Edgar Filing: MARATHON OIL CORP

form10q2009sept30.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)
[X]	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the Quarterly Period Ended September 30, 2009

[ ]	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the transition period from _____ to _____

Commission file number 1-5153

Marathon Oil Corporation

(Exact name of registrant as specified in its charter)

Delaware	25-0996816
State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

5555 San Felipe Road, Houston, TX 77056-2723

(Address of principal executive offices)

(713) 629-6600

(Registrant’s telephone number, including area code)

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. Yes Ö No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of

Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes Ö No

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 the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer Ö	Accelerated filer
Non-accelerated filer (Do not check if a smaller reporting company)	Smaller reporting company

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes No Ö

There were 707,845,149 shares of Marathon Oil Corporation common stock outstanding as of October 30, 2009.

MARATHON OIL CORPORATION

Form 10-Q

Quarter Ended September 30, 2009

		INDEX
			Page
PART I - FINANCIAL INFORMATION
Item 1.	Financial Statements:
	Consolidated Statements of Income (Unaudited)		2
	Consolidated Balance Sheets (Unaudited)		3
	Consolidated Statements of Cash Flows (Unaudited)		4
	Notes to Consolidated Financial Statements (Unaudited)		5
Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations		23
Item 3.	Quantitative and Qualitative Disclosures About Market Risk		35
Item 4.	Controls and Procedures		35
	Supplemental Statistics (Unaudited)		36
PART II - OTHER INFORMATION
Item 1.	Legal Proceedings		39
Item 1A.	Risk Factors		39
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		40
Item 6.	Exhibits		41
	Signatures		42

Unless the context otherwise indicates, references in this Form 10-Q to “Marathon,” “we,” “our,” or “us” are references to Marathon Oil Corporation, including its wholly-owned and majority-owned subsidiaries, and its ownership interests in equity method investees (corporate entities, partnerships, limited liability companies and other ventures over which Marathon exerts significant influence by virtue of its ownership interest).

Part I - Financial Information

Item 1. Financial Statements

MARATHON OIL CORPORATION

Consolidated Statements of Income (Unaudited)

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
(In millions, except per share data)	2009			2008			2009			2008
Revenues and other income:

Sales and other operating revenues (including	$	14,335		$	22,332		$	37,509		$	60,641
consumer excise taxes)
Sales to related parties		27			637			68			1,865
Income from equity method investments		75			270			184			735
Net gain on disposal of assets		5			15			200			37
Other income		35			47			112			151

Total revenues and other income		14,477			23,301			38,073			63,429
Costs and expenses:
Cost of revenues (excludes items below)		10,963			16,978			28,080			49,342
Purchases from related parties		133			244			338			609
Consumer excise taxes		1,258			1,273			3,658			3,784
Depreciation, depletion and amortization		630			584			1,988			1,513
Selling, general and administrative expenses		323			349			935			1,008
Other taxes		98			126			296			376
Exploration expenses		55			108			181			367

Total costs and expenses		13,460			19,662			35,476			56,999

Income from operations		1,017			3,639			2,597			6,430

Net interest and other financing costs		(35	)		(46	)		(63	)		(48	)

Income from continuing operations before income taxes		982			3,593			2,534			6,382

Provision for income taxes		590			1,601			1,549			2,949

Income from continuing operations		392			1,992			985			3,433

Discontinued operations		21			72			123			136

Net income	$	413		$	2,064		$	1,108		$	3,569
Per Share Data

Basic:

Income from continuing operations	$	0.55		$	2.82		$	1.39		$	4.84
Discontinued operations	$	0.03		$	0.10		$	0.17		$	0.19
Net income per share	$	0.58		$	2.92		$	1.56		$	5.03

Diluted:

Income from continuing operations	$	0.55		$	2.80		$	1.39		$	4.81
Discontinued operations	$	0.03		$	0.10		$	0.17		$	0.19
Net income per share	$	0.58		$	2.90		$	1.56		$	5.00

Dividends paid	$	0.24		$	0.24		$	0.72		$	0.72

The accompanying notes are an integral part of these consolidated financial statements.

MARATHON OIL CORPORATION

Consolidated Balance Sheets (Unaudited)

	September 30,		December 31,
(In millions, except per share data)	2009		2008
Assets
Current assets:
Cash and cash equivalents	$	1,370	$	1,285
Receivables, less allowance for doubtful accounts of $13 and $6		4,288		3,094
Receivables from United States Steel		24		23
Receivables from related parties		56		33
Inventories		3,680		3,507
Other current assets		208		461

Total current assets		9,626		8,403

Equity method investments		1,991		2,080
Receivables from United States Steel		453		469
Property, plant and equipment, less accumulated depreciation,depletion and amortization of $16,631 and $15,581		31,115		29,414
Goodwill		1,424		1,447
Other noncurrent assets		806		873

Total assets	$	45,415	$	42,686
Liabilities
Current liabilities:
Accounts payable	$	6,005	$	4,712
Payables to related parties		50		21
Payroll and benefits payable		367		400
Accrued taxes		593		1,133
Deferred income taxes		611		561
Other current liabilities		513		828
Long-term debt due within one year		105		98

