form10q2009june30.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 June 30, 2009

OR

[   ]
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     X    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         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    X     
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    X     

 
There were 707,726,372 shares of Marathon Oil Corporation common stock outstanding as of July 31, 2009.
 
 



MARATHON OIL CORPORATION
 
Form 10-Q
 
Quarter Ended June 30, 2009


   
 
Page
PART I - FINANCIAL INFORMATION
Item 1.
Financial Statements:
  
 
 
 
 
Item 2.
Item 3.
Item 4.
 
PART II - OTHER INFORMATION
Item 1.
Item 1A.
Item 2.
Item 4.
Item 6.
 

 
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).

 


 
1

 
Part I - Financial Information
 
Item 1. Financial Statements

MARATHON OIL CORPORATION
Consolidated Statements of Income (Unaudited)
 
 

   
Three Months Ended
    
Six Months Ended
  
   
June 30,
    
June 30,
  
(In millions, except per share data)
  
2009
    
2008
    
2009
    
2008
  
Revenues and other income:
                        
                         
   Sales and other operating revenues (including
   $ 13,059     $ 21,203     $ 23,213     $ 38,404  
       consumer excise taxes)
                                
   Sales to related parties
     21       686       41       1,228  
   Income from equity method investments
     62       256       109       465  
   Net gain on disposal of assets
     191       12       195       22  
   Other income
     25       45       77       104  
                                 
             Total revenues and other income
     13,358       22,202       23,635       40,223  
Costs and expenses:
                                
   Cost of revenues (excludes items below)
     9,776       17,985       17,133       32,400  
   Purchases from related parties
     110       226       205       365  
   Consumer excise taxes
     1,226       1,295       2,400       2,511  
   Depreciation, depletion and amortization
     701       493       1,363       933  
   Selling, general and administrative expenses
     321       361       612       659  
   Other taxes
     97       127       199       250  
   Exploration expenses
     64       130       126       259  
                                 
            Total costs and expenses
     12,295       20,617       22,038       37,377  
                                 
Income from operations
     1,063       1,585       1,597       2,846  
                                 
   Net interest and other financing costs
     (11 )     (11 )     (28 )     (4 )
                                 
                                 
Income from continuing operations before income taxes
     1,052       1,574       1,569       2,842  
                                 
   Provision for income taxes
     711       806       962       1,357  
                                 
Income from continuing operations
     341       768       607       1,485  
                                 
Discontinued operations
     72       6       88       20  
                                 
Net income
   $ 413     $ 774     $ 695     $ 1,505  
                                 
Per Share Data
                                
                                 
   Basic:
                                
                                 
       Income from continuing operations
   $ 0.48     $ 1.08     $ 0.86     $ 2.09  
       Discontinued operations
   $ 0.10     $ 0.01     $ 0.12     $ 0.02  
       Net income per share
   $ 0.58     $ 1.09     $ 0.98     $ 2.11  
                                 
   Diluted:
                                
                                 
       Income from continuing operations
   $ 0.48     $ 1.07     $ 0.86     $ 2.07  
       Discontinued operations
   $ 0.10     $ 0.01     $ 0.12     $ 0.03  
       Net income per share
   $ 0.58     $ 1.08     $ 0.98     $ 2.10  
                                 
   Dividends paid
   $ 0.24     $ 0.24     $ 0.48     $ 0.48  
 
 
The accompanying notes are an integral part of these consolidated financial statements.


 


 
2

MARATHON OIL CORPORATION
Consolidated Balance Sheets (Unaudited)
 

   
June 30,
    
December 31,
  
(In millions, except per share data)
  
2009
    
2008
  
Assets
            
Current assets:
            
    Cash and cash equivalents
   $ 1,496     $ 1,285  
    Receivables, less allowance for doubtful accounts of $9 and $6
     3,857       3,094  
    Receivables from United States Steel
     24       23  
    Receivables from related parties
     48       33  
    Inventories
     3,498       3,507  
    Other current assets
     191       461  
                 
            Total current assets
     9,114       8,403  
                 
Equity method investments
     2,035       2,080  
Receivables from United States Steel
     457       469  
Property, plant and equipment, less accumulated depreciation,
                
   depletion and amortization of $16,394 and $15,581
     30,452       29,414  
Goodwill
     1,423       1,447  
Other noncurrent assets
     960       873  
                 
            Total assets
   $ 44,441     $ 42,686  
Liabilities
                
Current liabilities:
                
