGLs in the Permian Basin.
A significant portion of Occidental's Permian Basin interests were obtained through the acquisition of Altura Energy Ltd. in 2000, as well as the properties obtained from Plains in 2008 and 2006. Occidental's total share of Permian Basin oil and gas production was approximately 198,000 BOE per day in 2008. At the end of 2008, Occidental's Permian Basin properties had 1.1 billion BOE in proved reserves.
Occidental's Permian Basin production is diversified across a large number of producing areas. In 2008, Wasson San Andres was Occidental's largest Permian producing field with approximately 35,000 BOE per day of production and 277 million BOE of proved reserves at year-end. This field represents approximately 18 percent of Occidental's 2008 daily Permian Basin production and 25 percent of its year-end Permian Basin proved reserves.
Occidentals interests in the Permian Basin offer additional development and exploitation potential. During 2008, Occidental drilled approximately 280 wells on its operated properties and participated in additional wells drilled on third-party-operated properties. Occidental conducted significant development activity on 11 carbon dioxide (CO2) projects during 2008, including implementation of new floods and expansion of existing CO2 floods. Occidental also focused on improving the performance of existing wells. Occidental had an average of 150 well service units working in the Permian area during 2008 performing well maintenance and workovers.
Approximately 66 percent of Occidentals Permian Basin oil production is from fields that actively employ the application of CO2 flood technology, an enhanced oil recovery (EOR) technique. This technique involves injecting CO2 into oil reservoirs where it acts as a solvent, causing the oil to flow more freely into producing wells. These CO2 flood operations make Occidental a world leader in the application of this technology.
Occidental's California operations consist of Elk Hills, THUMS, Tidelands and other interests in the Ventura, San Joaquin and Sacramento basins.
Occidental's interest at Elk Hills includes the Elk Hills oil and gas field in the southern portion of Californias San Joaquin Valley, which it operates with an approximately 78-percent interest, and other adjacent properties. The Elk Hills field is the largest producer of gas in California. Oil and gas production in 2008 from the Elk Hills properties was approximately 84,000 BOE per day. During 2008, Occidental continued to perform infill drilling, field extensions and recompletions identified by advanced reservoir characterization techniques, resulting in 275 new wells being drilled and 550 wells being worked over. At the end of 2008, the Elk Hills properties had an estimated 491 million BOE of proved reserves.
Occidental owns interests in California properties in the Ventura, San Joaquin and Sacramento basins, other than Elk Hills. The combined properties produce oil and gas from more than 50 fields. Oil and gas production from these properties in 2008 was approximately 24,000 BOE per day. At the end of 2008, the combined properties had an estimated 118 million BOE of proved reserves.
THUMS conducts the field operations for an oil production unit offshore Long Beach, California. Tidelands is the contract operator for an onshore oil production unit in Long Beach, California. Occidental's share of production and reserves from both properties is subject to contractual arrangements similar to a PSC. For 2008, Occidental's share of production from THUMS and Tidelands was approximately 20,000 BOE per day and proved reserves totaled 99 million BOE at year-end.
Midcontinent and Rockies
Occidental owns 739,000 acres in a large concentration of gas reserves, production interests and royalty interests in Kansas and Oklahoma where it drilled 87 company-operated wells in 2008.
Occidental also has over 77,000 net acres in western Colorado, including the properties acquired in 2008 from Plains where it drilled 68 company-operated wells in 2008.
In 2008, Occidentals Midcontinent and Rockies operations produced approximately 35,000 BOE per day. At December 31, 2008, proved reserves for these operations totaled 250 million BOE.
Middle East/North Africa
Middle East/North Africa
4. United Arab Emirates
Occidental's investment in the Dolphin Project, which was acquired in 2002, consists of two separate economic interests through which Occidental owns (i) a 24.5-percent undivided interest in the assets and liabilities associated with a Development and Production Sharing Agreement (DPSA) with the Government of Qatar to develop and produce natural gas and NGLs in Qatars North Field for 25 years from the start of production, with a provision to request a 5-year extension; and (ii) a 24.5-percent interest in the stock of Dolphin Energy Limited (Dolphin Energy).
Dolphin Energy is the operator under the DPSA and owns and operates a 230-mile-long, 48-inch natural gas pipeline (Dolphin Pipeline), which transports dry natural gas from Qatar to the UAE. Production of natural gas and NGLs under the DPSA from Qatar's North Field began during mid-2007 and, since mid-2008, production has been at full capacity of the plant. Occidentals share of production was approximately 52,000 BOE per day in 2008. At December 31, 2008, Occidentals share of proved oil and gas reserves from the Dolphin Project was 298 million BOE.
The pipeline has a capacity to transport up to 3.2 billion cubic feet (Bcf) of natural gas per day and currently transports approximately 2 Bcf per day. Demand for natural gas in the UAE and Oman has grown and Dolphin Energys customers have requested additional gas supplies. To help fulfill this growing demand, Dolphin Energy will continue to pursue an agreement to secure an additional supply of gas from Qatar.
In addition to its participation in the Dolphin Project, Occidental operates three offshore projects in Qatar: Idd El Shargi North Dome (ISND) and Idd El Shargi South Dome (ISSD), with a 100-percent working interest in each, and Al Rayyan (Block 12), with a 92.5-percent working interest. Additionally, Occidental holds a 92.5-percent working interest in the Block 13 exploration block.
In 2008, Occidental received approval from the Government of Qatar for the third phase of field development of the ISND field. Drilling under this phase is expected to continue through 2010, focusing on continued development of the mature reservoirs, while further delineating and developing the less mature reservoirs.
Occidentals share of production from ISND, ISSD and Block 12 was approximately 47,000 BOE per day in 2008. Proved reserves for these properties totaled 150 million BOE as of December 31, 2008.
Occidental owns contractual interests in three producing blocks in Yemen, including a 38-percent direct-working interest in the Masila field, which expires in December 2011, a 40.4-percent interest in the East Shabwa field, including an 11.8-percent equity interest in an unconsolidated entity, and a 75-percent working interest in Block S-1. In addition, Occidental owns a 75-percent working interest in Block 75.
Occidental's share of production from the Yemen properties was 21,000 BOE per day in 2008. Proved reserves for these properties totaled 28 million BOE as of December 31, 2008.
In Oman, Occidental is the operator of Block 9 and Block 27, with a 65-percent working interest in each, Block 53, with a 45-percent working interest, Block 54, with a 70-percent working interest and Block 62, with a 48-percent working interest.
Occidental and its partners signed a 30-year PSC for the Mukhaizna field (Block 53) with the Government of Oman in 2005. In September 2005, Occidental assumed operations of the Mukhaizna field. The Mukhaizna field, located in Omans south central interior, was discovered in 1975 and was brought into production in 2000. By the end of 2008, Occidental had drilled over 370 new wells and continued implementation of a major pattern steam flood project. As of year-end 2008, the exit rate of gross daily production was over six times higher than the production rate in September 2005, reaching over 50,000 BOE per day. Occidental plans to steadily increase production through continued expansion of the steam flood project.
The term for Block 9 is through December 2015, with a potential 10-year extension. The term for Block 27 is 30 years beginning in September 2005. Occidental and its partners began production in June 2006.
Occidental and its partners signed a PSC for Block 54 with the Government of Oman in June 2006 with an initial exploration phase of four years.
Occidental was awarded Block 62 in November 2008 under a 20-year contract. Block 62 is comprised of both development and exploration opportunities targeting gas and condensate resources.
Occidental's share of production from the Oman properties was approximately 27,000 BOE per day in 2008, and proved reserves totaled 142 million BOE as of December 31, 2008.
In 2005, Occidental signed an agreement with the Libyan National Oil Corporation (NOC) which allowed it to re-enter the country and participate in exploration and production operations in the Sirte Basin, which it left in 1986 pursuant to United States law. This re-entry agreement allowed Occidental to return to its Libyan operations on generally the same terms in effect when activities were suspended.
As discussed previously, in June 2008, Occidental and its partner signed new agreements with NOC to upgrade its existing contracts for up to 30 years.
Occidental's share of production during 2008 was approximately 15,000 BOE per day. In the second half of 2008, production was approximately 8,000 BOE per day as a result of the new agreements. At year-end 2008, proved reserves for Occidentals Libya assets totaled 28 million BOE.
In October 2008, Occidental announced the signing of the preliminary agreement with Abu Dhabi National Oil Company to appraise and develop the Jarn Yaphour and Ramhan oil and gas fields in the Emirate of Abu Dhabi. Occidental would operate both fields and hold a 100-percent interest in the newly created concessions. First production from the Jarn Yaphour field, located onshore, could be as early as 2010. Gross production from the initial development is anticipated to be approximately 10,000 BOE per day. At the Ramhan field, located in shallow water offshore, gross production also is expected to be approximately 10,000 BOE per day, if initial development is technically and commercially successful. First production from the Ramhan field could commence as early as 2011.