Total current liabilities		8,244		7,753

Long-term debt		8,581		7,087
Deferred income taxes		3,725		3,330
Defined benefit postretirement plan obligations		1,395		1,609
Asset retirement obligations		965		963
Payable to United States Steel		4		4
Deferred credits and other liabilities		410		531

Total liabilities		23,324		21,277

Commitments and contingencies

Stockholders’ Equity
Preferred stock – 5 million shares issued, 1 million and 3 million shares outstanding (no par value, 6 million shares authorized)		-		-
Common stock:
Issued – 769 million and 767 million shares (par value $1 per share, 1.1 billion shares authorized)		769		767
Securities exchangeable into common stock – 5 million shares issued, 1 million and 3 million shares outstanding (no par value, unlimited shares authorized)		-		-
Held in treasury, at cost – 61 million and 61 million shares		(2,711		(2,720	)
Additional paid-in capital		6,730		6,696
Retained earnings		17,857		17,259
Accumulated other comprehensive loss		(554		(593	)

Total stockholders' equity		22,091		21,409

Total liabilities and stockholders' equity	$	45,415	$	42,686

The accompanying notes are an integral part of these consolidated financial statements.

MARATHON OIL CORPORATION

Consolidated Statements of Cash Flows (Unaudited)

	Nine Months Ended
	September 30,
(In millions)	2009			2008
Increase (decrease) in cash and cash equivalents
Operating activities:
Net income	$	1,108		$	3,569
Adjustments to reconcile net income to net cash provided by operating activities:
Discontinued operations		(123	)		(136	)
Deferred income taxes		726			309
Depreciation, depletion and amortization		1,988			1,513
Pension and other postretirement benefits, net		(159	)		118
Exploratory dry well costs and unproved property impairments		48			154
Net gain on disposal of assets		(200	)		(37	)
Equity method investments, net		42			(139	)
Changes in the fair value of derivative instruments		7			218
Changes in:
Current receivables		(1,241	)		(396	)
Inventories		(184	)		(1,124	)
Current accounts payable and accrued liabilities		742			595
All other operating, net		71			(57	)
Net cash provided by continuing operations		2,825			4,587
Net cash provided by discontinued operations		81			220
Net cash provided by operating activities		2,906			4,807
Investing activities:
Capital expenditures		(4,350	)		(5,062	)
Disposal of assets		573			68
Trusteed funds - withdrawals		16			402
Investing activities of discontinued operations		(66	)		(106	)
All other investing, net		63			(102	)
Net cash used in investing activities		(3,764	)		(4,800	)
Financing activities:
Short term debt, net		-			1,288
Borrowings		1,491			1,248
Debt issuance costs		(11	)		(7	)
Debt repayments		(43	)		(1,331	)
Purchases of common stock		-			(402	)
Dividends paid		(510	)		(511	)
All other financing, net		(1	)		17
Net cash provided by financing activities		926			302
Effect of exchange rate changes on cash:
Continuing operations		19			(19	)
Discontinued operations		(2	)		(10	)
Net increase in cash and cash equivalents		85			280
Cash and cash equivalents at beginning of period		1,285			1,199
Cash and cash equivalents at end of period	$	1,370		$	1,479

The accompanying notes are an integral part of these consolidated financial statements.

Index

MARATHON OIL CORPORATION

Notes to Consolidated Financial Statements (Unaudited)

1. Basis of Presentation

These consolidated financial statements are unaudited; however, in the opinion of management, reflect all adjustments necessary for a fair statement of the results for the periods reported. All such adjustments are of a normal recurring nature unless disclosed otherwise. These consolidated financial statements, including notes, have been prepared in accordance with the applicable rules of the Securities and Exchange Commission and do not include all of the information and disclosures required by accounting principles generally accepted in the United States of America for complete financial statements. Certain reclassifications of prior year data have been made to conform to 2009 classifications. Events and transactions subsequent to the balance sheet date have been evaluated through November 6, 2009, the date these consolidated financial statements were issued, for potential recognition or disclosure in the consolidated financial statements.

These interim financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Marathon Oil Corporation (“Marathon”) 2008 Annual Report on Form 10-K. The results of operations for the quarter and nine months ended September 30, 2009 are not necessarily indicative of the results to be expected for the full year.

2. Accounting Standards

Recently Adopted

Subsequent events accounting standards were issued in May 2009 by the Financial Accounting Standards Board (“FASB”), which established the standards of accounting for and disclosing events that occur after the balance sheet date but before financial statements are issued or available to be issued. This codifies into the accounting standards guidance that existed in the auditing standards and should not significantly change the subsequent events that we report. We began applying these standards prospectively in the second quarter of 2009. The disclosures required appear in Note 1.

Interim disclosures about fair value of financial instruments were expanded by the FASB in April 2009. Disclosures about fair value of financial instruments are now required in interim reporting periods for publicly traded companies. This change was effective for the second quarter of 2009 and did not require disclosures for earlier periods presented for comparative purposes. Adoption did not have an impact on our consolidated results of operations, financial position or cash flows. The required disclosures are presented in Note 11.