    Accounts payable
     5,513       4,712  
    Payables to related parties
     29       21  
    Payroll and benefits payable
     310       400  
    Accrued taxes
     499       1,133  
    Deferred income taxes
     615       561  
    Other current liabilities
     704       828  
    Long-term debt due within one year
     103       98  
                 
            Total current liabilities
     7,773       7,753  
                 
Long-term debt
     8,518       7,087  
Deferred income taxes
     3,312       3,330  
Defined benefit postretirement plan obligations
     1,636       1,609  
Asset retirement obligations
     982       963  
Payable to United States Steel
     4       4  
Deferred credits and other liabilities
     403       531  
                 
            Total liabilities
     22,628       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
     (2,713 )     (2,720 )
Additional paid-in capital
     6,721       6,696  
Retained earnings
     17,614       17,259  
Accumulated other comprehensive loss
     (578 )     (593 )
                 
            Total stockholders' equity
     21,813       21,409  
                 
            Total liabilities and stockholders' equity
   $ 44,441     $ 42,686  
 
 
The accompanying notes are an integral part of these consolidated financial statements.


 



 
3

MARATHON OIL CORPORATION
Consolidated Statements of Cash Flows (Unaudited)
 
 

   
Six Months Ended
  
   
June 30,
  
(In millions)
  
2009
    
2008
  
Increase (decrease) in cash and cash equivalents
            
Operating activities:
            
Net income
   $ 695     $ 1,505  
Adjustments to reconcile net income to net cash provided by operating activities:
                
    Income from discontinued operations
     (88 )     (20 )
    Deferred income taxes
     333       8  
    Depreciation, depletion and amortization
     1,363       933  
    Pension and other postretirement benefits, net
     73       75  
    Exploratory dry well costs and unproved property impairments
     33       114  
    Net gain on disposal of assets
     (195 )     (22 )
    Equity method investments, net
     11       (149 )
    Changes in the fair value of derivative instruments
     23       748  
    Changes in:
                
          Current receivables
     (785 )     (1,759 )
          Inventories
     6       (1,737 )
          Current accounts payable and accrued liabilities
     168       3,191  
    All other, net
     78       (49 )
               Net cash provided by continuing operations
     1,715       2,838  
               Net cash provided by discontinued operations
     35       117  
               Net cash provided by operating activities
     1,750       2,955  
Investing activities:
                
Capital expenditures
     (2,939 )     (3,329 )
Disposal of assets
     402       24  
Trusteed funds - withdrawals
     16       258  
Investing activities of discontinued operations
     (47 )     (53 )
All other, net
     (51 )     (58 )
               Net cash used in investing activities
     (2,619 )     (3,158 )
Financing activities:
                
Short term debt, net
     -       980  
Borrowings
     1,491       1,248  
Debt issuance costs
     (11 )     (7 )
Debt repayments
     (40 )     (1,331 )
Purchases of common stock
     -       (295 )
Dividends paid
     (340 )     (342 )
All other, net
     (1 )     13  
               Net cash provided by financing activities
     1,099       266  
Effect of exchange rate changes on cash:
                
     Continuing operations
     (17 )     6  
     Discontinued operations
     (2 )     2  
Net increase in cash and cash equivalents
     211       71  
Cash and cash equivalents at beginning of period
     1,285       1,199  
Cash and cash equivalents at end of period
   $ 1,496     $ 1,270  
 
 
The accompanying notes are an integral part of these consolidated financial statements.


 


 
4

 
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 August 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 six months ended June 30, 2009 are not necessarily indicative of the results to be expected for the full year.
 

2.      New Accounting Standards
 
SFAS No. 165 – In May 2009, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 165, “Subsequent Events.”  This statement establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or available to be issued.  SFAS No. 165 should not significantly change the subsequent events that an entity reports.  It codifies into the accounting standards guidance that existed in the auditing standards.  We began applying this standard prospectively in the second quarter of 2009.  The disclosures required by SFAS No. 165 appear in Note 1.
 
 
FSP FAS 107-1 – In April 2009, the FASB issued a Staff Position (“FSP”) FAS 107-1 and APB 28-1, “Interim Disclosures about Fair Value of Financial Instruments” (“FSP FAS 107-1”).  FSP FAS 107-1 amends SFAS No. 107 and Accounting Principles Board (“APB”) Opinion No. 28 to require disclosures about fair value of financial instruments in interim reporting periods for publicly traded companies.  Disclosures are expanded, making the annual disclosures of SFAS No. 107 required in interim periods.  This FSP is effective for the second quarter of 2009 and does 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 10.
 