The Argentina assets consist of 23 concessions located in the San Jorge Basin in southern Argentina and the Cuyo Basin and Neuquén Basin in western Argentina. Occidental operates 20 of the concessions with a 100-percent working interest.
During 2008, Occidental drilled 162 new wells and performed a number of recompletions and well repairs. Occidental plans to increase production through drilling, waterflooding and EOR projects.
Occidentals share of production from Argentina was approximately 36,000 BOE per day in 2008. Proved reserves from these assets totaled 160 million BOE at December 31, 2008.
In 2006, Occidental acquired working interests in four blocks located in the Tarija, Chuquisaca and Santa Cruz regions of Bolivia as part of the Vintage acquisition. At the end of 2006, Occidental signed two new operation contracts with commercial terms that provide Bolivia with greater operational control and control over the commercialization of hydrocarbons. These contracts went into effect in May 2007. During 2008, Occidental completed two workovers in Naranjillos Field.
Occidental is the operator under four contracts within the Llanos Norte Basin: the Cravo Norte, Rondón, Cosecha, and Chipirón Association Contracts. Occidentals working interests under the four contracts are 42 percent (39 percent starting January 1, 2009), 44 percent, 53 percent and 61 percent, respectively. Colombia's national oil company, Ecopetrol, operates the Caño Limón-Coveñas oil pipeline and marine-export terminal. The pipeline transports oil produced from the Llanos Norte Basin for export to international markets.
In the Middle-Magdalena Basin, Occidental signed an agreement with Ecopetrol in 2005 for an EOR project in the La Cira-Infantas field, in which Occidental holds a 48-percent working interest. In December 2006, Occidental entered into the commercial phase of the project. Production from the field is transported by Ecopetrol through its pipeline and sold to Ecopetrol.
Additionally, Occidental holds various working interests in two exploration blocks.
Occidental's share of 2008 production from its Colombia operations was approximately 37,000 BOE per day and proved reserves for these interests totaled 85 million BOE at the end of 2008.
Occidental's consolidated subsidiaries had proved reserves at year-end 2008 of 2,978 million BOE, as compared with the year-end 2007 amount of 2,866 million BOE. Proved reserves consisted of 74 percent oil and 26 percent natural gas. Proved developed reserves represented approximately 74 percent of Occidentals total proved reserves at year-end 2008 compared to 80 percent at year-end 2007.
Proved Reserve Additions
The total proved reserve additions from consolidated subsidiaries from all sources were 463 million BOE in 2008, before the effect of price-related revisions. The total revisions were as follows:
Revisions of Previous Estimates
In 2008, Occidental experienced a reduction, before the effect of price revisions, of 18 million BOE of proved reserves through negative revisions of previous estimates, primarily in the Permian Basin, California and Argentina, partially offset by positive revisions in the Middle East/North Africa. Occidental experienced an additional negative net price-related revision of 127 million BOE that was attributable to changes in the prices of oil and gas from year-end 2007 to year-end 2008. Negative domestic price revisions were partially offset by positive price revisions in the Middle East/North Africa as a result of the impact of PSCs. Oil price changes affect proved reserves recorded by Occidental. For example, when oil prices increase, less oil volume is required to recover costs under PSCs, which would result in a reduction of Occidental's share of proved reserves. Conversely, when oil prices drop, Occidental's share of proved reserves would increase for these PSCs. Oil and natural gas price changes also tend to affect the economic lives of proved reserves, primarily in domestic properties, in a manner partially offsetting the PSC reserve volume changes. Apart from the effects of product prices, Occidental believes its approach to interpreting technical data regarding proved oil and gas reserves makes it more likely that future proved reserve revisions will be positive rather than negative.
In 2008, Occidental added reserves of 247 million BOE through improved recovery. In the United States, improved recovery additions were 146 million BOE. Latin America additions were 52 million BOE and Middle East/North Africa added 49 million BOE. These improved recovery additions were attributable to EOR techniques, such as CO2, water and steam injection programs, as well as Occidental's ongoing development programs.
Extensions and Discoveries
Occidental also obtains reserve additions from extensions and discoveries, which are dependent on successful exploitation programs. In 2008, as a result of such programs, Occidental added proved reserves of 24 million BOE, primarily associated with its California operations.
The success of extension and discovery projects depends on reservoir characteristics and technology improvements, as well as oil and gas prices, capital costs and operating costs. Many of these factors are outside of management's control, and will affect whether or not these historical sources of proved reserve additions continue at similar levels.
Purchases and Divestitures of Proved Reserves
In 2008, Occidental purchased proved reserves of 210 million BOE (207 million BOE net of divestitures), all of which were in the United States. Occidental continues to add reserves through acquisitions when properties are available at prices it deems reasonable. As market conditions change, the available supply of properties may increase or decrease accordingly.
Proved Undeveloped Reserves
In 2008, Occidental had proved undeveloped reserve additions of 317 million BOE resulting from improved recovery, extensions and discoveries and purchases, primarily in the Midcontinent and Rockies, the Permian Basin, Elk Hills, and Oman. These proved undeveloped reserve additions were offset by reserves transfers of 99 million BOE to the proved developed category as a result of the 2008 development programs. In the United States, the Elk Hills and Permian Basin properties both transferred 22 million BOE into proved developed reserves from proved undeveloped reserves.
Reserves Evaluation and Review Process
A senior corporate officer of Occidental is responsible for the internal audit and review of its oil and gas reserves data. In addition, a Corporate Reserves Review Committee (Reserves Committee) has been established, consisting of senior corporate officers, to monitor and review Occidental's oil and gas reserves. The Reserves Committee reports to the Audit Committee of Occidental's Board of Directors periodically throughout the year. Occidental has retained Ryder Scott Company, L.P. (Ryder Scott), independent petroleum engineering consultants, to review its annual oil and gas reserve estimation processes since 2003.
In 2008, Ryder Scott compared Occidentals methods and procedures for estimating oil and gas reserves to generally accepted industry standards and reviewed certain pertinent facts interpreted and assumptions made in estimating the proved reserves volumes, preparing the economic evaluations and determining reserves classifications. Ryder Scott reviewed the specific application of such methods and procedures for selected oil and gas properties considered to be a valid representation of Occidentals total reserves portfolio. In 2008, Ryder Scott reviewed approximately 22 percent of Occidentals proved oil and gas reserves. Since being engaged in 2003, Ryder Scott has reviewed the specific application of Occidentals reserve estimation methods and procedures for approximately 66 percent of Occidentals proved oil and gas reserves.
Based on its reviews, including the data, technical processes and interpretations presented by Occidental, Ryder Scott has concluded that the overall procedures and methodologies utilized in determining the proved reserves for the reviewed properties as estimated by Occidental are reasonable and consistent with generally accepted industry standards and comply with current Securities and Exchange Commission (SEC) standards. Ryder Scott has not been engaged to render an opinion as to the reasonableness of reserves quantities reported by Occidental.
The petroleum industry is highly competitive and subject to significant volatility due to numerous market forces affecting supply and demand. Worldwide oil prices experienced a high degree of volatility during 2008. WTI settled at $145.31 per barrel on July 3, 2008, up from $95.98 per barrel as of December 31, 2007, and then dropped to $44.60 per barrel at the end of 2008. While many factors precipitated these price fluctuations, the worldwide drop in demand for oil caused by the global economic crisis appears to have been the major contributor to the significant and steady drop in oil prices in the second half of 2008.
In the near term, a continued global economic downturn could have a depressing effect on oil prices, while recently announced and enacted production cuts by OPEC members and certain other producing nations, as well as other potential similar future actions of these countries, could offset the effects of falling demand. In the longer term, a recovery in global economic conditions should result in increased demand, which, coupled with concerns about supply availability, could result in higher prices. A lower long-term demand growth rate could result in lower oil prices. The factors discussed above make it impossible to predict the future direction of oil prices with a reliable degree of certainty. However, Occidental is adjusting to current economic conditions by reducing its operating expenses and adjusting capital expenditures with the goal of keeping returns well above its cost of capital. Typical industry response to sustained deterioration in product prices would be to limit drilling and other growth activities.
While local supply and demand fundamentals, as well as availability of transportation capacity from producing areas, are decisive factors affecting domestic natural gas prices over the long term, day-to-day prices may be more volatile in the futures markets, such as on the NYMEX and other exchanges, making it difficult to forecast prices with any degree of confidence. Over the last ten years, the NYMEX gas price has averaged approximately $5.72 per Mcf.