Guidance for determining fair value when the volume and level of activity for the asset or liability have significantly decreased and guidance on identifying circumstances that indicate a transaction is not orderly was also issued in April 2009 by the FASB. It was effective for the second quarter of 2009 and did not require disclosures for earlier periods presented for comparative purposes. Adoption did not have a significant impact on our consolidated results of operations, financial position or cash flows.

Accounting considerations for equity method investments were ratified by the FASB in November 2008, which address the initial measurement, decreases in value and changes in the level of ownership of the equity method investment. These were effective on a prospective basis on January 1, 2009 and for interim periods. Early application by an entity that has previously adopted an alternative accounting policy is not permitted. Since these were applied prospectively, adoption did not have a significant impact on our consolidated results of operations, financial position or cash flows.

Guidance for determining whether instruments granted in share-based payment transactions are participating securities was issued by the FASB in June 2008. It provides that unvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and, therefore, need to be included in the earnings allocation in computing earnings per share (“EPS”) under the two-class method. It was effective January 1, 2009 and all prior-period EPS data (including any amounts related to interim periods, summaries of earnings and selected financial data) were adjusted retrospectively to conform to its provisions. While our restricted stock awards meet this definition of participating securities, this application did not have a significant impact on our reported EPS.

Guidance for determining the useful life of intangible assets was issued in April 2008 by the FASB. This guidance amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset. The intent is to improve the consistency between the useful life of a recognized intangible asset and the period of expected cash flows used to measure the fair value of the asset. It was effective on January 1, 2009 and was applied prospectively to intangible assets acquired after the effective date, except

Index

Notes to Consolidated Financial Statements (Unaudited)

for the disclosure requirements which must be applied prospectively to all intangible assets recognized as of, and subsequent to, the effective date. Since this is applied prospectively, adoption did not have a significant impact on our consolidated results of operations, financial position or cash flows.

Disclosures requirements for derivative instruments and hedging activities were expanded by the FASB in March 2008 to provide information regarding (i) how and why an entity uses derivative instruments, (ii) how derivative instruments and related hedged items are accounted for and (iii) how derivative instruments and related hedged items affect an entity’s financial position, financial performance and cash flows. Requirements include qualitative disclosures about objectives and strategies for using derivatives, quantitative disclosures about fair value amounts and gains and losses on derivative instruments and disclosures about credit-risk-related contingent features in derivative agreements. The amendments were effective January 1, 2009 and encouraged, but did not require, disclosures for earlier periods presented for comparative purposes at initial adoption. The new disclosures required appear in Note 12.

Accounting for business combinations was revised by the FASB in December 2007. This significantly changes the accounting for business combinations. An acquiring entity will be required to recognize all the assets acquired, liabilities assumed and any noncontrolling interest in the acquiree at their acquisition-date fair value with limited exceptions. The definition of a business is expanded and is expected to be applicable to more transactions. In addition, there are changes in the accounting treatment for changes in control, step acquisitions, transaction costs, acquired contingent liabilities, in-process research and development, restructuring costs, changes in deferred tax asset valuation allowances as a result of a business combination and changes in income tax uncertainties after the acquisition date. Accounting for changes in valuation allowances for acquired deferred tax assets and the resolution of uncertain tax positions for prior business combinations will impact tax expense instead of impacting recorded goodwill. Additional disclosures are also required. In April 2009, the FASB issued guidance for accounting for assets acquired and liabilities assumed in a business combination that arise from contingencies. Both the December 2007 revision and the April 2009 guidance were effective on January 1, 2009 for all new business combinations. Because we had no business combinations in progress at January 1, 2009, adoption did not have a significant impact on our consolidated results of operations, financial position or cash flows.

Accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary were issued in December 2007 by the FASB. Specifically, the standards clarified that a noncontrolling interest in a subsidiary (sometimes called a minority interest) is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements, but separate from the parent's equity. It requires that the amount of consolidated net income attributable to the noncontrolling interest be clearly identified and presented on the face of the consolidated income statement. It also clarifies that changes in a parent's ownership interest in a subsidiary that do not result in deconsolidation are equity transactions if the parent retains its controlling financial interest. In addition, a parent must recognize a gain or loss in net income when a subsidiary is deconsolidated, based on the fair value of the noncontrolling equity investment on the deconsolidation date. Additional disclosures are required that clearly identify and distinguish between the interests of the parent and the interests of the noncontrolling owners. In January 2009, the FASB ratified implementation questions regarding the new accounting standards for noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. Both the new accounting standards and the implementation questions were effective January 1, 2009 and must be applied prospectively, except for the presentation and disclosure requirements which must be applied retrospectively for all periods presented in consolidated financial statements. Adoption did not have a significant impact on our consolidated results of operations, financial position or cash flows.

Accounting and reporting standards for fair value measurements were issued in September 2006 by the FASB. The standards define fair value, establish a framework for measuring fair value in generally accepted accounting principles and expand disclosures about fair value measurements. The standards do not require any new fair value measurements but may require some entities to change their measurement practices. We adopted these standards effective January 1, 2008 with respect to financial assets and liabilities and effective January 1, 2009 with respect to nonfinancial assets and liabilities. Adoption did not have a significant effect on our consolidated results of operations, financial position or cash flows.