 
FSP FAS 157-4 – Also in April 2009, the FASB issued FSP FAS 157-4, “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly,”.  FSP FAS 157-4 provides additional guidance for estimating fair value in accordance with SFAS No. 157 when the volume and level of activity for the asset or liability has significantly decreased.  It also includes guidance on identifying circumstances that indicate a transaction is not orderly.  FSP FAS 157-4 is effective for the second quarter of 2009 and does 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.
 
 
EITF 08-6 – In November 2008, the FASB ratified Emerging Issues Task Force (“EITF”) Issue 08-6, “Equity Method Investment Accounting Considerations” (“EITF 08-6”) which clarifies how to account for certain transactions involving equity method investments.  The initial measurement, decreases in value and changes in the level of ownership of the equity method investment are addressed.  EITF 08-6 is 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 this standard will be applied prospectively, adoption did not have a significant impact on our consolidated results of operations, financial position or cash flows.
 
 
FSP EITF 03-6-1 – In June 2008, the FASB issued FSP EITF 03-6-1, “Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities” which 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.  FSP EITF 03-6-1 is effective January 1, 2009 and all prior-period EPS data (including any amounts related to interim periods, summaries of earnings and selected financial data) will be adjusted retrospectively to conform to its provisions. While our restricted stock awards meet this definition of participating securities, the application of FSP EITF 03-6-1 did not have a significant impact on our reported EPS.
 
 
   FSP FAS 142-3 – In April 2008, the FASB issued FSP FAS 142-3, “Determination of the Useful Life of Intangible Assets” (“FSP FAS 142-3”), which amends the factors that should be considered in developing renewal or extension
 

 
5

Notes to Consolidated Financial Statements (Unaudited)

 
 
assumptions used to determine the useful life of a recognized intangible asset under SFAS No. 142, “Goodwill and Other Intangible Assets.” The intent of this FSP 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.   FSP FAS 142-3 is effective on January 1, 2009.  Early adoption is prohibited.  The provisions of FSP FAS 142-3 are to be applied prospectively to intangible assets acquired after the effective date, except for the disclosure requirements which must be applied prospectively to all intangible assets recognized as of, and subsequent to, the effective date.  Since this standard is applied prospectively, adoption did not have a significant impact on our consolidated results of operations, financial position or cash flows.
 
 
SFAS No. 161 – In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities – an amendment of FASB Statement No. 133.”  This statement expands the disclosure requirements for derivative instruments to provide information regarding (i) how and why an entity uses derivative instruments, (ii) how derivative instruments and related hedged items are accounted for under SFAS No. 133 and its related interpretations and (iii) how derivative instruments and related hedged items affect an entity’s financial position, financial performance and cash flows.  To meet these objectives, the statement requires 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.  This standard is effective January 1, 2009.  The statement encourages but does not require disclosures for earlier periods presented for comparative purposes at initial adoption.  The disclosures required by SFAS No. 161 appear in Note 11.
 
SFAS No. 141(R) – In December 2007, the FASB issued SFAS No. 141 (Revised 2007), “Business Combinations” (“SFAS No. 141(R)”).   This statement significantly changes the accounting for business combinations. Under SFAS No. 141(R), 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 statement expands the definition of a business and is expected to be applicable to more transactions than the previous standard on business combinations. The statement also changes 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 an FSP on FAS 141(R), “Accounting for Assets Acquired and Liabilities Assumed in a Business Combination That Arise from Contingencies”  (“FSP FAS 141(R)-1”), which addressed SFAS No. 141(R) implementation issues related to contingent assets and liabilities acquired in a business combination.  Both SFAS No. 141(R) and FSP FAS 141(R)-1 are effective on January 1, 2009 for all new business combinations.  Because we had no business combinations in progress at January 1, 2009, adoption of these standards did not have a significant impact on our consolidated results of operations, financial position or cash flows.
 
SFAS No. 160 – In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements - an amendment of ARB No. 51.”  This statement establishes new accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary.  Specifically, this statement clarifies 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.  SFAS No. 160 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, this statement requires that a parent 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 EITF Issue 08-10, “Selected Statement 160 Implementation Questions” (“EITF 08-10”).  Both SFAS No. 160 and EITF 08-10 are effective January 1, 2009.  The statements 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 of these standards did not have a significant impact on our consolidated results of operations, financial position or cash flows.
 