The chemical segment earnings increased in 2008 despite the deepening global economic downturn. Higher prices and margins for caustic soda were the primary drivers of the earnings improvement. Increased demand for and competitiveness of domestically produced products in export markets, aided by favorable feedstock prices and foreign currency exchange rates, also contributed to the improved earnings. Partially
offsetting these improvements was the continued fallout from the eroding United States housing market, which resulted in lower domestic demand and earnings in the PVC business.
During 2008, demand and pricing for basic chemical products generally remained strong, although U.S. chlorine demand fell further compared to 2007 due to the acceleration of the economic downturn late in the year. Exports of chlorine-derived products remained steady throughout 2008 due to the weakness of the U.S. dollar along with various feedstock cost advantages. Domestic industry demand for caustic soda in 2008 remained relatively stable until the fourth quarter when demand weakened due to the slowing economic conditions. The tight caustic supply during 2008 was due in part to the demand weakness of the co-produced product chlorine. Caustic soda exports also remained strong throughout the year. As a result, caustic soda pricing increased each quarter of 2008, which enabled the industry to realize improved margins over 2007. OxyChems chlor-alkali operating rate for 2008 was 85 percent of capacity, which was higher than the industry average operating rate, but lower than the 2007 operating rate of 92 percent.
Domestic demand for PVC in 2008 was 17 percent below 2007 as a result of the significant slump in housing and automotive industries. This decline was partially offset by exports, which were up 27 percent in 2008 over 2007, resulting in an overall decline in PVC demand of 13 percent. Compared to 2007, PVC prices increased 24 percent, but a 16-percent increase in ethylene costs and a significant volume decline resulted in lower earnings in the PVC business.
Future performance will depend on the recovery of domestic housing and construction markets, global economic recovery, the competitiveness of the United States in the world markets and feedstock and energy pricing.
Operating rates would continue to be challenged throughout the year if demand remains suppressed in chlorine, vinyls and various chlorine-derivative markets. Demand for basic chemical products could decline further in 2009 as the U.S. housing, automotive and durable goods sectors are expected to remain weak. Margins are expected to be similar to 2008 as pricing for caustic soda is generally expected to remain strong. The anticipated strong caustic pricing is due to the continued weak demand for its co-product chlorine.
Industry-wide PVC operating rates are expected to be lower in 2009 as a result of weak demand, especially in housing. In addition, exports are expected to decline in 2009 due to raw material cost parity with other industrialized regions.
MIDSTREAM, MARKETING AND OTHER SEGMENT
The midstream and marketing segment gathers, treats, processes, transports, stores, trades and markets crude oil, natural gas, NGLs, condensate and CO2 and generates and markets power. Midstream and marketings 2008 earnings increased, reflecting an increase in gas processing margins at the Dolphin Pipeline investment.
Oil and Gas Marketing and Trading
The marketing and trading group markets substantially all of Occidentals oil and gas production. Marketing and trading earnings are affected primarily by margins in oil and gas transportation and storage programs. These operations periodically use derivative instruments to maximize realized prices for Occidental's products and in third-party marketing and trading activities.
In 2008, Occidentals marketing operations earnings declined due to lower margins in oil marketing.
Gas Processing Plants and CO2 Fields and Facilities
Occidental processes its and third-party domestic wet gas to extract NGLs and other gas by-products, including CO2, and deliver dry gas to pipelines. Margins result from the difference between inlet costs of gas and market prices for NGLs.
In June 2008, Occidental signed an agreement for a third party to construct a west Texas gas processing plant and pipeline infrastructure that will provide CO2 for Occidentals EOR projects in the Permian Basin. Occidental will own and operate the new facility and pipeline system and expects to incur capital expenditures of approximately $1.1 billion over several years of which it had spent approximately $115 million as of December 31, 2008.
Occidentals 2008 earnings from these operations improved due to higher gas processing margins.
Margin and cash flow from pipeline transportation operations mainly reflect volumes shipped. The Dolphin Pipeline investment contributes significantly to pipeline transportation results. See "Oil and Gas Segment Middle East/North Africa Dolphin Project." In August 2008, Occidental purchased a minority interest in a North American oil and gas pipeline entity for approximately $330 million.
Occidentals 2008 pipeline transportation earnings improved due to increased earnings from the Dolphin Pipeline investment.
Power Generation Facilities
Earnings from power generation facilities represent the sales of excess steam and power to third parties.
Occidentals 2008 earnings from these facilities increased due to higher margins between the selling prices of power and steam and the cost of gas used in their production.
Occidental expects future performance of the midstream and marketing segment to remain relatively stable unless it makes significant acquisitions or dispositions.
In July 2008, Occidental purchased a 15-percent interest in the Joslyn Oil Sands Project (Joslyn) in northern Alberta, Canada, for approximately $500 million in cash.
SEGMENT RESULTS OF OPERATIONS
Segment earnings generally exclude income taxes, interest income, interest expense, environmental remediation expenses, unallocated corporate expenses and discontinued operations, but include gains and losses from dispositions of segment assets and income from the segments' equity investments. Seasonality is not a primary driver of changes in Occidental's consolidated quarterly earnings during the year.
The following table sets forth the sales and earnings of each operating segment and corporate items:
In millions, except per share amounts
Oil and Gas
The following tables set forth the sales volumes and production of oil and liquids and natural gas per day for each of the three years in the period ended December 31, 2008. The differences between the sales volumes and production per day are generally due to the timing of shipments at Occidentals international locations where product is loaded onto tankers. Sale at these locations is not recognized until a tanker is loaded and title passes.
(See footnotes following the Average Sales Price table)
(See footnotes following the Average Sales Price table)
Oil and gas segment earnings in 2008 were $10.7 billion, compared to $8.0 billion in 2007. The increase in segment earnings reflects higher average oil and natural gas prices and increased oil and gas volumes, which were offset by higher operating expenses and production taxes and increased depreciation, depletion and amortization (DD&A) rates. Oil and gas segment earnings in 2008 include pre-tax foreign exchange gains of $74 million, a pre-tax charge of $599 million for asset impairments consisting of undeveloped acreage in Argentina and Yemen and impairments of producing properties in the U.S. and a pre-tax charge of $58 million for termination of rig contracts.
Average consolidated production costs for 2008, excluding taxes other than on income, were $12.13 per BOE, compared to the average 2007 production cost of $10.37 per BOE. The increases resulted from higher production, maintenance and workover costs.
Oil and gas segment earnings in 2007 were $8.0 billion, compared to $6.7 billion in 2006. Oil and gas segment earnings in 2007 included an after-tax gain of $412 million from the sale of Occidentals interest in a Russian joint venture, an after-tax gain of $112 million from certain litigation settlements, a pre-tax gain of $103 million from the sale of exploration properties, a pre-tax gain of $35 million from the sale of miscellaneous domestic oil and gas interests and a $74 million pre-tax loss from the impairment of properties. In addition to the matters discussed above, oil and gas segment earnings for 2007, compared to 2006, reflected higher crude oil prices and higher oil and gas production, partially offset by increased DD&A rates and higher operating and exploration expenses.
Chemical segment earnings in 2008 were $669 million, compared to $601 million in 2007. The increase in segment earnings is primarily due to higher caustic soda margins, partially offset by lower volumes in chlorine, caustic soda and PVC and a $90 million charge for plant closure and impairments.
Chemical segment earnings in 2007 were $601 million, compared to $906 million in 2006. The decrease in segment earnings was primarily due to lower margins in PVC.
Midstream, Marketing and Other
Midstream and marketing segment earnings in 2008 were $520 million, compared to $367 million in 2007. The increase in segment earnings in 2008 reflects higher income from the Dolphin Pipeline and higher margins in gas processing.
The increase in segment earnings in 2007, compared to 2006, was primarily due to higher natural gas trading margins and, to a lesser degree, increased crude oil trading margins.
SIGNIFICANT ITEMS AFFECTING EARNINGS
The following table sets forth, for the years ended December 31, 2008, 2007 and 2006, the effects of significant transactions and events affecting Occidentals earnings that vary widely and unpredictably in nature, timing and amount:
Significant Items Affecting Earnings
Deferred tax liabilities, net of deferred tax assets of $1.4 billion, were $2.5 billion at December 31, 2008. The current portion of the deferred tax assets of $200 million is included in prepaid expenses and other. The deferred tax assets, net of allowances, are expected to be realized through future operating income and reversal of temporary differences.
Worldwide Effective Tax Rate
The following table sets forth the calculation of the worldwide effective tax rate for income from continuing operations:
Occidentals 2008 worldwide tax rate was 40 percent, which is comparable to 2007.