Application guidance to address fair value measurements for purposes of lease classification or measurement in accounting for leases was issued in February 2008 by the FASB. This guidance removes certain leasing transactions from the scope of fair value accounting and adoption did not have a significant effect on our consolidated results of operations, financial position or cash flows.

Guidance for determining the fair value of a financial asset when the market for that asset is not active was issued by the FASB in October 2008. It clarifies the application of fair value measurements in a market that is not active and provides an example to illustrate key considerations in determining the fair value of a financial asset when the market for that financial asset is not active. This guidance was effective upon issuance, including prior periods for which financial statements had not been issued, and any revisions resulting from a change in the valuation technique or its

Index

Notes to Consolidated Financial Statements (Unaudited)

application were required to be accounted for as a change in accounting estimate. Application of this new guidance did not cause us to change our fair value valuation techniques for assets and liabilities.

The fair value disclosures are presented in Note 11.

An employer’s disclosures about plan assets of defined benefit pension or other postretirement plans were expanded in December 2008 by the FASB. Additional disclosures about investment policies and strategies, the reporting of fair value by asset category and other information about fair value measurements is required. This was effective January 1, 2009 and early application is permitted. Upon initial application, these new disclosures are not required for earlier periods that are presented for comparative purposes. We will expand disclosures in our Annual Report on Form 10-K for the year ending December 31, 2009; however, the adoption of this standard is not expected to have an impact on our consolidated results of operations, financial position or cash flows.

Not Yet Adopted

Measuring liabilities at fair value, a FASB accounting standards update, was issued in August 2009. This update provides clarification for circumstances in which a quoted price in an active market for the identical liability is not available. In such circumstances, an entity is required to measure fair value that uses (1) the quoted price of the identical liability when traded as an asset, or (2) quoted prices for similar liabilities or similar liabilities when traded as assets, or (3) another valuation technique consistent with the fair value measurement principles such as an income approach or a market approach. The new update for measuring liabilities at fair value is effective for the first reporting period (including interim periods) beginning after August 27, 2009 and is not expected to have a significant effect on our consolidated results of operations, financial position or cash flows.

Variable interest accounting standards were amended by the FASB in June 2009. The new accounting standards replace the existing quantitative-based risks and rewards calculation for determining which enterprise has a controlling financial interest in a variable interest entity with an approach focused on identifying which enterprise has the power to direct the activities of a variable interest entity. In addition, the concept of qualifying special-purpose entities has been eliminated and therefore, will now be evaluated for consolidation in accordance with the applicable consolidation guidance. Ongoing assessments of whether an enterprise is the primary beneficiary of a variable interest entity are also required. The amended variable interest accounting standard requires reconsideration for determining whether an entity is a variable interest entity when changes in facts and circumstances occur such that the holders of the equity investment at risk, as a group, lack the power from voting rights or similar rights to direct the activities of the entity. Enhanced disclosures are required for any enterprise that holds a variable interest in a variable interest entity. Application will be prospective beginning in the first quarter of 2010, and for all interim and annual periods thereafter. Earlier application is prohibited. We are currently evaluating the provisions of this statement.

In December 2008, the SEC announced that it had approved revisions to its oil and gas reporting disclosures. The new disclosure requirements include provisions that:

Introduce a new definition of oil and gas producing activities. This new definition allows companies to include volumes in their reserve base from unconventional resources. Such unconventional resources include bitumen extracted from oil sands and oil and gas extracted from coal beds and shale formations.

Report oil and gas reserves using an unweighted average price using the prior 12-month period, based on the closing prices on the first day of each month, rather than year-end prices.

Permit companies to disclose their probable and possible reserves on a voluntary basis. Under current rules, proved reserves are the only reserves allowed in the disclosures.

Require companies to provide additional disclosure regarding the aging of proved undeveloped reserves.

Permit the use of reliable technologies to determine proved reserves if those technologies have been demonstrated empirically to lead to reliable conclusions about reserves volumes.

Replace the existing "certainty" test for areas beyond one offsetting drilling unit from a productive well with a "reasonable certainty" test.

Require additional disclosures regarding the qualifications of the chief technical person who oversees the company's overall reserve estimation process. Additionally, disclosures regarding internal controls surrounding reserve estimation, as well as a report addressing the independence and qualifications of its reserves preparer or auditor will be mandatory.

Require separate disclosure of reserves in foreign countries if they represent more than 15 percent of total proved reserves, based on barrels of oil equivalents.

Index

Notes to Consolidated Financial Statements (Unaudited)

We expect to begin complying with the disclosure requirements in our Annual Report on Form 10-K for the year ending December 31, 2009. The new rules may not be applied to disclosures in quarterly reports prior to the first annual report in which the revised disclosures are required.

The FASB issued an exposure draft in September 2009 which aligns the FASB’s reporting requirements with the above SEC reporting requirements. The exposure draft also addresses the impact of changes in the SEC’s rules and definitions on accounting for oil and gas producing activities. Similar to the SEC requirements, the exposure draft requirements would be effective for periods ending on or after December 31, 2009. We are currently in the process of evaluating the new requirements by the SEC and awaiting the final standard from the FASB.