 
SFAS No. 157 – In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements.”  This statement defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements.  SFAS No. 157 does not require any new fair value measurements but may require some entities to change their measurement practices.  We adopted SFAS No. 157 effective January 1, 2008 with respect to financial assets and liabilities and effective January 1, 2009 with respect to nonfinancial assets and
 

 
6

 

Notes to Consolidated Financial Statements (Unaudited)
 
 
liabilities.  Adoption did not have a significant effect on our consolidated results of operations, financial position or cash flows.
 
 
In February 2008, the FASB issued FSP FAS 157-1, “Application of FASB Statement No. 157 to FASB Statement No. 13 and Other Accounting Pronouncements That Address Fair Value Measurements for Purposes of Lease Classification or Measurement under Statement 13,” which removes certain leasing transactions from the scope of SFAS No. 157, and FSP FAS 157-2, “Effective Date of FASB Statement No. 157,” which deferred the effective date of SFAS No. 157 for one year for certain nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis.
 
 
In October 2008, the FASB issued FSP FAS 157-3, “Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active,” which clarifies the application of SFAS No. 157 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.  FSP FAS 157-3 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 application were required to be accounted for as a change in accounting estimate.  Application of FSP FAS 157-3 did not cause us to change our valuation techniques for assets and liabilities measured under SFAS No. 157.
 
 
The additional disclosures regarding assets and liabilities recorded at fair value and measured under SFAS No. 157 are presented in Note 10.
 
 
FSP FASB 132(R)-1 – In December 2008, the FASB issued FSP FAS 132(R)-1, “Employers’ Disclosures about Postretirement Benefit Plan Assets” (“FSP FAS 132(R)-1”) which provides guidance on an employer’s disclosures about plan assets of defined benefit pension or other postretirement plans.  This FSP requires additional disclosures about investment policies and strategies, the reporting of fair value by asset category and other information about fair value measurements.  The FSP is effective January 1, 2009 and early application is permitted.  Upon initial application, the provisions of FSP FAS 132(R)-1 are not required for earlier periods that are presented for comparative purposes.  We will expand our disclosures in accordance with FSP FAS 132(R)-1 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.
 

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 June 30,
  
 
2009
    
2008
  
(In millions, except per share data)
Basic
  
Diluted
    
Basic
  
Diluted
  
           
Income from continuing operations
   $ 341     $ 341     $ 768     $ 768  
Discontinued operations
     72       72       6       6  
Net income
   $ 413     $ 413     $ 774     $ 774  
           
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
   $ 0.48     $ 0.48     $ 1.08     $ 1.07  
    Discontinued operations
   $ 0.10     $ 0.10     $ 0.01     $ 0.01  
    Net income
   $ 0.58     $ 0.58     $ 1.09     $ 1.08  


 
7

 

Notes to Consolidated Financial Statements (Unaudited)
 
 
 
 
Six Months Ended June 30,
  
 
2009
    
2008
  
(In millions, except per share data)
Basic
  
Diluted
    
Basic
  
Diluted
  
           
Income from continuing operations
   $ 607     $ 607     $ 1,485     $ 1,485  
Discontinued operations
     88       88       20       20  
Net income
   $ 695     $ 695     $ 1,505     $ 1,505  
           
Weighted average common shares outstanding
     709       709       711       711  
Effect of dilutive securities
     -       2       -       5  
Weighted average common shares, including
                                
     dilutive effect
     709       711       711       716  
           
Per share:
                                
    Income from continuing operations
   $ 0.86     $ 0.86     $ 2.09     $ 2.07  
    Discontinued operations
   $ 0.12     $ 0.12     $ 0.02     $ 0.03  
    Net income
   $ 0.98     $ 0.98     $ 2.11     $ 2.10  
 
The per share calculations above exclude 8 million stock options for the second quarter and the first six months of 2009 and 6 million stock options for the second quarter and the first six months of 2008, as they were antidilutive.
 

4.      Dispositions
 
Ireland disposition - 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.  Activities related to our operated properties in Ireland had been reported in our Exploration and Production (“E&P”) segment.
 
 
On June 24, 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.  Activities related to the Corrib development also had been reported in our E&P segment.  Total proceeds will range between $235 million and $400 million, subject to the timing of first commercial gas at Corrib and closing adjustments.   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.  The fair value of the consideration for this asset was $311 million which was less than its book value.  An impairment of $154 million was recognized in the second quarter of 2009 in discontinued operations.  Additional gains or losses may be recognized until the final proceeds payment is received (see Note 10).
 