Occidentals 2007 worldwide effective tax rate was 41 percent. The decrease in the income tax rate in 2007, compared to 2006, resulted from lower taxes on the 2007 sale of certain properties.
CONSOLIDATED RESULTS OF OPERATIONS
The changes in the following components of Occidental's results of operations are discussed below:
Selected Revenue and Other Income Items
The increase in net sales in 2008, compared to 2007, reflects higher average oil and natural gas prices and higher oil and gas volumes, including increased volumes from the Dolphin Project, offset by lower volumes from PSCs and the new Libya contract.
The increase in net sales in 2007, compared to 2006, reflects higher crude oil prices and increased oil and gas volumes, including production from the start-up of the Dolphin Project in the third quarter of 2007.
Interest, dividends and other income in 2007 and 2006 included gains related to litigation settlements of $112 million and $108 million, respectively.
Gains on disposition of assets, net in 2007, includes a $326 million gain from the sale of 21 million shares of Lyondell, a $412 million gain from the sale of Occidentals interest in a Russian joint venture and a gain of $103 million from the sale of exploration properties in West Africa.
Gains on disposition of assets, net in 2006, includes a gain of $90 million from the sale of 10 million shares of Lyondell stock.
Selected Expense Items
Cost of sales increased in 2008, compared to 2007, due to higher oil and natural gas volumes, as well as higher maintenance, workover, field operating and feedstock costs.
Cost of sales increased in 2007, compared to 2006, due to higher oil and natural gas production and maintenance costs and higher chemicals feedstock costs.
Selling, general and administrative and other operating expenses decreased in 2008, compared to 2007, due to a decrease in equity compensation expense and foreign exchange gains of $91 million, which were partially offset by rig contract termination charges of $58 million.
Selling, general and administrative and other operating expenses increased in 2007, compared to 2006, due to 2007 severance charges and higher stock-based and incentive compensation expense. The increase in stock-based and incentive compensation expense in 2007, compared to 2006, resulted from a 58-percent increase in Occidental's stock price and higher net income, which increased the performance measures used to value certain of the existing stock-based awards, partially offset by a decrease in the value of awards granted in 2007.
DD&A increased in 2008, compared to 2007, due to the increase in sales volumes, mainly from the Dolphin Project, and higher DD&A rates caused by the cost of new proved reserve additions being higher than the existing average rates, especially in Latin America and the Middle East/North Africa. The 2008 amount also included a charge of $42 million for domestic asset impairments.
DD&A increased in 2007, compared to 2006, due to increased sales volumes, mainly from the Dolphin Project, and higher costs of new proved reserve additions resulting in a higher DD&A rate.
The increase in taxes other than on income in 2008, compared to 2007, reflects higher production taxes resulting from higher net sales as well as an increase in ad valorem taxes due to increases in oil and gas property values.
Exploration expense decreased in 2008, compared to 2007, due to decreases in Colombia and Middle East/North Africa. The 2007 amount included expenses for exploration properties in West Africa, which were sold in the third quarter of 2007.
Exploration expense increased in 2007, compared to 2006, due to increases in the Colombia and Middle East/North Africa exploration programs and impairments in California.
Interest and debt expense in 2007 and 2006 included pre-tax debt repayment expenses of $167 million and $35 million, respectively. Excluding the effect of the 2007 debt repayment charges, interest expense decreased in 2008, compared to 2007, due to lower average debt levels and lower effective interest rates.
Selected Other Items
The increase in the provision for income taxes in 2008, compared to 2007, was due to higher income before taxes in 2008. The 2008 worldwide effective tax rate was comparable to 2007.
The increase in the provision for income taxes in 2007, compared to 2006, was due to higher income before taxes in 2007.
The increase in income from equity investments in 2008, compared to 2007, was due to higher income from the Dolphin Pipeline.
The decrease in income from equity investments in 2007, compared to 2006, was due to the sale of Occidentals interest in Lyondell and a Russian joint venture.
Discontinued operations in 2007 included after-tax income of $326 million for the operations of Horn Mountain and Pakistan that were sold as part of a series of transactions with BP as well as the results of operations of these assets before disposal.
Discontinued operations in 2006 included a $296 million after-tax loss for Ecuador after Occidental's contract for its Block 15 operations was terminated in May 2006. The 2006 amount also included $285 million of after-tax income for the operations of Horn Mountain and Pakistan as well as the Vintage assets that were held for sale and subsequently sold in 2006.
CONSOLIDATED ANALYSIS OF FINANCIAL POSITION
The changes in the following components of Occidentals balance sheet are discussed below:
Selected Balance Sheet Components
See "Liquidity and Capital Resources Cash Flow Analysis" for discussion about the change in cash and cash equivalents.
The decrease in trade receivables, net was due to lower oil and natural gas prices offset slightly by higher volumes during the fourth quarter of 2008, compared to the fourth quarter of 2007. The increase in marketing and trading assets and other was attributable to fair value adjustments on derivatives and increases of federal tax and joint venture receivables. The increase in investments in unconsolidated entities reflected the 2008 minority interest acquisitions in a North American oil and gas pipeline entity and a gas processing plant and pipeline and the increase in equity income from the Dolphin Project pipeline investment.
The increase in property, plant and equipment, net was due to capital expenditures, the purchases of oil and gas interests from Plains and an interest in Joslyn, the Libya signature bonus and the acquisitions of other various oil and gas interests, partially offset by 2008 DD&A.
Liabilities and Stockholders' Equity
The increase in current maturities of long-term debt and notes payable is due to the 2009 maturities of the Dolphin Energy loans and Occidental's 10 1/8-percent senior notes. The decrease in accounts payable reflected lower crude oil prices and volumes in the marketing and trading operations during the fourth quarter of 2008 compared to the fourth quarter of 2007. The increase in accrued liabilities was due to the accrual of the current portion of the unpaid Libya signature bonus and higher ad valorem taxes, rig contract termination, payroll and contractor accruals, partially offset by fair value adjustments on derivatives. The increase in long-term debt, net was due to the 2008 issuance of $1 billion of 7-percent senior notes, partially offset by the reduction resulting from the Dolphin loans and the 10 1/8-percent senior notes being moved to current maturities. The increase in deferred credits and other liabilities income taxes is due to the additional deferred taxes recorded as part of the Joslyn acquisition. The increase in stockholders equity reflected net income for 2008, partially offset by 2008 treasury stock repurchases of approximately 19.8 million shares and dividend payments.
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 2008, Occidental had approximately $1.8 billion in cash on hand. Income and cash flows are largely dependent on oil and gas prices, which have fallen steeply since mid-2008, and sales volumes. Occidental believes that cash on hand and cash generated from operations will be sufficient to fund its operating needs, planned capital expenditures, dividends and debt payments. If needed, Occidental could access its existing credit facilities.
In the third quarter of 2008, Occidental filed a shelf registration statement which facilitates issuing senior debt securities. In October 2008, Occidental issued $1 billion of 7-percent senior notes receiving $985 million of net proceeds using this shelf registration. Interest on the notes will be payable semi-annually in arrears on May 1 and November 1 of each year, beginning on May 1, 2009. The notes will mature on November 1, 2013. As of December 31, 2008, no other securities were issued under the shelf.
In September 2006, Occidental amended and restated its $1.5 billion bank credit (Credit Facility) to, among other things, lower the interest rate and extend the term to September 2011. In September 2007, participating lenders extended the maturity date on $1.4 billion of aggregate loan commitments under the Credit Facility to September 2012. The Credit Facility provides for the termination of the loan commitments and requires immediate repayment of any outstanding amounts if certain events of default occur or if Occidental files for bankruptcy. Occidental did not draw down any amounts under the Credit Facility during 2008. Available but unused lines of committed bank credit totaled approximately $1.5 billion at December 31, 2008.
None of Occidental's committed bank credits contain material adverse change (MAC) clauses or debt rating triggers that could restrict Occidental's ability to borrow under these lines. Occidental's credit facilities and debt agreements do not contain rating triggers that could terminate bank commitments or accelerate debt in the event of a ratings downgrade. Up to $350 million of the Credit Facility is available in the form of letters of credit.
As of December 31, 2008, under the most restrictive covenants of certain financing agreements, Occidental's capacity for additional unsecured borrowing was approximately $65.3 billion, and the capacity for the payment of cash dividends and other distributions on, and for acquisitions of, Occidental's capital stock was approximately $25.1 billion, assuming that such dividends, distributions and acquisitions were made without incurring additional borrowing. Since 2007, Occidentals long-term senior unsecured debt has been rated A by Fitch Ratings. In 2008, Occidental's long-term senior unsecured debt was upgraded from A- to A by Standard and Poors Ratings Services, from A3 to A2 by Moodys Investors Service and from A (low) to A by Dominion Bond Rating Service. A security rating is not a recommendation to buy, sell or hold securities, may be subject to revision or withdrawal at any time by the assigning rating organization and should be evaluated independently of any other rating.