3. Income per Common Share

Basic income per share is based on the weighted average number of common shares outstanding, including securities exchangeable into common shares. Diluted income per share includes exercise of stock options, provided the effect is not antidilutive.

	Three Months Ended September 30,
	2009				2008
(In millions, except per share data)	Basic		Diluted		Basic		Diluted

Income from continuing operations	$	392	$	392	$	1,992	$	1,992
Discontinued operations		21		21		72		72
Net income	$	413	$	413	$	2,064	$	2,064

Weighted average common shares outstanding		709		709		707		707
Effect of dilutive securities		-		2		-		4
Weighted average common shares, including
dilutive effect		709		711		707		711

Per share:
Income from continuing operations	$	0.55	$	0.55	$	2.82	$	2.80
Discontinued operations	$	0.03	$	0.03	$	0.10	$	0.10
Net income	$	0.58	$	0.58	$	2.92	$	2.90

	Nine Months Ended September 30,
	2009					2008
(In millions, except per share data)	Basic		Diluted			Basic	Diluted

Income from continuing operations	$	985	$	985	$	3,433	$	3,433
Discontinued operations		123		123		136		136
Net income	$	1,108	$	1,108	$	3,569	$	3,569

Weighted average common shares outstanding		709		709		710		710
Effect of dilutive securities		-		2		-		4
Weighted average common shares, including
dilutive effect		709		711		710		714

Per share:
Income from continuing operations	$	1.39	$	1.39	$	4.84	$	4.81
Discontinued operations	$	0.17	$	0.17	$	0.19	$	0.19
Net income	$	1.56	$	1.56	$	5.03	$	5.00

The per share calculations above exclude 11 million stock options for the third quarter and 10 million stock options for the first nine months of 2009, as they were antidilutive. Excluded in the third quarter and the first nine months of 2008 were 6 million and 5 million stock options.

Index

Notes to Consolidated Financial Statements (Unaudited)

4. Dispositions

During 2009, we have disposed of our exploration and production businesses in Ireland and certain producing assets in the Permian Basin of New Mexico and Texas. At September 30, 2009, agreements are pending to dispose of our exploration and production business in Gabon and certain assets under development in Angola. These dispositions all relate to our Exploration and Production (“E&P”) segment. Our Irish and Gabonese exploration and production businesses have been reported as discontinued operations in the consolidated statements of income and the consolidated statements of cash flows for all periods presented. Assets and liabilities related to the Gabonese business are classified as held for sale in the consolidated balance sheet as of September 30, 2009.

Discontinued operations - Revenues and pretax income associated with our discontinued Irish and Gabonese operations are shown in the following table:

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
(In millions)	2009		2008		2009		2008
Revenues applicable to discontinued operations	$	65	$	144	$	188	$	342
Pretax income from discontinued operations	$	48	$	109	$	98	$	202

Net assets held for sale - As of September 30, 2009, assets and liabilities held for sale, which primarily represented our operated interests in Gabon, are shown in the following table:

(In millions)
Other current assets	$	10
Other noncurrent assets		46
Total assets		56

Other current liabilities		12
Deferred credits and other liabilities		17
Total liabilities		29
Net assets held for sale	$	27

Pending Gabon disposition - In August 2009, we entered into an agreement to sell our operated fields offshore Gabon for $282 million, excluding any purchase price adjustments at closing, with an effective date of January 1, 2009. We expect to close this transaction in the fourth quarter of 2009.

Pending Angola disposition - In July 2009, we entered into an agreement to sell an undivided 20 percent outside-operated interest in the Production Sharing Contract and Joint Operating Agreement in Block 32 offshore Angola for $1.3 billion, excluding any purchase price adjustments at closing, with an effective date of January 1, 2009. We will retain a 10 percent outside-operated interest in Block 32. As of September 30, 2009, the book value being sold was $481 million. We expect to close the transaction by year end 2009, subject to government and regulatory approvals.

Permian Basin disposition - In June 2009, we closed sales of a portion of our operated and all of our outside-operated Permian Basin producing assets in New Mexico and west Texas for net proceeds after closing adjustments of $293 million. A $196 million pretax gain on the sale was recorded.

Ireland dispositions - In April 2009, we closed the sale of our operated properties in Ireland for net proceeds of $84 million, after adjusting for cash held by the sold subsidiary. A $158 million pretax gain on the sale was recorded. As a result of this sale, we terminated our pension plan in Ireland, incurring a charge of $18 million.

In June 2009 we entered into an agreement to sell the subsidiary holding our 19 percent outside-operated interest in the Corrib natural gas development offshore Ireland. Total proceeds will range between $235 million and $400 million, subject to the timing of first commercial gas at Corrib and closing adjustments. The fair value of the consideration for this asset was $311 million, which was less than its book value. A $154 million impairment of the held for sale asset was recognized in discontinued operations in the second quarter of 2009 (see Note 11). At closing on July 30, 2009, the initial $100 million payment plus closing adjustments was received. Additional proceeds of $135 million to $300 million will be received on the earlier of first commercial gas or December 31, 2012.