 
As a result of these dispositions, our Irish 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.  The net loss on the sales reported in discontinued operations for 2009 was $14 million before income taxes.  Revenues and pretax income associated with the operations are shown in the following table:
 
   
Three Months Ended
    
Six Months Ended
  
   
June 30,
    
June 30,
  
(In millions)
  
2009
    
2008
    
2009
    
2008
  
Revenues applicable to discontinued operations
   $ 4     $ 23     $ 83     $ 102  
Pretax income (loss) from discontinued operations
   $ (2 )   $ 10     $ 33     $ 40  

 
Existing guarantees of our subsidiaries’ performance issued to Irish government entities will remain in place after the sales until the purchaser issues similar guarantees to replace them.  The guarantees, related to asset retirement obligations and natural gas production levels, have been indemnified by the purchaser.  Our maximum potential undiscounted payments under these guarantees were $155 million as of June 30, 2009.
 
 
Permian Basin disposition - In June 2009, we closed the 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
 

 
8

 

Notes to Consolidated Financial Statements (Unaudited)
 
 
$292 million.  A $199 million pretax gain on the sale was recorded.  Activities related to these assets also had been reported in our E&P segment.
 
 
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.  The carrying value of the 20 percent interest at June 30, 2009 was $430 million which will be classified as held for sale beginning August 1, 2009.  We expect to close the transaction by year end 2009, subject to government and regulatory approvals.  Activities related to these assets are being reported in our E&P segment.
 
 
Assets held for sale - As of June 30, 2009, assets held for sale primarily represented our outside-operated interest in the Corrib development in Ireland as shown in the following table:
 

(In millions)
      
Other current assets
   $ 1  
Other noncurrent assets
     373  
     Total assets
     374  
         
Other current liabilities
     52  
Deferred credits and other liabilities
     9  
     Total liabilities
     61  
          Net assets held for sale
   $ 313  

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.
 
 
 
1)
Exploration and Production (“E&P”) – explores for, produces and markets liquid hydrocarbons and natural gas on a worldwide basis;
 
 
 
2)
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;
 
 
 
3)
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
 
 
 
4)
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 businesses have been reported as discontinued operations. Segment information for all presented periods excludes amounts for these operations.

 
9

 
Notes to Consolidated Financial Statements (Unaudited)

 
 
 

 
 
Three Months Ended June 30, 2009
  
(In millions)
  
E&P
    
OSM
    
RM&T
    
IG
    
Total
  
                               
Revenues:
                              
    Customer
  $ 1,871     $ 126     $ 11,052     $ 7     $ 13,056  
    Intersegment (a)
     123       29       8       -       160  
    Related parties
    14       -       7       -       21  
        Segment revenues
    2,008       155       11,067       7       13,237  
    Elimination of intersegment revenues
     (123 )     (29 )     (8 )     -       (160 )
    Gain on U.K. natural gas contracts
     3       -       -       -       3  
        Total revenues
  $ 1,888     $ 126     $ 11,059     $ 7     $ 13,080  
Segment income
   $ 220     $ 2     $ 165     $ 13     $ 400  
Income from equity method investments(b)
     26       -       8       28       62  
Depreciation, depletion and amortization (c)
     502       34       157       1       694  
Income tax provision (c)
     444       -       104       2       550  
Capital expenditures (d)
     617       281       713       1       1,612  
     
 
Three Months Ended June 30, 2008
  
(In millions)
  
E&P
    
OSM
    
RM&T
    
IG
    
Total
  
                                         
Revenues:
                                        
    Customer
  $ 3,160     $ (80 )   $ 18,267     $ 21     $ 21,368  
    Intersegment (a)
     226       96       37       -       359  
    Related parties
    15       -       671       -       686  
        Segment revenues
    3,401       16       18,975       21       22,413  
    Elimination of intersegment revenues
     (226 )     (96 )     (37 )     -       (359 )
    Loss on U.K. natural gas contracts
     (165 )     -       -       -       (165 )
        Total revenues
  $ 3,010     $ (80 )   $ 18,938     $ 21     $ 21,889  
Segment income (loss)
   $ 822     $ (157 )   $ 158     $ 102     $ 925  
Income from equity method investments(b)
     77       -       43       136       256  
Depreciation, depletion and amortization (c)
     300       33       150       1       484  
Income tax provision (benefit)(c)
     851       (54 )     108       36       941  
Capital expenditures (d)
     839       262       702       -       1,803  
     
 
Six Months Ended June 30, 2009
  
(In millions)
  