In May 2007, Occidental redeemed all $276 million of the outstanding principal amount of its 8.25-percent Vintage senior notes due 2012. In January 2007, Occidental completed cash tender offers for portions of various debt instruments totaling $659 million in principal amount. The redemption and repurchases resulted in a pre-tax interest expense of $167 million.
Cash Flow Analysis
The most important sources of the increase in operating cash flow in 2008, compared to 2007, were higher average oil and natural gas prices and, to a lesser extent, higher oil and gas sales volumes. The increased operating cash flow also reflects the higher caustic soda margins and higher margins in gas processing in 2008 in the chemical and midstream and marketing businesses, respectively. In 2008, compared to 2007, Occidentals global realized crude oil prices increased by 36 percent and realized natural gas prices increased by 23 percent in the U.S., where approximately 70 percent of Occidental's natural gas was produced. Occidentals oil and gas sales volumes increased by 5 percent in 2008, mainly due to the increase in production from the Dolphin Project.
The increase in operating cash flow in 2007, compared to 2006, resulted from higher oil prices and higher oil and gas sales volumes partially offset by the effects of lower chemical margins, particularly PVC, and reduced cash flow from discontinued operations. In 2007, Occidentals realized crude oil prices increased 12 percent and its oil and gas sales volumes increased by over 4 percent compared to 2006. The increase in sales volumes was mainly due to the start-up of the Dolphin Project production in the third quarter of 2007.
Increases, in each case, from the previous year, in the costs of producing oil and gas, such as purchased goods and services, and higher utility, maintenance, workover and gas plant costs, and higher production and ad valorem taxes partially offset the effect of increases in realized oil and natural gas prices and volumes in both 2008 and 2007. Other cost elements, such as labor costs and overhead, are not significant drivers of changes in cash flow because they are relatively stable within a narrow range over the short to intermediate term. These cost increases had a much smaller effect on cash flow than the higher oil and gas prices and higher oil and natural gas sales volumes.
Most of Occidental's major chemical product prices, especially caustic soda, increased in 2008, compared to 2007, which increased margins. The increase in NGL prices in 2008, compared to 2007, resulted in higher gas processing margins in the midstream and marketing segment. The overall impact of the chemical product price increases and gas processing margins on cash flow was less significant than the increases in oil and gas prices because the chemical and midstream and marketing segments' earnings and cash flow were significantly smaller than those for the oil and gas segment.
Other non-cash charges to income in 2008, 2007 and 2006 included stock incentive plan amortization, deferred compensation and environmental remediation accruals. The 2008 amount also included a charge of $557 million for asset impairments of undeveloped acreage in Argentina and Yemen and a $90 million charge for chemical plant closure and impairments.
Occidentals capital spending estimate for 2009 is approximately $3.5 billion and will focus on the goal of keeping Occidental's returns well above its cost of capital given current oil and gas prices and the cost environment. Occidental has accumulated a sizable inventory of projects, of which a substantial portion can be delayed until industry costs are aligned with product prices. Occidental will continue to fully fund much of its Middle East operations, the exploration programs in California, Utah and Argentina, and the midstream and marketing and CO2 programs, which it believes have higher return and growth potential.
The 2008 other investing activities, net amount includes cash payments for the acquisitions of oil and gas interests from Plains for $2.7 billion, an interest in Joslyn for approximately $500 million, a minority interest in a North American oil and gas pipeline entity for approximately $330 million and approximately $700 million of various other acquisitions. The 2008 amount also includes the first payment of the signature bonus under the Libya agreements of $450 million.
The 2007 other investing activities, net amount includes cash proceeds of $672 million from the sale of 21 million shares of Lyondell, $485 million received from the sale of Occidentals interest in a Russian joint venture, $509 million from the sale of other businesses and properties, and $250 million from the sale of auction rate securities. The 2007 amount also includes the cash paid for the acquisitions of various oil and gas and chemical interests, a Permian Basin common carrier pipeline system and a gas processing plant in Texas totaling $1.4 billion.
The 2006 other investing activities, net amount includes the cash payments associated with the acquisition of Vintage and a property acquisition from Plains, partially offset by cash proceeds from the Vintage assets subsequently sold and from the sale of Lyondell shares.
Commitments at December 31, 2008, for major fixed and determinable capital expenditures during 2009 and thereafter were approximately $1.1 billion. Occidental expects to fund these commitments and capital expenditures with cash from operations.
The 2008 amount includes the net proceeds of $985 million from the issuance of $1 billion of 7-percent senior notes. The 2008 amount also includes $1.5 billion of cash paid for repurchases of 19.8 million shares of Occidentals common stock at an average price of $76.33 per share.
The 2007 amount includes net debt payments of $1.2 billion, including the repurchase of various debt issues under cash tender offers and the redemption of Vintage notes. The 2007 amount also included $1.1 billion of cash paid for repurchases of 20.6 million shares of Occidentals common stock at an average price of $54.75 per share.
The 2006 amount consists of $1.5 billion of cash paid for stock repurchases and net debt payments of approximately $900 million.
Occidental also paid common stock dividends of $940 million in 2008, $765 million in 2007 and $646 million in 2006.
In the course of its business activities, Occidental pursues a number of projects and transactions to meet its core business objectives. Occidental also makes commitments on behalf of unconsolidated entities. Some of these projects, transactions and commitments (off-balance-sheet arrangements) are not reflected on Occidentals balance sheets, as a result of the application of generally accepted accounting principles (GAAP) to their specific terms. The following is a description of the business purpose and nature of these off-balance-sheet arrangements.
See "Oil and Gas Segment Business Review Middle East/North Africa Dolphin Project" and "Midstream, Marketing and Other Segment Business Review Dolphin Project" for further information about the structure of the Dolphin Project.
In July 2005, Dolphin Energy entered into a bridge loan in an amount of $2.45 billion. The new bridge loan had a term of four years as a revolving credit facility through April 2008 and was converted to a term loan thereafter. In September 2005, Dolphin Energy entered into an agreement with banks to provide a $1.0 billion facility to fund the construction of a certain portion of the Dolphin Project. Occidental guarantees 24.5 percent of both of these obligations. At December 31, 2008, Occidentals portion of the bridge loan and financing facility was $845 million. Of this amount, Occidental had recorded $600 million as its proportionately consolidated share on the balance sheet at December 31, 2008. At December 31, 2008, the remaining $245 million of the bridge loan and financing facility represents a substantial majority of Occidental's guarantees discussed in the "Guarantees" section.
In Ecuador, Occidental has a 14-percent interest in the Oleoducto de Crudos Pesados Ltd. (OCP) oil export pipeline, which Occidental records as an equity investment. The project was funded in part by senior project debt, which is to be repaid with the proceeds of ship-or-pay tariffs of certain upstream producers in Ecuador. In May 2006, Ecuador terminated Occidental's contract for the operation of Block 15, which comprised all of its oil-producing operations in the country, and seized Occidental's Block 15 assets. As of December 31, 2008, Occidental's net investment in and advances to the project totaled $66 million and Occidental had accrued $263 million for related obligations, including all tariffs.
Occidental has entered into various operating-lease agreements, mainly for railcars, power plants, manufacturing facilities and office space. Occidental leases assets when leasing offers greater operating flexibility. Lease payments are expensed mainly as cost of sales. For more information, see "Contractual Obligations."
Occidental has guaranteed equity investees' debt and has entered into various other guarantees including performance bonds, letters of credit, indemnities, commitments and other forms of guarantees provided by Occidental to third parties, mainly to provide assurance that OPC or its subsidiaries and affiliates will meet their various obligations (guarantees).
The table below summarizes and cross-references certain contractual obligations that are reflected in the Consolidated Balance Sheets as of December 31, 2008 and/or disclosed in the accompanying Notes.
LAWSUITS, CLAIMS, COMMITMENTS, CONTINGENCIES AND RELATED MATTERS
OPC or certain of its subsidiaries are named, in the normal course of business, in lawsuits, claims and other legal proceedings that seek, among other things, compensation for alleged personal injury, breach of contract, property damage, punitive damages, civil penalties or other losses, or injunctive or declaratory relief. OPC or certain of its subsidiaries also have been named in proceedings under the Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA) and similar federal, state, local and foreign environmental laws. These environmental proceedings seek funding or performance of remediation and, in some cases, compensation for alleged property damage, punitive damages, civil penalties and injunctive relief; however, Occidental is usually one of many companies in these proceedings and has to date been successful in sharing response costs with other financially sound companies. With respect to all such lawsuits, claims and proceedings, including environmental proceedings, Occidental accrues reserves when it is probable a liability has been incurred and the amount of loss can be reasonably estimated. Environmental matters are further discussed under the caption "Environmental Liabilities and Expenditures" below.