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Notes to Consolidated Financial Statements (Unaudited)

Existing guarantees of our subsidiaries’ performance issued to Irish government entities will remain in place after the sales until the purchasers issue similar guarantees to replace them. The guarantees, related to asset retirement obligations and natural gas production levels, have been indemnified by the purchasers. Our maximum potential undiscounted payments under these guarantees are $160 million.

5. Segment Information

We have four reportable operating segments. Each of these segments is organized and managed based upon the nature of the products and services they offer.

Exploration and Production (“E&P”) – explores for, produces and markets liquid hydrocarbons and natural gas on a worldwide basis;

Oil Sands Mining (“OSM”) – mines, extracts and transports bitumen from oil sands deposits in Alberta, Canada, and upgrades the bitumen to produce and market synthetic crude oil and by-products;

Refining, Marketing and Transportation (“RM&T”) – refines, markets and transports crude oil and petroleum products, primarily in the Midwest, upper Great Plains, Gulf Coast and southeastern regions of the United States; and

Integrated Gas (“IG”) – markets and transports products manufactured from natural gas, such as liquefied natural gas (“LNG”) and methanol, on a worldwide basis, and is developing other projects to link stranded natural gas resources with key demand areas.

As discussed in Note 4, our Irish and Gabonese businesses have been reported as discontinued operations. Segment information for all presented periods excludes amounts for these operations.

	Three Months Ended September 30, 2009
(In millions)	E&P			OSM			RM&T			IG		Total

Revenues:
Customer	$	1,816		$	130		$	12,387		$	15	$	14,348
Intersegment (a)		148			37			8			-		193
Related parties		15			-			12			-		27
Segment revenues		1,979			167			12,407			15		14,568
Elimination of intersegment revenues		(148	)		(37	)		(8	)		-		(193	)
Loss on U.K. natural gas contracts(b)		(13	)		-			-			-		(13	)
Total revenues	$	1,818		$	130		$	12,399		$	15	$	14,362
Segment income	$	491		$	25		$	158		$	13	$	687
Income from equity method investments(c)		40			-			14			21		75
Depreciation, depletion and amortization (d)		427			26			167			1		621
Income tax provision (d)		297			7			119			12		435
Capital expenditures (e)		516			267			634			-		1,417

(a)	Management believes intersegment transactions were conducted under terms comparable to those with unrelated parties.

(b)	The U.K. natural gas contracts expired in September 2009.

(c)	Our investment in Pilot Travel Centers LLC, which was reported in our RM&T segment, was sold in the fourth quarter of 2008.

(d)	Differences between segment totals and our financial statement totals represent amounts related to corporate administrative activities and other unallocated items and are included in “Items not allocated to segments, net of income taxes” in reconciliation below.

(e)	Differences between segment totals and our financial statement totals represent amounts related to corporate administrative activities.

Index

Notes to Consolidated Financial Statements (Unaudited)

Index

	Three Months Ended September 30, 2008
(In millions)	E&P			OSM			RM&T			IG		Total

Revenues:
Customer	$	3,439		$	532		$	18,139		$	24	$	22,134
Intersegment (a)		278			68			1			-		347
Related parties		11			-			626			-		637
Segment revenues		3,728			600			18,766			24		23,118
Elimination of intersegment revenues		(278	)		(68	)		(1	)		-		(347	)
Gain on U.K. natural gas contracts(b)		198			-			-			-		198
Total revenues	$	3,648		$	532		$	18,765		$	24	$	22,969
Segment income	$	869		$	288		$	771		$	65	$	1,993
Income from equity method investments(c)		65			-			115			90		270
Depreciation, depletion and amortization (d)		389			37			148			1		575
Income tax provision(d)		947			98			464			34		1,543
Capital expenditures (e)		686			271			765			3		1,725

	Nine Months Ended September 30, 2009
(In millions)	E&P			OSM			RM&T			IG		Total

Revenues:
Customer	$	4,952		$	353		$	32,099		$	33	$	37,437
Intersegment (a)		390			91			25			-		506
Related parties		44			-			24			-		68
Segment revenues		5,386			444			32,148			33		38,011
Elimination of intersegment revenues		(390	)		(91	)		(25	)		-		(506	)
Gain on U.K. natural gas contracts(b)		72			-			-			-		72
Total revenues	$	5,068		$	353		$	32,123		$	33	$	37,577
Segment income	$	782		$	3		$	482		$	53	$	1,320
Income from equity method investments(c)		77			-			16			91		184
Depreciation, depletion and amortization (d)		1,391			97			476			3		1,967
Income tax provision (benefit)(d)		910			(1	)		329			27		1,265
Capital expenditures (e)		1,490			834			2,007			1		4,332