E&P
    
OSM
    
RM&T
    
IG
    
Total
  
                                         
Revenues:
                                        
    Customer
  $ 3,175     $ 223     $ 19,712     $ 18     $ 23,128  
    Intersegment (a)
     242       54       17       -       313  
    Related parties
    29       -       12       -       41  
        Segment revenues
    3,446       277       19,741       18       23,482  
    Elimination of intersegment revenues
     (242 )     (54 )     (17 )     -       (313 )
    Gain on U.K. natural gas contracts
     85       -       -       -       85  
        Total revenues
  $ 3,289     $ 223     $ 19,724     $ 18     $ 23,254  
Segment income (loss)
   $ 305     $ (22 )   $ 324     $ 40     $ 647  
Income from equity method investments(b)
     37       -       2       70       109  
Depreciation, depletion and amortization (c)
     969       71       309       2       1,351  
Income tax provision (benefit)(c)
     616       (8 )     210       15       833  
Capital expenditures (d)
     990       567       1,373       1       2,931  


 
10

 

Notes to Consolidated Financial Statements (Unaudited)
 
 


   
Six Months Ended June 30, 2008
  
(In millions)
  
E&P
    
OSM
    
RM&T
    
IG
    
Total
  
                               
Revenues:
                              
    Customer
  $ 5,900     $ 99     $ 32,600     $ 40     $ 38,639  
    Intersegment (a)
     385       116       202       -       703  
    Related parties
    29       -       1,199       -       1,228  
        Segment revenues
    6,314       215       34,001       40       40,570  
    Elimination of intersegment revenues
     (385 )     (116 )     (202 )     -       (703 )
    Loss on U.K. natural gas contracts
     (235 )     -       -       -       (235 )
        Total revenues
  $ 5,694     $ 99     $ 33,799     $ 40     $ 39,632  
Segment income (loss)
   $ 1,494     $ (130 )   $ 83     $ 201     $ 1,648  
Income from equity method investments(b)
     139       -       71       255       465  
Depreciation, depletion and amortization (c)
     548       67       298       2       915  
Income tax provision (benefit)(c)
     1,521       (45 )     63       84       1,623  
Capital expenditures (d)
     1,596       510       1,213       1       3,320  
 
(a)
Management believes intersegment transactions were conducted under terms comparable to those with unrelated parties.
 
(b)
Pilot Travel Centers LLC, which was reported in our RM&T segment, was sold in the fourth quarter of 2008.
 
 (c)
Differences between segment totals and our 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.
 
 (d)
Differences between segment totals and our totals represent amounts related to corporate administrative activities.


The following reconciles segment income to net income as reported in the consolidated statements of income:
  
                         
 
Three Months Ended
  
Six Months Ended
  
 
June 30,
  
June 30,
  
(In millions)
2009
    
2008
  
2009
  
2008
  
Segment income
   $ 400     $ 925     $ 647     $ 1,648  
Items not allocated to segments, net of income taxes:
                                
     Corporate and other unallocated items
     (89 )     (57 )     (140 )     (78 )
     Foreign currency remeasurement of deferred taxes
     (94 )     (16 )     (66 )     35  
     Gain (loss) on U.K. natural gas contracts
     2       (84 )     44       (120 )
     Gain on dispositions
     122       -       122       -  
     Discontinued operations
     72       6       88       20  
          Net income
  $ 413     $ 774     $ 695     $ 1,505  

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
  
Six Months Ended
  
 
June 30,
  
June 30,
  
(In millions)
2009
    
2008
  
2009
  
2008
  
Total revenues
   $ 13,080     $ 21,889     $ 23,254     $ 39,632  
Less:  Sales to related parties
     21       686       41       1,228  
Sales and other operating revenues (including
                                
       consumer excise taxes)
   $ 13,059     $ 21,203     $ 23,213     $ 38,404  


 
11

 
Notes to Consolidated Financial Statements (Unaudited)

 
 
 
6.      Defined Benefit Postretirement Plans
 
The following summarizes the components of net periodic benefit cost:
 

 
Three Months Ended June 30,
  
 
Pension Benefits
  
Other Benefits
  
(In millions)
2009
  
2008
  
2009
  
2008
  
Service cost
   $ 37     $ 39     $ 4     $ 4  
Interest cost
     42       41       9       10  
Expected return on plan assets
     (40 )     (42 )     -       -  
Amortization:
                                