Lawsuits have been filed in Nicaragua against OxyChem and other companies that once manufactured or used a pesticide, dibromochloropropane (DBCP). These lawsuits claim damages of several billion dollars for alleged personal injuries. In the opinion of management, the claims against OxyChem are without merit because, among other things, the DBCP it manufactured was never sold or used in Nicaragua. In order to preserve its jurisdictional defense, OxyChem elected not to make a substantive appearance in these cases. Nicaraguan courts have entered judgments of approximately $900 million against four defendants, including OxyChem. Under Nicaraguan law, the judgments would be shared equally among the defendants. The plaintiffs attempted to enforce one judgment in Miami. In January 2009, the federal district court in Miami granted summary judgment in favor of OxyChem and refused to enforce the judgment. OxyChem has no assets in Nicaragua and, in the opinion of management, no such Nicaraguan judgment would be enforceable in the United States.
During the course of its operations, Occidental is subject to audit by tax authorities for varying periods in various federal, state, local and foreign tax jurisdictions. While the audits for taxable years through 2007 have concluded for U.S. federal income tax purposes, the 2008 taxable year is currently under audit by the U.S. Internal Revenue Service pursuant to its compliance assurance program (CAP). Foreign government tax authorities are in various stages of auditing Occidental, and income taxes for taxable years from 2000 through 2008 remain subject to examination in certain jurisdictions. During the course of such audits, disputes have arisen and other disputes may arise as to facts and matters of law.
Occidental has entered into agreements providing for future payments to secure terminal and pipeline capacity, drilling rigs and services, electrical power, steam and certain chemical raw materials. Occidental has certain other commitments under contracts, guarantees and joint ventures, including purchase commitments for goods and services at market-related prices and certain other contingent liabilities. Occidental's capital spending estimate for 2009 is approximately $3.5 billion. At December 31, 2008, commitments for major fixed and determinable capital expenditures during 2009 and thereafter were approximately $1.1 billion.
Occidental has indemnified various parties against specified liabilities that those parties might incur in the future in connection with purchases and other transactions that they have entered into with Occidental. These indemnities usually are contingent upon the other party incurring liabilities that reach specified thresholds. As of December 31, 2008, Occidental is not aware of circumstances that it believes would reasonably be expected to lead to future indemnity claims against it in connection with these transactions that would result in payments materially in excess of reserves.
The ultimate amount of losses and the timing of any such losses that OPC and its subsidiaries may incur resulting from currently outstanding lawsuits, claims and proceedings, audits, commitments, contingencies and related matters cannot be determined reliably at this time. If these matters were ultimately resolved unfavorably at amounts substantially exceeding Occidentals reserves, an outcome not currently expected, it is possible that such outcome could have a material adverse effect upon Occidentals consolidated financial position or results of operations. However, after taking into account reserves, management does not expect the ultimate resolution of any of these matters to have a material adverse effect upon Occidentals consolidated financial position or results of operations.
ENVIRONMENTAL LIABILITIES AND EXPENDITURES
Occidentals operations are subject to stringent federal, state, local and foreign laws and regulations relating to improving or maintaining environmental quality. Occidentals environmental compliance costs have generally increased over time and could continue to rise in the future. Occidental factors environmental expenditures for its operations into its business planning process as an integral part of producing quality products responsive to market demand.
The laws that require or address environmental remediation, including CERCLA and similar federal, state, local and foreign laws, may apply retroactively and regardless of fault, the legality of the original activities or the current ownership or control of sites. OPC or certain of its subsidiaries participate in or actively monitor a range of remedial activities and government or private proceedings under these laws with respect to alleged past practices at operating, closed and third-party sites. Remedial activities may include one or more of the following: investigation involving sampling, modeling, risk assessment or monitoring; cleanup measures involving removal, treatment or disposal; or operation and maintenance of remedial systems. The environmental proceedings seek funding or performance of remediation and, in some cases, compensation for alleged property damage, punitive damages, civil penalties, injunctive relief and government oversight costs.
As of December 31, 2008, Occidental participated in or monitored remedial activities or proceedings at 166 sites.
The following table presents Occidentals environmental remediation reserves as of December 31, 2008, 2007 and 2006, grouped in the following four categories of environmental remediation sites: (1) sites listed or proposed for listing by the U.S. Environmental Protection Agency on the CERCLA National Priorities List (CERCLA NPL); (2) other third-party sites; (3) Occidental-operated sites; and (4) Occidental's closed or non-operated sites.
As of December 31, 2008, Occidentals environmental reserves exceeded $10 million each at 14 of the 166 sites described above, and 115 of the sites had reserves from $0 to $1 million each.
As of December 31, 2008, two landfills in western New York owned by Occidental accounted for 65 percent of its reserves associated with CERCLA NPL sites. Maxus Energy Corporation has retained the liability and indemnified Occidental for 17 of the remaining 38 CERCLA NPL sites.
As of December 31, 2008, Maxus has also retained the liability and indemnified Occidental for 14 of the 76 other third-party sites. Two of the remaining 62 other third-party sites a former copper mining and smelting operation in Tennessee and an active refinery in Louisiana where Occidental reimburses the current owner and operator for certain remedial activities accounted for 60 percent of Occidentals reserves associated with these sites.
Five sites chemical plants in Kansas, Louisiana and New York and two groups of oil and gas properties in the southwestern United States accounted for 71 percent of Occidentals reserves associated with its operated sites. Five other sites former chemical plants in Delaware, Michigan, Tennessee and Washington and a closed coal mine in Pennsylvania accounted for 71 percent of the reserves associated with Occidental's closed or non-operated sites.
The following table shows environmental reserve activity for the past three years:
Occidental expects to expend funds corresponding to about half of the current environmental reserves over the next four years and the balance over the subsequent ten or more years. Occidental believes its range of reasonably possible additional loss beyond those liabilities recorded for environmental remediation at the sites described above could be up to $400 million. See "Critical Accounting Policies and Estimates Environmental Liabilities and Expenditures" for additional information.
Occidentals environmental costs, some of which may include estimates, are shown below for each segment for the years ended December 31:
Operating expenses are incurred on a continual basis. Capital expenditures relate to longer-lived improvements in currently operating properties. Remediation expenses relate to existing conditions from past operations.
Occidental presently estimates capital expenditures for environmental compliance of approximately $120 million for 2009.
Many of Occidentals assets are located outside of North America. At December 31, 2008, the carrying value of Occidentals assets in countries outside North America aggregated approximately $11.2 billion, or approximately 27 percent of Occidentals total assets at that date. Of such assets, approximately $6.9 billion are located in the Middle East/North Africa and approximately $4.3 billion are located in Latin America. For the year ended December 31, 2008, net sales outside North America totaled $8.8 billion, or approximately 36 percent of total net sales.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The process of preparing financial statements in accordance with GAAP requires the management of Occidental to make estimates and judgments regarding certain items and transactions. It is possible that materially different amounts could be recorded if these estimates and judgments change or if the actual results differ from these estimates and judgments. Occidental considers the following to be its most critical accounting policies and estimates that involve the judgment of Occidentals management. There has been no material change to these policies over the past three years. The selection and development of these critical accounting policies and estimates have been discussed with the Audit Committee of the Board of Directors.
Oil and Gas Properties
Occidental uses the successful efforts method to account for its oil and gas properties. Under this method, costs of acquiring properties, costs of drilling successful exploration wells and development costs are capitalized. The costs of exploratory wells are initially capitalized pending a determination of whether proved reserves have been found. At the completion of drilling activities, the costs of exploratory wells remain capitalized if a determination is made that proved reserves have been found. If no proved reserves have been found, the costs of the related exploratory wells are charged to expense. In some cases, a determination of proved reserves cannot be made at the completion of drilling, requiring additional testing and evaluation of the wells. Occidental's practice is to expense the costs of such exploratory wells if a determination of proved reserves has not been made within a twelve-month period after drilling is complete. Occidental has no proved oil and gas reserves for which the determination of commercial viability is subject to the completion of major additional capital expenditures.
Annual lease rentals and geological, geophysical and seismic costs are expensed as incurred.
Proved oil and gas reserves are the estimated quantities of oil and natural gas that geological and engineering data demonstrate, with reasonable certainty, can be recovered in future years from known reservoirs under existing economic and operating conditions considering future production and development costs. Depreciation and depletion of oil and gas producing properties is determined by the unit-of-production method.