	Nine Months Ended September 30, 2008
(In millions)	E&P			OSM			RM&T			IG		Total

Revenues:
Customer	$	9,244		$	631		$	50,739		$	64	$	60,678
Intersegment (a)		663			184			203			-		1,050
Related parties		40			-			1,825			-		1,865
Segment revenues		9,947			815			52,767			64		63,593
Elimination of intersegment revenues		(663	)		(184	)		(203	)		-		(1,050	)
Loss on U.K. natural gas contracts(b)		(37	)		-			-			-		(37	)
Total revenues	$	9,247		$	631		$	52,564		$	64	$	62,506
Segment income	$	2,316		$	158		$	854		$	266	$	3,594
Income from equity method investments(c)		204			-			186			345		735
Depreciation, depletion and amortization (d)		933			104			446			3		1,486
Income tax provision (d)		2,459			53			527			118		3,157
Capital expenditures (e)		2,281			781			1,978			4		5,044

Index

Notes to Consolidated Financial Statements (Unaudited)

The following reconciles segment income to net income as reported in the consolidated statements of income:

	Three Months Ended							Nine Months Ended
	September 30,							September 30,
(In millions)	2009				2008			2009				2008
Segment income		$	687		$	1,993			$	1,320			$	3,594
Items not allocated to segments, net of income taxes:
Corporate and other unallocated items			(159	)		(178	)			(299	)			(253	)
Foreign currency remeasurement of taxes			(114	)		76				(180	)			111
Gain (loss) on U.K. natural gas contracts			(7	)		101				37				(19	)
Gain (loss) on disposal of assets			(15	)		-				107				-
Discontinued operations			21			72				123				136
Net income		$	413		$	2,064			$	1,108			$	3,569

The following reconciles total revenues to sales and other operating revenues (including consumer excise taxes) as reported in the consolidated statements of income:

	Three Months Ended					Nine Months Ended
	September 30,					September 30,
(In millions)	2009			2008		2009			2008
Total revenues		$	14,362	$	22,969		$	37,577		$	62,506
Less: Sales to related parties			27		637			68			1,865
Sales and other operating revenues (including
consumer excise taxes)		$	14,335	$	22,332		$	37,509		$	60,641

6. Defined Benefit Postretirement Plans

The following summarizes the components of net periodic benefit cost:

	Three Months Ended September 30,
	Pension Benefits						Other Benefits
(In millions)	2009			2008			2009			2008
Service cost	$	36		$	37		$	4		$	5
Interest cost		42			40			11			11
Expected return on plan assets		(41	)		(42	)		-			-
Amortization:
– prior service cost (credit)		4			3			(1	)		(2	)
– actuarial loss (gain)		8			8			(2	)		-
Net periodic benefit cost	$	49		$	46		$	12		$	14

	Nine Months Ended September 30,
	Pension Benefits				Other Benefits
(In millions)	2009		2008		2009		2008
Service cost	$	108	$	110	$	13	$	14
Interest cost		126		120		31		33
Expected return on plan assets		(121)		(126)		-		-
Amortization:
– prior service cost (credit)		11		10		(4)		(6)
– actuarial loss (gain)		24		23		(4)		1
– net settlement/curtailment loss(a)		18		-		-		-
Net periodic benefit cost	$	166	$	137	$	36	$	42

(a) The curtailment and settlement is related to our discontinued operations in Ireland, as discussed in Note 4. Pension expense relatedto Ireland was not material in any period presented.

Index

Notes to Consolidated Financial Statements (Unaudited)

During the first nine months of 2009, we made contributions of $326 million to our funded pension plans. We expect to make additional contributions up to an estimated $7 million to our funded pension plans over the remainder of 2009. Current benefit payments related to unfunded pension and other postretirement benefit plans were $11 million and $25 million during the first nine months of 2009.

7. Income Taxes

The following is an analysis of the effective income tax rates for the periods presented:

	Nine Months Ended September 30,
	2009			2008
Statutory U.S. income tax rate		35	%		35	%
Foreign taxes in excess of federal statutory rate		25			11
State and local income taxes, net of federal income tax effects		1			1
Other tax effects		-			(1	)
Effective income tax rate		61	%		46	%

The effective income tax rate is influenced by a variety of factors including the geographic and functional sources of income, the relative magnitude of these sources of income, and foreign currency remeasurement effects. The change in mix of liquid hydrocarbon and natural gas sales in 2009 from 2008 resulted in more income in jurisdictions with high tax rates. Beginning in the third quarter of 2009, we are crediting certain foreign taxes that were previously treated as deductible for U.S. tax purposes. We continue to assess the realizability of our deferred tax assets. Our assessments include estimates of our expected future taxable income and assumptions about matters that are dependent on future events. These future events include, but are not limited to, future operating and financial conditions. The 2009 effective tax rate increased due to a change in judgment about the realizability of a portion our deferred tax asset related to U.S. foreign tax credits generated during the year. These changes, as well as unfavorable foreign currency remeasurement effects, contributed to the increase in the effective income tax rate in the first nine months of 2009 as compared to the same period in 2008.

We are continuously undergoing examination of our U.S. federal income tax returns by the Internal Revenue Service. Such audits have been completed through the 2005 tax year. We believe adequate provision has been made for federal income taxes and interest which may become payable for years not yet settled. Further, we are routinely involved in U.S. state income tax audits and foreign jurisdiction tax audits. We believe all other audits will be resolved within the amounts paid and/or provided for these liabilities. As of September 30, 2009, our income tax returns remain subject to examination in the following major tax jurisdictions for the tax years indicated.