    – prior service cost (credit)
     4       4       (2 )     -  
    – actuarial loss (gain)
     10       11       (2 )     (2 )
    – net settlement/curtailment loss(a)
     18       -       -       -  
Net periodic benefit cost
   $ 71     $ 53     $ 9     $ 12  
                                 
 
Six Months Ended June 30,
  
 
Pension Benefits
  
Other Benefits
  
(In millions)
2009
  
2008
  
2009
  
2008
  
Service cost
   $ 72     $ 73     $ 9     $ 9  
Interest cost
     84       80       20       22  
Expected return on plan assets
     (80 )     (84 )     -       -  
Amortization:
                                
    – prior service cost (credit)
     7       7       (3 )     (4 )
    – actuarial loss (gain)
     16       15       (2 )     1  
    – net settlement/curtailment loss(a)
     18       -       -       -  
Net periodic benefit cost
   $ 117     $ 91     $ 24     $ 28  
 
 
(a)   The curtailment and settlement is related to our discontinued operations in Ireland, as discussed in Note 4.  Pension expense related to Ireland was not material in any period presented.

 
During the first six months of 2009, we made contributions of $40 million to our funded pension plans.  We expect to make additional contributions up to an estimated $290 million to our funded pension plans over the remainder of 2009, the majority of which will occur in the third quarter of 2009.  We are still evaluating guidance issued by the Internal Revenue Service on March 31, 2009, which may cause actual contributions to differ from our estimate.  Current benefit payments related to unfunded pension and other postretirement benefit plans were $8 million and $16 million during the first six months of 2009.
 

 
12

 
Notes to Consolidated Financial Statements (Unaudited)

 
 
 
7.      Income Taxes
 
The following is an analysis of the effective income tax rates for the periods presented:
 
   
Six Months Ended June 30,
  
   
2009
    
2008
  
Statutory U.S. income tax rate
     35 %     35 %
Foreign taxes in excess of federal statutory rate
     25       14  
State and local income taxes, net of federal income tax effects
     1       1  
Other tax effects
     -       (2 )
        Effective income tax rate
     61 %     48 %
 
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 included more sales in jurisdictions with high tax rates.  This change, as well as unfavorable foreign currency remeasurement effects, contributed to the increase in the effective income tax rate in the first six months of 2009 when 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 June 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 - 2007
Canada
2000 - 2008
Equatorial Guinea
2006 - 2008
Libya
2006 - 2008
Norway
2007 - 2008
United Kingdom
2007 
 
(a)
Includes federal and state jurisdictions.

 
8.      Comprehensive Income
 
 
The following sets forth comprehensive income for the periods indicated:
 

   
Three Months Ended
    
Six Months Ended
  
   
June 30,
    
June 30,
  
(In millions)
  
2009
    
2008
    
2009
    
2008
  
Net income
  $ 413     $ 774     $ 695     $ 1,505  
Other comprehensive income, net of taxes:
                                
     Defined benefit postretirement plans
    19       (31 )     18       (20 )
     Derivatives
     26       1       (4 )     4  
     Other
     -       -       1       (5 )
Comprehensive income
  $ 458     $ 744     $ 710     $ 1,484  


 
13

 
Notes to Consolidated Financial Statements (Unaudited)

 
 
 
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.
 

   
June 30,
    
December 31,
  
(In millions)
  
2009
    
2008
  
Liquid hydrocarbons, natural gas and bitumen
   $ 1,122     $ 1,376  
Refined products and merchandise
     1,935       1,797  
Supplies and sundry items
     441       334  
        Total, at cost
   $ 3,498     $ 3,507  

10.           Fair Value Measurements
 
Fair Values - Recurring
 
 
The following table presents the assets (liabilities) accounted for at fair value on a recurring basis as of June 30, 2009, and December 31, 2008:
 

 
June 30, 2009
  
(In millions)
  
Level 1
    
Level 2
    
Level 3
    
Total
  
     Derivative Instruments:
                        
          Commodity
   $ 18     $ 1     $ (6 )   $ 13  
          Interest rate
     -       -       (23 )     (23 )
          Foreign currency
     -       (22 )     -       (22 )
               Total derivative instruments
     18       (21 )     (29 )     (32 )
      Other assets
     2       -       -       2  
               Total at fair value
   $ 20     $ (21 )   $ (29 )   $ (30 )
                                 
                                 
 
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 $17 million in broker accounts covered by master netting agreements are netted against the value to arrive at the fair values of commodity derivatives.  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 June 30, 2009 include two U.K. natural gas sales contracts that are accounted for as derivative instruments and crude oil options related to sales of Canadian synthetic crude oil.  The fair value of the U.K. natural gas contracts is measured with an income approach by applying the difference between the contract price
 

 
14

 
Notes to Consolidated Financial Statements (Unaudited)

 
 
 
and the U.K. forward natural gas strip price to the expected sales volumes for the remaining contract term.  These contracts originated in the early 1990s and expire in September 2009.  The contract prices are reset annually in October based on the previous twelve-month changes in a basket of energy and other indices.  Consequently, the prices under these contracts do not track forward natural gas prices.  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.
 