Several factors could change Occidentals proved oil and gas reserves. Occidental receives a share of production from PSCs to recover its costs and an additional share for profit. Occidentals share of production and reserves from these contracts decreases when oil prices rise and increases when oil prices decline. Overall, Occidentals net economic benefit from these contracts is greater at higher oil prices. In other contractual arrangements, lower product prices may lead to a situation where production of proved reserves becomes uneconomical. Estimation of future production and development costs is also subject to change partially due to factors beyond Occidental's control, such as energy costs and inflation or deflation of oil field service costs. These factors, in turn, could lead to changes in the quantity of proved reserves. An additional factor that could result in a change of proved reserves is the reservoir decline rates differing from those estimated when the proved reserves were initially recorded. Occidental's revisions to proved reserves were negative for 2008, which was largely due to changes in oil and gas prices from year-end 2007 to year-end 2008. Excluding price revisions, the negative revisions amounted to less than one percent of the total proved reserves for 2008. Occidentals revisions to proved reserves were negative for 2007 and amounted to less than three percent of the total proved reserves for the year. Occidental's revisions to proved reserves have been positive for six of the last ten years.
If Occidentals consolidated proved oil and gas reserves were to change based on the factors mentioned above, the most significant impact would be on the DD&A rate, which is determined using the unit-of-production method. For example, a 5-percent increase in the amount of consolidated oil and gas reserves would change the rate from $10.17 per barrel to $9.69 per barrel, which would increase pre-tax income by $106 million annually. A 5-percent decrease in the oil and gas reserves would change the rate from $10.17 per barrel to $10.71 per barrel and would result in a decrease in pre-tax income of $119 million annually. The change in the DD&A rate over the past three years due to revisions of previous proved reserve estimates has been immaterial.
A portion of the carrying value of Occidentals oil and gas properties is attributable to unproved properties. At December 31, 2008, the net capitalized costs attributable to unproved properties were $2.3 billion. The unproved amounts are not subject to DD&A or impairment until a determination is made as to the existence of proved reserves. As exploration and development work progresses, if reserves on these properties are proved, capitalized costs attributable to the properties will be subject to depreciation and depletion. If the exploration and development work were to be unsuccessful, or management's plans changed with respect to these properties, as a result of economic, operating or contractual conditions, the capitalized costs of the related properties would be expensed in the period in which the determination was made. The timing of any writedowns of these unproved properties, if warranted, depends upon management's plans and the nature, timing and extent of future exploration and development activities and their results. Occidental believes its current plans and exploration and development efforts will allow it to realize its unproved property balance. Additionally, Occidental performs impairment tests with respect to its proved properties generally when prices decline other than temporarily, reserve estimates change significantly or other significant events occur that may impact the ability to realize the recorded asset amounts. Impairment tests incorporate a number of assumptions involving expectations of future cash flows, which can change significantly over time. These assumptions include estimates of future product prices, which Occidental bases on forward price curves, estimates of oil and gas reserves and estimates of future expected operating and development costs.
The steady increase in oil and gas prices over the past several years has also caused steep increases in capital and operating costs, including costs of materials and supplies and oil field services. The rapid and significant decline in product prices in the second half of 2008 has resulted in capital and operating costs that are not aligned with current product prices. Current pricing, coupled with a sustained high production cost environment, could cause management's plans to change with respect to unproved properties and could cause the carrying values of proved properties to be unrealizable. Such circumstances could result in impairments in the carrying values of proved or unproved properties or both.
The most critical accounting policy affecting Occidentals chemical assets is the determination of the estimated useful lives of its PP&E. Occidental's chemical plants are depreciated using either the unit-of-production or straight-line method, based upon the estimated useful lives of the facilities. The estimated
useful lives of Occidentals chemical assets, which range from three years to 50 years, are used to compute depreciation expense and are also used for impairment tests. The estimated useful lives used for the chemical facilities are based on the assumption that Occidental will provide an appropriate level of annual expenditures to ensure productive capacity is sustained. Without these continued expenditures, the useful lives of these plants could decrease significantly. Other factors that could change the estimated useful lives of Occidentals chemical plants include sustained higher or lower product prices, which are particularly affected by both domestic and foreign competition, demand, feedstock costs, energy prices, environmental regulations and technological changes.
Occidental performs impairment tests on its assets whenever events or changes in circumstances lead to a reduction in the estimated useful lives or estimated future cash flows that would indicate that the carrying amount may not be recoverable, or when managements plans change with respect to those assets.
Occidental's net PP&E for chemicals is approximately $2.5 billion and its depreciation expense for 2009 is expected to be approximately $260 million. If the estimated useful lives of Occidentals chemical plants were to decrease based on the factors mentioned above, the most significant impact would be on depreciation expense. For example, a reduction in the remaining useful lives of one year would increase depreciation and reduce pre-tax earnings by approximately $30 million per year.
Midstream, Marketing and Other Assets
The most critical accounting policies affecting Occidentals midstream and marketing assets are accounting for derivative instruments and the determination of the estimated useful lives of its PP&E.
Derivative instruments are carried at fair value. Occidental applies either fair value or cash flow hedge accounting when transactions meet specified criteria for hedge accounting treatment. If the derivative does not qualify as a hedge or is not designated as a hedge, any fair value gains or losses are recognized in earnings. If the derivative qualifies for hedge accounting and is designated and documented as a hedge, the gain or loss on the derivative is either recognized in income with an offsetting adjustment to the basis of the item being hedged for fair value hedges, or deferred in Other Comprehensive Income to the extent the hedge is effective for cash flow hedges. Cash flow hedge-realized gains and losses, and any ineffectiveness, are classified within the net sales line item. Gains and losses are reported net in the income statement and are also netted on the balance sheets when a right of offset exists.
A hedge is regarded as highly effective and qualifies for hedge accounting if, at inception and throughout its life, it is expected that changes in the fair value or cash flows of the hedged item are almost fully offset by the changes in the fair value or changes in cash flows of the hedging instrument and actual effectiveness is within a range of 80 to 125 percent. In the case of hedging a forecasted transaction, the transaction must be probable and must present an exposure to variations in cash flows that could ultimately affect reported net income or loss. Occidental discontinues hedge accounting when it determines that a derivative has ceased to be highly effective as a hedge; when the derivative expires, or is sold, terminated, or exercised; when the hedged item matures or is sold or repaid; or when a forecasted transaction is no longer deemed probable.
Occidental's midstream and marketing assets are depreciated using either the unit-of-production or straight-line method, based upon the estimated useful lives of the assets. Occidental performs impairment tests on its assets whenever events or changes in circumstances lead to a reduction in the estimated useful lives or estimated future cash flows that would indicate that the carrying amount may not be recoverable, or when managements plans change with respect to those assets.
Environmental Liabilities and Expenditures
Environmental expenditures that relate to current operations are expensed or capitalized as appropriate. Occidental records environmental reserves for estimated remediation costs that relate to existing conditions from past operations when environmental remediation efforts are probable and the costs can be reasonably estimated. In determining the reserves and the range of reasonably possible additional loss, Occidental refers to currently available information, including relevant past experience, remedial objectives, available technologies, applicable laws and regulations and cost-sharing arrangements. Occidental bases environmental reserves on managements estimate of the most likely cost to be incurred, using the most cost-effective technology reasonably expected to achieve the remedial objective. Occidental periodically reviews reserves and adjusts them as new information becomes available. Occidental records environmental reserves on a discounted basis only when the aggregate amount and the timing of cash payments are reliably determinable at the time the reserves are established. The reserve methodology with respect to discounting for a specific site is not modified once it has been established. Occidental generally records reimbursements or recoveries of environmental remediation costs in income when received. As of December 31, 2008, 2007 and 2006, Occidental has not accrued any reimbursements or recoveries.
Many factors could affect Occidentals future remediation costs and result in adjustments to its environmental reserves and range of reasonably possible additional loss. The most significant are: (1) cost estimates for remedial activities may be inaccurate; (2) the length of time, type or amount of remediation necessary to achieve the remedial objective may change due to factors such as site conditions, the ability to identify and control contaminant sources or the discovery of additional contamination; (3) the regulatory agency may ultimately reject or modify Occidentals proposed remedial plan; (4) improved or alternative remediation technologies may change remediation costs; and (5) laws and regulations may impose more or less stringent remediation requirements or affect cost sharing or allocation of liability.
At sites involving multiple parties, Occidental provides environmental reserves based upon its expected share of liability. Occidental evaluates the financial viability of other parties with whom it is alleged to be jointly liable, the degree of their commitment to participate and the consequences to Occidental of their failure to participate when estimating Occidental's ultimate share of liability. Based on these factors,
Occidental believes that it will not be required to assume a share of liability of such other potentially responsible parties in an amount that would have a material effect on Occidentals consolidated financial position, liquidity or results of operations.