United States (a)	2001 - 2008
Canada	2000 - 2008
Equatorial Guinea	2006 - 2008
Libya	2006 - 2008
Norway	2007 - 2008
United Kingdom	2007 - 2008

(a)	Includes federal and state jurisdictions.

Index

Notes to Consolidated Financial Statements (Unaudited)

8. Comprehensive Income

The following sets forth comprehensive income for the periods indicated:

	Three Months Ended					Nine Months Ended
	September 30,					September 30,
(In millions)	2009		2008			2009		2008
Net income	$	413	$	2,064		$	1,108	$	3,569
Other comprehensive income, net of taxes:
Defined benefit postretirement plans		9		22			27		2
Derivatives		15		(12	)		11		(8	)
Other		-		(14	)		1		(19	)
Comprehensive income	$	437	$	2,060		$	1,147	$	3,544

9. Inventories

Inventories are carried at the lower of cost or market value. The cost of inventories of crude oil, refined products and merchandise is determined primarily under the last-in, first-out (“LIFO”) method.

	September 30,		December 31,
(In millions)	2009		2008
Liquid hydrocarbons, natural gas and bitumen	$	1,462	$	1,376
Refined products and merchandise		1,841		1,797
Supplies and sundry items		377		334
Inventories, at cost	$	3,680	$	3,507

10. Property, Plant and Equipment

Exploratory well costs capitalized greater than one year after completion of drilling were $371 million as of September 30, 2009, an increase of $317 million from December 31, 2008. Our Angola Block 32 exploration project is now in this category because exploratory drilling ceased in the third quarter of 2008. The $327 million of suspended costs for this project relate to 16 successful wells that have been drilled since 2002 in this license area. We plan to drill an additional exploration well in the fourth quarter of 2009. As discussed in Note 4, we have agreed to sell an undivided 20 percent outside-operated interest in this Angola Block 32.

In addition, an exploration well drilled for $20 million in early 2008 on the Southwest Foinaven prospect in the U.K. Atlantic Margin was added in the first quarter of 2009. It is being evaluated for combined development in conjunction with nearby prospects. For the North Sea Gudrun field, $24 million was removed since engineering and design efforts commenced on its development during the second quarter of 2009.

Index

Notes to Consolidated Financial Statements (Unaudited)

11. Fair Value Measurements

Fair Values - Recurring

The following table presents the assets (liabilities) accounted for at fair value on a recurring basis as of September 30, 2009 and December 31, 2008:

	September 30, 2009
(In millions)		Level 1		Level 2			Level 3			Total
Derivative Instruments:
Commodity		$	27	$	2		$	(5	)	$	24
Interest rate			-		-			3			3
Foreign currency			-		3			1			4
Total derivative instruments			27		5			(1	)		31
Other assets			2		-			-			2
Total at fair value		$	29	$	5		$	(1	)	$	33


	December 31, 2008
(In millions)		Level 1		Level 2			Level 3			Total
Derivative Instruments:
Commodity		$	107	$	6		$	(55	)	$	58
Interest rate			-		-			29			29
Foreign currency			-		(75	)		-			(75	)
Total derivative instruments			107		(69	)		(26	)		12
Other assets			2		-			-			2
Total at fair value		$	109	$	(69	)	$	(26	)	$	14

Deposits of $25 million and $121 million in broker accounts covered by master netting agreements are netted against the values to arrive at the fair values of commodity derivatives as of September 30, 2009 and December 31, 2008. Derivatives in Level 1 are exchange-traded contracts for crude oil, natural gas, refined products and ethanol measured at fair value with a market approach using the close-of-day settlement prices for the market. Derivatives in Level 2 are measured at fair value with a market approach using broker quotes or third-party pricing services, which have been corroborated with data from active markets. Level 3 derivatives are measured at fair value using either a market or income approach. Generally at least one input is unobservable, such as the use of an internally generated model or an external data source.

Commodity derivatives in Level 3 at September 30, 2009 include crude oil options related to sales of Canadian synthetic crude oil. The crude oil options, which expire December 2009, are measured at fair value using a Black-Scholes option pricing model, an income approach that utilizes prices from an active market and market volatility calculated by a third-party service. The two U.K. natural gas sales contracts accounted for as derivative instruments which were previously included in Level 3 expired in September 2009.

Also in Level 3 are commodity derivatives intended to manage price risk related to acquisition of ethanol for blending and light products fixed priced sales contracts. The fair value of these derivatives is measured using quoted market prices adjusted for broker market assessments.

The fair value of interest rate swaps is measured using broker quotes or quotes from a reporting service which are not corroborated with data from an active market; therefore these inputs are classified as Level 3. The fair value of the foreign currency options are measured using an option pricing model and Level 3 inputs.

The following is a reconciliation of the net beginning and ending balances recorded for derivative instruments classified as Level 3 in the fair value hierarchy for the three and nine months ended September 30, 2009:

Index

Notes to Consolidated Financial Statements (Unaudited)


(In millions)	Three Months Ended September 30, 2009
Beginning balance	$	(29	)
Total realized and unrealized losses:
Included in net income		19
Purchases, sales, issuances and settlements, net		9
Ending balance	$