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 to data from an active market; therefore these inputs are classified as Level 3.

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 six months ended June 30, 2009:

   
Three Months Ended
  
(In millions)
  
June 30, 2009
  
Beginning balance
   $ 9  
     Total realized and unrealized losses:
        
          Included in net income
     (33 )
     Purchases, sales, issuances and settlements, net
     (5 )
Ending balance
   $ (29 )
         
   
Six Months Ended
  
(In millions)
  
June 30, 2009
  
Beginning balance
   $ (26 )
     Total realized and unrealized losses:
        
          Included in net income
     44  
     Purchases, sales, issuances and settlements, net
     (47 )
Ending balance
   $ (29 )

Net income for the second quarter and first six months of 2009 included unrealized losses of $4 million and unrealized gains of $76 million, respectively, related to instruments held at June 30, 2009.  Amounts reported in net income are classified as sales and other operating revenues or cost of revenues for commodity derivative instruments, as net interest and other financing income for interest rate derivative instruments and as cost of revenues for foreign currency derivatives, except those designated as hedges of future capital expenditures.  
 

 
Fair Values - Nonrecurring
 
 
The following table shows the June 30, 2009 values of assets measured at fair value on a nonrecurring basis during the second quarter of 2009 by major category:
 

   
June 30, 2009
        
(In millions)
  
Total
    
Level 1
    
Level 2
    
Level 3
    
Impairment
  
                               
Long-lived assets held for sale
   $ 311     $ -     $ -     $ 311     $ 154  
Long-lived assets held for use
     5       -       -       5       15  


 
15

 
Notes to Consolidated Financial Statements (Unaudited)

 
 
 
 
The impairment charge related to the sale of the Corrib natural gas development offshore Ireland was based on a fair value assessment of the anticipated sale proceeds (see Note 4).  At closing on July 30, 2009, the initial $100 million payment was received.  Additional proceeds of $135 million to $300 million will be received on the earlier of first commercial gas or December 31, 2012.  These proceeds were classified as Level 3 inputs because a portion is variable in timing and amount depending upon timing of first gas. The Level 3 inputs were valued using an income method that incorporated a probability-weighted approach with respect to timing of first commercial gas and an associated sliding scale on the amount of corresponding consideration specified in the sales agreement:  the longer it takes to achieve first gas, the lower the amount of the consideration.  The minimum amount due of $135 million is payable no later than December 31, 2012.
 
 
The ultimate timing of the gain or loss recognized related to the sale of the Corrib development will depend on the resolution by accounting standard-setters of the appropriate accounting for contingent consideration.  The EITF is currently deliberating the appropriate accounting treatment for contingent consideration by sellers.  In connection with that deliberation, the EITF has asked the FASB staff for interpretative guidance on the initial recognition of contingent consideration by sellers.   The timing of any further gain or loss recognition will depend on the resolution reached by the FASB staff and the EITF and may or may not require a reassessment of the fair value of the contingent consideration each reporting period.
 
 
Several long-lived assets held for use were evaluated for impairment in the second quarter of 2009 due to reductions in estimated reserves and declining natural gas prices.  An impairment was required on one natural gas field in East Texas. Fair value of the asset was measured using an income approach based upon internal estimates of future production levels, prices and discount rate, which are Level 3 inputs.
 

 
Fair Values - Reported
 
 
The following table summarizes financial instruments, excluding the derivative financial instruments, and their reported fair value by individual balance sheet line item at June 30, 2009 and December 31, 2008:
 

                         
   
June 30, 2009
    
December 31, 2008
  
   
Fair
    
Carrying
    
Fair
    
Carrying
  
(In millions)
  
Value
    
Amount
    
Value
    
Amount
  
Financial assets
                        
     Receivables from United States Steel, including current portion
   $ 470     $ 481     $ 438     $ 492  
     Other noncurrent assets(a)
     405       217       286       113  
                                 
          Total financial assets  
     875       698       724       605