Most cost-sharing arrangements with other parties fall into one of the following three categories: (1) environmental proceedings that result in a negotiated or prescribed allocation of remediation costs among Occidental and other alleged potentially responsible parties; (2) oil and gas ventures in which each participant pays its proportionate share of remediation costs reflecting its working interest; or (3) contractual arrangements, typically relating to purchases and sales of properties, in which the parties to the transaction agree to methods of allocating remediation costs.
In all three of these categories, Occidental records reserves at its expected net cost of remedial activities.
In addition to the costs of investigations and cleanup measures, which often take in excess of ten years at CERCLA NPL sites, Occidentals reserves include managements estimates of the costs to operate and maintain remedial systems. If remedial systems are modified over time in response to significant changes in site-specific data, laws, regulations, technologies or engineering estimates, Occidental reviews and adjusts its reserves accordingly.
If Occidental adjusts the environmental reserve balance based on the factors described above, the amount of the increase or decrease would be recognized in earnings. For example, if the reserve balance were reduced by 10 percent, Occidental would record a pre-tax gain of $44 million. If the reserve balance were increased by 10 percent, Occidental would record an additional remediation expense of $44 million.
Other Loss Contingencies
Occidental is involved with numerous lawsuits, claims, proceedings and audits in the normal course of its operations. Occidental records a loss contingency for these matters when it is probable that an asset has been impaired or a liability has been incurred and the amount of the loss can be reasonably estimated. In addition, Occidental discloses, in aggregate, its exposure to loss in excess of the amount recorded on the balance sheet for these matters if it is reasonably possible that an additional material loss may be incurred. Occidental reviews its loss contingencies on an ongoing basis.
These reserves are based on judgments made by management with respect to the likely outcome of these matters and are adjusted as appropriate. Managements judgments could change based on new information, changes in laws or regulations, changes in managements plans or intentions and the outcome of legal proceedings, settlements or other factors. See "Lawsuits, Claims, Commitments and Related Matters" for additional information.
SIGNIFICANT ACCOUNTING CHANGES
Listed below are significant changes in accounting principles.
Future Accounting Changes
SFAS No. 141(R)
In December 2007, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 141(R), "Business Combinations." This statement provides new accounting guidance and disclosure requirements for business combinations and is effective for business combinations which occur starting with the first fiscal year beginning on or after December 15, 2008.
SFAS No. 160
In December 2007, the FASB issued SFAS No. 160, "Noncontrolling Interests in Consolidated Financial Statements." This statement provides new accounting guidance and disclosure and presentation requirements for noncontrolling interests in an entity. SFAS No. 160 is effective for the first fiscal year beginning on or after December 15, 2008. Occidental does not expect the effect of this statement on its financial statements to be material.
SFAS No. 161
In March 2008, the FASB issued SFAS No. 161, which provides new disclosure requirements for an entitys derivative and hedging activities. SFAS No. 161 is effective for periods beginning after November 15, 2008. Occidental does not expect the effect of this statement on its financial statements to be material.
FSP EITF Issue No. 03-6-1
In June 2008, the FASB issued FASB Staff Position (FSP) Emerging Issues Task Force (EITF) Issue No. 03-6-1. This FSP concluded that instruments granted in share-based payment transactions are participating securities prior to vesting and, therefore, should be included in the earnings allocations in computing basic earnings per share under the two-class method. This FSP is effective for financial statements issued for fiscal years beginning after December 15, 2008 with prior period retrospective application. Occidental does not expect the effect of this FSP on its financial statements to be material.
FSP SFAS No. 132(R)-1
In December 2008, the FASB issued FSP SFAS No. 132(R)-1. This FSP requires companies to enhance disclosures related to the assets held in defined benefit plans and other post-retirement benefits. Occidental will be required to provide greater detail as to the categories of plan assets as well as the level within the fair value hierarchy discussed in SFAS No. 157, in which the plan assets fall. This FSP is effective for financial statements issued for fiscal years ending after December 15, 2009. Occidental does not expect the effect of this FSP on its financial statements to be material.
Recently Adopted Accounting Changes
SFAS No. 159
In February 2007, the FASB issued SFAS No. 159, which allows companies to measure individually selected financial instruments at fair value. SFAS No. 159 is effective for financial statements issued for periods beginning after November 15, 2007. Since Occidental did not elect the fair value option on any qualifying financial instruments at any time during 2008, this statement has had no impact on Occidentals financial statements.
SFAS No. 157
In September 2006, the FASB issued SFAS No. 157, which establishes a framework for measuring fair value and expands disclosures about fair value measurements. SFAS No. 157 is effective for financial statements issued for periods beginning after November 15, 2007. In February 2008, the FASB issued FSP FAS 157-2, which defers the effective date of SFAS No. 157 for non-financial assets and liabilities that are not recorded at fair value on a recurring basis until periods beginning after November 15, 2008. Occidental adopted the non-deferred portion of SFAS No. 157 on January 1, 2008 on a prospective basis. See Note 11 to the Consolidated Financial Statements for further information. In October 2008, the FASB issued FSP FAS 157-3, which became effective immediately and clarified the application of SFAS No. 157 in a market that is not active. The adoption of FSP FAS 157-3 has not had a material impact on Occidentals financial statements.
DERIVATIVE ACTIVITIES AND MARKET RISK
Occidental is exposed to risk that is inherent with changing commodity price risk. In order to mitigate price risk, Occidental, from time to time, enters into derivative transactions. A derivative is an instrument that, among other characteristics, derives its value from changes in another instrument or variable.
In general, the fair value recorded for derivative instruments is based on quoted market prices, dealer quotes and the Black Scholes or similar valuation models, as applicable.
Commodity Price Risk
Occidentals results are sensitive to fluctuations in oil and natural gas prices. Based on current levels of production, if oil prices vary by $1 per barrel, it would have an estimated annual effect on pre-tax income of approximately $150 million. If domestic natural gas prices vary by $0.50 per Mcf, it would have an estimated annual effect on pre-tax income of approximately $93 million. If production levels change in the future, the sensitivity of Occidentals results to oil and gas prices also would change.
Occidentals results are also sensitive to fluctuations in chemical prices. If chlorine and caustic soda prices vary by $10 per ton, it would have a pre-tax annual effect on income of approximately $10 million and $30 million, respectively. If PVC prices vary by $.01 per lb, it would have a pre-tax annual effect on income of approximately $30 million. If ethylene dichloride (EDC) prices vary by $10 per ton, it would have a pre-tax annual effect on income of approximately $5 million. Historically, product price changes either precede or follow raw material and feedstock product price changes; therefore, the margin effect of price changes are generally mitigated over time. According to Chemical Market Associates, Inc., December 2008 average contract prices were: chlorine$220 per ton, caustic soda$1,080 per ton, PVC$0.44 per lb and EDC$40 per ton.
Marketing and Trading Operations
Occidental periodically uses different types of derivative instruments to achieve the best prices for oil and gas. Derivatives have been used by Occidental to reduce its exposure to price volatility on a small portion of its production. Occidental enters into low-risk marketing and trading activities through its separate marketing organization, which operates under established policy controls and procedures. Occidental's marketing and trading operations utilize a combination of futures, forwards, options and swaps to mitigate the price risk associated with various physical transactions.
Occidental conducts its risk management activities for energy commodities (which include buying, selling, marketing, trading, and hedging activities) under the controls and governance of its risk control policy. The President and Chief Financial Officer and the Risk Management Committee, comprising members of Occidental's management, oversee these controls, which are implemented and enforced by a Trading Control Officer. The Trading Control Officer provides an independent and separate check on marketing and trading activities. Controls for energy commodities include limits on value at risk, limits on credit, limits on trading, segregation of duties, delegation of authority and a number of other policy and procedural controls.
Fair Value of Marketing and Trading Derivative Contracts
The following tables show the changes in the net fair value of Occidentals marketing and trading derivative contracts, a portion of which are hedges, during 2008 and 2007, and segregate the open contracts at December 31, 2008 by maturity periods.
During the next twelve months, Occidental expects that approximately $48 million of net derivative after-tax gains included in Accumulated Other Comprehensive Income, based on their valuation as of December 31, 2008, will be recognized in earnings. Hedge ineffectiveness did not have a material impact on earnings for any of the years ended December 31, 2008, 2007 and 2006.
Occidental holds a series of collar agreements that qualify as cash-flow hedges for the sale of a small portion of its crude oil production. These agreements continue to the end of 2011. The 2008 volume that was hedged was less than 3 percent of Occidentals 2008 crude oil production. Further detail about these cash-flow hedges, which are included in the total fair value of ($139) million in the table above, is presented below as of December 31, 2008 (volumes in thousands of barrels):